According to a recent survey conducted by GoBankingRates, 56% of Americans have less than $10,000 saved for retirement. We face many obstacles in saving for retirement, including student debt, credit card debt, low wages, and high housing costs, so it’s no surprise that most Americans struggle with the idea of a smaller paycheck today in exchange for greater comfort decades from now.
The good news is you don’t necessarily need to make big sacrifices to boost your retirement. Contributing pre-tax dollars to your 401(k) through your paycheck can help you steadily build up your retirement account and the hit to your paycheck may be lower than you expect.
Here’s how it works: Let’s say you’re in the 25% tax bracket (single filer with taxable income between $37,651 and $91,150). Every $10 you contribute to your 401(k) will only reduce your paycheck by $7.50, not $10, because the contribution is pre-tax.
When you opt to receive that $10 in pay, it will cost you $2.50 in income tax at this tax rate. When you divert the money to your 401(k), you won’t have an immediate tax bill. Instead you pay taxes on the money when you withdraw it during retirement.
The higher your tax bracket, the smaller the impact on your paycheck! If you’re in the 35% tax bracket, for example, the $10 contribution will only cost $6.50 to your paycheck. Income that’s subject to local and state taxes further reduces your out-of-pocket cost for contributing to retirement.
Along with avoiding taxes today, you can also take advantage of matching contributions from your employer. If your employer offers a dollar-for-dollar match, the $10 contribution may cost you $7.50 or less from your paycheck but your 401(k) balance will grow by $20!
As noted by VTA Publications CEO Jim Hunt through his Twitter page, there can be other surprising tax benefits of retirement contributions. Sometimes adding more to your 401(k) will reduce your adjusted gross income (AGI) enough to qualify for tax breaks like the tax credit for retirement savings. For 2016, the Saver’s Credit is available for single filers with an AGI of up to $30,750 and couples filing jointly with an AGI of up to $61,500. If you get your AGI low enough to qualify, the Saver’s Credit allows you to save twice by giving you a credit of up to 50% of your contribution! That’s worth up to $4,000 — all for putting aside a little extra money every payday.
You can talk with your company’s payroll department to find out exactly how your paycheck will be impacted by increasing your contributions and use an online calculate to estimate the effect.
Don’t underestimate just how important it is to get an early start on saving: if you’re 30 years old and put aside $5,000 a year for the next 35 years and earn 8%, your account will be worth $861,500 when you retire at 65. Delaying your savings for just 1 year will cost you $68,450! Saving even 1% of your pay is a lot easier than you may think and it will add up significantly over time.