Part 1: The Cost of Waiting a Year

January 15, 2019

Part 1 of “Financial Follies: Common Retirement-Planning Mistakes and How to Avoid Them,” a recurring series about the best savings “levers” to pull depending on where you are in your career and your life.

If you’re just starting your career, you probably don’t make a lot of money…and yet, you still have many needs to finance. After years of postponing your personal desires—such as traveling or finally upgrading that car you’ve had since college—you probably have many wants, too.

Trying to balance needs and wants with a limited budget makes for stressful financial decisions. Compounding the issue: It’s hard to estimate what the future costs of those decisions will be. Should you spend your hard-earned money on clothes, travel, paying down student loans—or, waaay down the list of desirables, starting to save for retirement? What can you do right now that will have the biggest benefit later?

Retirement planners will tell you to start saving early and to begin making steady contributions to your retirement plan ASAP. Sure, that’s easy if you don’t have other things to spend your money on. Besides, at the beginning of your career you’re making  a pettily small amount compared to what you will make in the future. Surely, waiting until you’re raking in the big bucks will make the biggest bump in your final amount (right?!). What difference does a few dollars now make compared to what you can toss in later?

To answer that question, let’s look at what would happen to a representative saver.

Brenda started her career in 1984 at age 30. While it might not seem like that much by today’s standards, with a salary of $22,438, Brenda was actually earning the median household income of the day. The economy was tough, unemployment was high, and Brenda was concerned about her future. It was a struggle, but between her retirement contribution and her employer’s match, she was able to put 10% of her salary into her retirement plan. Not being the savviest of investors, Brenda chose to go with the “plain vanilla” equity fund, and stuck with it throughout her career.

Brenda had a great life and a wonderful family, but her personal income never really soared; she earned right around the median household income throughout her career. After 35 years of working, she felt it was time to consider retirement.

Brenda is now 65 years old and the year is 2017. Maybe 2018 will be the year she finally hangs it up and does what she wants to do. How did her retirement savings plan work out? After contributing 10% of her paycheck each year and earning the market return, Brenda’s savings grew to $876,306. Financial planners use an assumption that you can spend 4% of your savings per year and still have that money last you though your retirement. That would yield Brenda $35,052 per year to spend on herself. To put this in perspective, that’s 57% of her final salary coming from her personal retirement plan. Add to that her company or PERA retirement plan and any Social Security earned, and it looks like Brenda should have a very comfortable retirement.

Now for a counter example.

Let’s look at Brenda’s twin brother, Billy. Back in 1984, Billy had a few financial distractions and decided to postpone his retirement plan contributions until the following year. After all, what difference could a single year make? And what does it matter, anyway—his current salary was peanuts compared to what he would be earning in the future.

So, Billy opted not to make any contributions in 1984, but got with the program in 1985. He earned the same amount as Brenda (hypothetical scenario, people!), and made the same 10% contribution to the equity fund. Everything was the same, except that Billy missed the initial contribution of $2,244 in his first year of saving.

The cost of Billy’s waiting that one year was huge. When he checked his retirement account at the end of 2017, he had just $796,753$79,553 less than his twin sister even though they had the same investments. While Brenda was able to replace 57% of her final salary, Billy was only able to replace 40% of his.

That year of procrastination ended up costing Billy greatly. By skipping that initial $2,244 contribution in 1984, Billy ended up having $3,182 less to spend than his sister—not just for a single year, but for every year for the rest of their lives. So, while Brenda will be jet-setting on an annual vacation, Billy will be making other arrangements and wondering what might have been…

The moral of the story? Don’t be like Billy. Start saving for retirement as early as you can.