Everyone knows that they should be saving at least 10% of their gross income for retirement, but that can seem like an impossible goal after paying all your bills. However, don't just figure that you can't come close to saving 10% of your income without looking at the after-tax cost.
For instance, assume you earn $50,000 annually and your employer matches 50 cents for every dollar you contribute to the 401(k) plan, up to 6% of your pay. So, if you put 6% of your pay, or $3,000, in the plan, your employer will match 3%, or $1,500. Your contribution really costs less than 6%, because the money is taken out before income taxes. If you are in the 25% tax bracket, your $3,000 contribution will save $750 in taxes, or 1.5% of your pay. So, between your contribution and your employer's match, you will contribute 9% of your pay toward retirement, but it will only cost you 4.5% of your pay.
What if you don't have a 401(k) plan at work? Take a look at individual retirement accounts (IRAs). While you won't get an employer match, you can contribute to a deductible IRA, if eligible, and contribute pre-tax dollars, which reduces your contribution's cost by your marginal income tax rate. In 2007, you can contribute a maximum of $4,000 to an IRA, and individuals over age 50 can make an additional $1,000 catch-up contribution. So, if you are in the 25% tax bracket and make a $4,000 contribution, you will save $1,000 in income taxes. Or, you may prefer to contribute to a Roth IRA. While you won't get a current income tax deduction for your contribution, you can make qualified distributions free from federal income taxes.
Don't just assume that you don't have the funds to save for retirement, without taking a look at the after-tax cost. Please call if you'd like help with this analysis.