Examples: Cutting Deposits to Your Retirement Savings Comes At a Price

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We all know that we should be saving for our retirement. Even in the best of times, however, it takes effort to diligently put away 5%, 10%, or even 20% of your income into tax-advantaged vehicles such as 401Ks or IRAs. The economic downturn that started in 2008 has put millions of people out of jobs.

a road sign saying to retirement 401k invest wisely

Even more are underemployed -- they are working fewer hours than they'd like, or they are bypassing high-paying but less secure positions. Retirement savings is one of the first casualties of unemployment or other instances of lower earnings. After all, retirement is not an immediate concern when compared to paying the rent or mortgage, buying groceries, getting medication, or repaying credit card debt.

But because every dollar that you save can grow multiple times its original value through years of compounding interest, the lack of savings during lean years has repercussions down the road.

Let's say that 28-year-old Jane Smith formerly stashed $200 a month into her retirement account. Because she lost her job, however, she suspended her retirement savings for two years. The value of her forgone contributions is $4,800 ($200 x 24 months). If she were to have continued her contributions, the $4,800 in contributions would have grown to $36,893 after 35 years, at a reasonable 6% annual interest rate [see calculator]. True, you can't retire on $37,000, but it is still a not-insignificant sum of money. Now, if Jane Smith formerly contributed $500 a month, and had to forgo that contribution for two years, her $12,000 ($500 x 24 months) in contributions would have yielded $92,233 when Jane turns 65.*

Even more damaging, however, may be the recession impact on young people who are unable to begin retirement contributions. Every dollar that a 22-year-old saves will be more valuable than the same dollar that a 42-year-old saves, because the 22-year-old would have more time for that dollar to grow.

A 25-year-old who saves $3,000 a year for five years will have $17,000 by the time she is 30. If she allows that money to continue to grow, even with no future contributions, she will have $130,600 by the time she is 65 at 6% interest rate. Now THAT is a nice chunk of change.

With young people's unemployment rate at a record high, however, it is an ordeal just to get a job with a 401K, or to make enough money to move out from Mom and Dad's, much less start putting money away. But if the economic downturn has forced you to scale back on retirement contributions, don't despair. The important thing to do is to save what you can, while you can. Instead of completely eliminate your 401K contributions, cut back so you at least get the full company match. If you don't have a 401K at your job, or if you lack both a company match and adequate investment choices, look into a Roth IRA. Even some freelancing assignments or a part-time job can bring enough money to put a little away for retirement.

Recent college graduates with financially comfortable parents can raise the topic of retirement funds as a gift. For example, instead of giving a netbook or a smartphone for Christmas, parents can give $200 for Junior to put into his or her Roth IRA instead. Even $5 or $10 here and there make a difference.

*Please note that I have assumed the entire two years of contributions will begin compounding at the same time.

 

Savvy Living Through Personal Finance

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