Retirement 101: A Rubric for Independence

IN THIS ARTICLE

• Start Early
• Save to the Match
• Increase Savings
• Invest for Growth
• Don't Cash Out
• Consider Roth Contributions
• Consider a High Deductible Health Plan
• Avoid Early Withdrawals
• Take a Long-Term View
  
  

January is the star when it comes to new year's resolutions: New Year, New You. But September to me is the second new year. It’s been decades since I’ve been a student and my kids are grown, so I no longer follow the academic calendar, but every September, I can’t shake the feeling that I'm about to embark on a new year. The fall still feels like the last push to get everything I wanted to accomplish this year done by year-end.

September asks: how are you doing? It’s not just a feeling either. Fall is when most companies conduct their annual enrollment, locking in benefits changes ahead of the new year. That makes it a good time to review your retirement plan, too. Having spent my career in the 401(k) industry, I always recommend a retirement checkup during annual enrollment season, and here's a rubric for success.

1. Start Early, but Know It’s Never Too Late

The younger you start, the more time your money has to potential to grow, and time is the one variable no amount of saving later can fully replace. A 25-year-old who saves modestly for a decade and then stops can still end up ahead of a 35-year-old who saves aggressively for the next thirty years, simply because the earlier dollars have more time to compound. If you're older, it's never too late, because starting now is still better than starting later.

2. Save to the Match

If your company offers a matching contribution, it's important to save enough to take advantage of it. If your company matches 4%, try to also save 4%, for a total of 8%. Saving less than 4% means you wouldn't get the full company match, and you'd be leaving free money on the table. It's part of your overall compensation, and if you don't take advantage of it, it's gone.

Over a forty-year career, that 4% match in the hypothetical example below accumulates to $120K of employer money plus the associated compounding growth. In this case, where you contributed 4% and your employer contributed 4% half of the compounding or half of the $485K is due to the match. So by not saving up to the match in this illustrative example you’d be leaving the $120K of employer contributions on the table plus the $242,500 of compounding on that money.

Saving to the 4% Match

$75,000 salary, 4% employee plus 4% company match (dollar for dollar), 5% return, Age 25 to 65

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

3. Increase Savings Toward 15%

Aim to save a total of 15% inclusive of company match. If you can't swing 15% now, start with saving to the match and then try increasing by 1% a year until you reach 15%. Often it can help to increase by 1% when you receive a pay increase or cost of living adjustment, so you don't feel the impact as much in your paycheck. As the chart below illustrates, the difference between saving to the match and saving a total of 15% is significant over time. In this scenario you’d contribute an extra $210k ($330K - $120K) over the course of your career but end up with $1.36M versus $725K. You’d amass an extra $635K, by contributing $210K more.

Saving 15% Total

$75,000 salary, 11% employee plus 4% company match (dollar for dollar), 5% return, Age 25 to 65

4. Invest for Growth

When you're young, time is on your side, so it's important to invest for long-term growth. If you invest too conservatively, you might not outpace inflation. If you don't have the skill, will, or time to choose and manage your investments, consider a target date fund or managed account. A target date fund focuses on growth when you're younger and gradually shifts to a more conservative mix as you get closer to retirement. In a managed account, your investment mix is managed for you, often with guidance from a financial professional or advisory service.

5. Don't Cash Out Your 401(k) When You Change Jobs

When you change employers, it can be tempting to cash out your 401(k), but doing so may trigger income tax and a 10% early-withdrawal penalty. You would also lose the future growth those assets could have generated. In most cases, you have other options that keep your money invested for the long term: leave it in your former employer's plan if the balance is large enough, roll it into your new employer's plan, or move it to an IRA. Any one of those choices keeps your money working for you.

6. Consider Roth 401(k) Contributions

With traditional pre-tax 401(k) contributions, you get a tax break now and pay taxes on withdrawals in retirement. With a Roth 401(k), you contribute after-tax dollars now, but qualified withdrawals in retirement, including all the compounding growth, come out tax-free. Roth 401(k) assets are no longer subject to required minimum distributions (RMDs), which makes them more flexible for long-term planning. The decision between Roth and pre-tax doesn't have to be one or the other, it can be both, which gives you greater long-term flexibility.

7. Consider a High Deductible Health Plan (HDHP) with a Health Savings Account (HSA)

HSAs offer a triple tax advantage that's hard to find anywhere else: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are also tax-free. Unlike a flexible spending account, which is “use it or lose it”, you get to keep any HSA funds you don't use, and they can be invested. So whatever you don't spend on healthcare now can be invested and potentially grow for decades. Those assets can become a dedicated pool of tax-free money for medical expenses in retirement, which, for most people, end up being one of the largest costs they face later in life.

8. Avoid Early Withdrawals

Pulling money out of your 401(k) before age 59½ typically triggers a 10% penalty on top of ordinary state and federal income tax. This is a costly combination that can undo years of careful saving in a single transaction.

9. Take a Long-Term View

One of the benefits of contributing to your 401(k) every paycheck is that you're investing a fixed amount at regular intervals, no matter what the market is doing that week. That means you buy more shares when prices dip and fewer when they're expensive. The cost per share smooths out over time, without you having to time anything. That's dollar-cost averaging, and in a 401(k), it happens automatically when you keep contributing. And if you keep the money invested over time, those small weekly or bi-weekly contributions can add up to a significant sum.

What makes this rubric powerful is that following these steps consistently, year after year, can lead to long-term growth. It works the same way showing up for class every day eventually adds up to an education. The chart above shows what that consistency looks like in dollar terms — small, steady contributions, given enough time, growing into something significant.

Want to find out if you’re on track? A financial advisor can help you look at your specific situation and build a plan around it. If you're not ready for that conversation yet, most retirement plan providers offer free online tools that can estimate whether you're on track. Either way, September is a great time to check your own progress report and adjust before the new year begins.