As a professor of accounting practice, one of the most wonderful experiences I have is sending our accounting graduates off each year to start great jobs in great firms. Because we are accountants, the subject of money invariably comes up while discussing career plans. Since most of our accounting students begin their careers in New York City, there is a little sticker shock on how to effectively budget expenses – managing money for living, commuting and even eating. Then when I throw in the idea of how important it is that they start saving some tax-free money in their 401K plan, I have clearly lost them.
For them, the rationale is simple: unlike my parents, I am never going to retire, so why should I save in a retirement plan? But there are multiple appealing answers to this question, so let’s see if we can find one that works.
First of all, you would be reducing your tax burden. Most plans defer your income into the plan, thus making it tax deferred. That means that if you are in a 25% tax bracket, every $1,000 you contribute would only cost you $750.
Secondly, most plans offer an employee match. So, if you are contributing $1,000, your employer would offer some type of match that could range anywhere from 5% to 100% of your contributions. That match, like the amount you deferred, is nontaxable to you.
Finally, time is on your side. Let’s say that you are going to defer $1,000 per month from your salary and your employer has a 50% match. That would be $1,500 per month per year or $18,000 per year. If you invested this money in a simple index fund, chances are pretty good that you would average an 8% growth rate compounded each year. Untouched, that means you would accumulate $267,408. After 20 years of contributing the same level, you would have $823,714! The best part: all of this has been earned tax-free and contributed to by both your employer and the government.
You would be in your early 40s, and if nothing else, it would give you the capital you need to have all the options on your side. Times when previous generations saw firemen and policemen retire with big pension guarantees and then go on to start a second career would be no more. If you wanted to change careers, start a business of your own or take some time off, you would have the capital to pursue it. Or, you can use this capital to simply fund your nest egg. The choice is yours – so long as you start saving in this millennium.
What can go wrong? Well, like anything in life, things change. The market may not earn 8%, even though it has historically done so. You may not be able to earn enough to put $18,000 a year away. Finally, your employer may not have a matching benefit. Would all of that mean you shouldn’t bother? The opposite is true. Everyone’s situation is going to be different, but the facts still remain — this is the most effective and efficient way to save money. What you want to accomplish is to experience that fact, so that you are doing something. The tax advantages still exist and at the end of the year you have something tangible to show for your hard work, and a platform on which to build. Saving is habit forming, and small results lead to big efforts. Try it. You’ll like it.
William Walsh is a professor accounting practice and director of the Joseph I. Lubin School of Accounting at the Martin J. Whitman School of Management at Syracuse University. A member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants, Walsh teaches a number of accounting and entrepreneurship courses. He holds an MBA from the Whitman School.
