You can’t overestimate how important a small change, over a large period of time will make when it comes to planning for retirement. Putting away additional money now if you have a long time until retirement can have a huge impact on what you have to work with once you get there.
So what’s the change?
The trick here is that whatever you are putting away for retirement right now, increase your contribution by 1% each year. You can do it around the same time of year. If you are saving into a company plan like a 401(k) or a 403(b) your plan provider might even have this as an automatic option. If you set this for the time of year you have your review and a potential pay raise there is a good chance you won't even miss it.
Tell me more!
So let's tell a story. You just got your first adult job, right? You're in the workforce. You're making money and you're starting to put money away for retirement. You say to yourself, because who doesn’t talk to themselves “I know I need to put away money, but I'm not sure how much I can afford. I'm going to start out relatively small.” Let’s say you start out by putting away 6% of your pay. Let’s say you make $60,000 a year and the company will give you a match. They're going to give you another 3% from the match. So you’re off to a really good start. You’re putting away 9% of your pay per year. But you shouldn't stop there and I'll explain why. If you put away 9% per year into your retirement account, making $60,000 a year and you do that for 30 years, with a reasonable historic rate of return (8.5% per year in this case), you're going to retire with around $750,000 in your retirement account. Certainly not bad. But well, if we're talking about 30 years from now, $750,000 is not going to buy what it will today. So you recognize that you’ve got to do better. How can you do better and still manage to, you know, be able to buy groceries and gas and, and go to a restaurant every now and then?
Well, if you'll bump up that amount by 1% per year, with all of the other information the same it drastically changes your numbers. Let’s try it. You still make $60,000 a year. You put away 6%. They put away 3%. But then for the first 10 years of your work career you bump your contribution 1% each year. You go from six to seven, seven to eight, eight to nine. So on and so on. Do that for 10 years and then cap it off. Then just keep saving at the level that you're currently saving.
And the pay off is (Drumroll)..........
If you do that with the same returns over the same timeframe, same 30 years, instead of retiring with $750,000, you're going to retire with around $1.4 million in your retirement account. Not quite double, but pretty close. All you did was add 1% per year at the time that you get your pay raise for 10 years and then just let it be on auto for the next 20 years of your work career. That’s a little change, a small amount. You won't miss 1%, but it will make a huge difference. Future you loves this idea and wants you to do it immediately. And here’s a pro tip: It's much more likely that you will succeed in doing this than in saying, well, I'm just going to put away 15 or 16% from the start. If you're that disciplined and you can do that and stick to it, God bless you and do it right? Because again, future, you loves that. But if you need to find a way to make it happen without taking such a big bite all at once, do it with the annual step-up, you'll never see it coming, you probably won't miss it, and in the future, you'll be thankful that you did.