A quick thought on retirement savings accounts and expenses
Just a quick run through some numbers to get you thinking about another reason you should try to reduce your expenses and save for retirement.
Suppose you had $400 in monthly debt payments, and your tax rate was 20%. You would have to earn $500 a month before taxes to make a $400 debt payment. So once that debt is paid off, you can now contribute $500 a month to a pretax retirement account such as a 401k or IRA and still maintain the same budget you had when you were making the debt payments. So now not only are you not paying interest on your debt, but you can now save an extra $100 a month not paying the tax man. That works out to an additional $1200 a year that you can keep to yourself on top of the $4800 saved from not making debt payments.
Now of course if your tax rate is higher you will save even more money by paying off debt and investing in a tax advantaged account. If your effective tax rate is 30%, you will need to make about $572 to make $400 after tax. [$572 * 0.70 = $400.40]
Pay off that debt and you will have $6864 that you could contribute to a retirement account. With that retirement account growing at 9% a year tax free, you will have over $1 million in about 30 years. Start doing this at 30 and you can be a millionaire by the time you’re 60. And thanks to the miracle of compound interest, you will have $2 million in another 8 years at 9% interest. All because you reduced your expense $400 a month. Pretty cool, huh?
Stay tuned as I start a series on retirement accounts and investment decisions. And as always please fee free to leave a comment with any questions, or email me at rich@freefrommoney.net
