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The Importance of Retirement Investing Over Saving for Older Employees

You‘ve heard the same message from many people, including myself:  due to the time-value of money, the earlier you start saving for retirement, the better off you will be when you retire.  When building retirement wealth, the critical factor is the age at which you commence retirement savings.

In fact, investments matter very little when you are just starting, since investment returns represents a negligible portion of your retirement savings.  Think about it, if you have a $10,000 account balance, and saving $3,000 a year, that savings amount currently represents a 30% “return” on your money.  If you have a very good year with a return of 10%, your investment return will be just north of $1,000 ($1,000, plus the prorated return of the $3,000 you contributed).  So where you invest when you are starting out is not all that important.

However, for older employees, the priorities switch rather dramatically.  Let’s say I am a mid-to-late career employee who has a $1 million account balance.  While $1 million may sound like a lot, in terms of retirement, it only provides about $40,000 in income a year (assuming the standard 4% withdrawal rate which experts say will prevent you from outliving your savings).  

If my $1 million has a modest annual return rate of 5%, I will earn $50,000 on it in the coming year.  That greatly exceeds the maximum annual amount of $24,000 (presuming I am over age 50) that I can save in my 401(k)/403(b).  In addition, due to the time-value of money, that $24,000 maximum contribution has less time to compound, and becomes an even smaller portion of my $1 million+ account balance in future years.  At this point, therefore, how I invest becomes far more critical than how much I save.

Now, this certainly does not mean that I am advocating for people nearing retirement to stop saving. Many mid-to-late career employees have not saved nearly enough for retirement, and for these employees, every savings dollar counts!  However, many of us assign great importance to retirement plan investing, which is likely misplaced for someone early in their career.  But for individuals with larger account balances, investments become increasingly significant as the difference in, say, a 5% return and a 6% return, begins to matter.  Younger participants give themselves a substantial “guaranteed” return in the form of retirement savings—which is not so for older participants.

Retirement plan sponsors (and those who work with them) should consider these factors when planning participant communication.  To those participants with smaller account balances, are you communicating the importance of saving early and often, rather than investments (which they need not be hung-up on)?  And, for employees with larger balances, are you getting the message across that proper investment allocation is absolutely critical, indeed far more so than savings rate? If not, you should consider customizing your communication in this fashion.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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