Hands off the 401(k)
“One day Harold heard about a brand-new retirement plan that would allow him to set aside up to half of his income—then about $30,000 a year—in a tax-free account. When he told his wife, she panicked. ‘Harold, that’s insane. We can’t afford to raise three kids on $15,000 a year.’ Harold’s response? ‘Shirley, we can’t afford not to.’ Harold won the argument. Today the couple, both now in their eighties, are happily living off that retirement savings.”
It started with a conversation.
Harold and Shirley are my parents. They grew up during the 1930s, in the grip of the Great Depression. In those days, money to spend was scarce, let alone money to save. That’s why this story—how one late-1960s money talk ensured my parents’ peace of mind in retirement—continues to amaze me. After rising to relative middle-class comfort, with three kids and a house in Queens, my educator dad and homemaker mom saw an opportunity, discussed it, and together decided to live within a much tighter budget. (My mom, with her triple coupon days and bulk buying, really made the most of what they had.) They did it because they understood that saving as much as possible, as early as possible, meant there would be a healthy nest egg waiting for them decades later.
The benefits didn’t end there. Their souped-up savings plan allowed my parents (and us kids) to experience the virtues of living on less. Harold and Shirley never felt deprived because they knew that every payday sacrifice meant a retirement that much more worry-free. What’s more, it meant that once we grew up, we wouldn’t need to support our parents in their old age.
“If you don’t start saving in a tax-favored retirement account while you’re young, you’ll miss out on perhaps the best investment opportunity of your life.”
The “brand-new retirement plan” that grabbed my dad’s attention in the late 1960s was a predecessor of today’s 401(k). No one had to tell him how special this opportunity was. Harold had come of age and formed his money values during the Great Depression. He knew that he couldn’t afford to miss out on the chance for tax-free compounding to get to work on the family’s savings. And because my dad was the original maker of money geniuses, he made sure to explain it all to his kids. It’s no coincidence that you’ll find this sentence in my other book, Get a Financial Life: “If you don’t start saving in a tax-favored retirement account while you’re young, you’ll miss out on perhaps the best investment opportunity of your life.”
Which is why the news coming out of Capitol Hill is so troubling. In a week that’s already been bad for consumers, Congress is threatening to handcuff retirement savers, too. They’re weighing proposals to slash the amount you can contribute tax-free to a 401(k) from $18,500 a year to $2,400. This would be a disaster for middle-class Americans. But whatever Congress settles on, it won’t undermine the principle that my dad understood so well, and that all young people should adopt: Save early, as much as you can.
To explain why starting early pays, consider these two different two scenarios: A 20-year-old puts $5,000 a year into her 401(k). At 30, she stops. That means she invested for just 10 years—from age 20 to 30—and then never invested a dime again. The money just sat in the account earning interest. In the other scenario, a 30-year-old also puts $5,000 a year into her 401(k) for 10 years—from age 30 to 40—then stops. Who will have more money at age 65, when retirement looms? Assuming a growth rate of 7%, the 30-year-old saver would have $400,000 at age 65. But the winner is the 20-year-old saver, and by a huge margin. Her savings would have grown to nearly double that: $800,000.
The reason: starting early allowed the miracle of compound interest to work its magic. The vehicle: the miraculous 401(k). The inspiration: life-changing money conversations like the one my dad had with my mom.