Financial Thoughts – Employer Retirement Plans

In a previous post, I discussed several suggestions on how to maximize your savings and target your money so that it is used most efficiently. I want to focus a post on each of these suggestions individually, and today I will start with the employer retirement plans.

Many employers offer retirement plans, and of those, many offer matching amounts. What this means is that your employer will match a certain amount of what you put in to your retirement account. This is a tremendous advantage for you because it allows you to double your retirement savings up to the employer match amount. And, contributions to these retirement accounts are tax deductible. We throw that phrase around frequently, so I want to give a very practical example to illustrate what the real dollar impact would be.

Let's say that someone makes an annual salary of $35,000. According to the IRS tax schedules for 2006/2007, the estimated tax would be around $5,850 (before any deductions, just taking that gross number). If you were to save 5% of your income, the taxes that you owe would be reduced to $5,325, a $525 savings. Now, while you saved $1,750 in order to meet that savings (5% of $35,000), what this means practically is that you were only out of pocket $1,225 (which is about $100/month); the remaining amount was met through the money you saved in the taxes you owe ($1,225 contributed by you plus the $525 tax savings amount).

Now, if your employer matches up to 4% of your contributions, then there would be an additional $1,400 contributed to your account. This will result in a balance of $3,150 at the end of the year. The amount your employer contributed is not subject to tax (until retirement). Now, if we assume an 8% growth rate over a period of 30 years with a yearly investment of this amount (more than likely it will grow as your income increases), this account will grow to $356,842.12. This ended up costing you 30 payments of $1,225 (because of the tax savings), or only $36,750 over that period of 30 years. That is 10 times what you have put in! If one was to skip out on the employer matching by not investing in the employer retirement account (and investing separately), the $1,750 would only result in $198,245.62 at the end of 30 years (over $158,000 less!).

As shown above, the employer retirement account is usually not sufficient for retirement, but it can contribute to it. It is a great way to set aside some money for your retirement, have some or that entire amount matched by your employer, and receive a tax deduction for doing so. I would encourage you at a minimum to consider investing at least the amount your employer matches, if they do. I certainly don't want to turn down $158,000!

I am not familiar enough with the teacher retirement plans of Texas (or other states) to post any suggestions on those, but I suspect that there is some benefit to contributing something to those plans as well -- it would not surprise me if the state matched a certain contribution amount as well.

As always, if you are confused or need assistance, please see a financial advisor to discuss what is best for you. The suggestions I offer here are not backed by any certification or background in financial management; these are just things I have learned over the last few years of my own savings.