Financial Well-Being: Blending Financial Concepts with Personal Health
As the former Chief Benefits Officer at the University of Kentucky, I had the opportunity to guest lecture to soon-to-be-graduates on Total Compensation. The lecture was designed to give students an understanding of the components of pay (annual salary, shift differentials, overtime, etc.) and benefits (retirement, health, disability, etc.) as well as personal finance. With the competing factors of rising tuition and student debt putting pressure on saving for retirement post-graduation, it is increasingly important to encourage students to balance their participation in these programs. Below, we take a look at some of the concepts we shared:
The Rule of 72 and the Power of Compounding
One significant financial concept for graduates to understand is the “Rule of 72,” which illustrates how long it takes for a sum of money to double. To calculate the Rule of 72, divide 72 by the expected investment rate of return to get the number of years it will take for the amount to double. For example, under the rule of 72, $20,000 with an 8% annual return will grow to approximately $40,000 in nine years, if no additional contributions are added to the initial investment.
The Rule of 72 is often used to demonstrate how much money an employee could have if they begin to participate in their company’s retirement plan at an early age, instead of waiting until later. Exhibit 1 illustrates how a recent graduate who begins saving at age 22 can have double the amount of a colleague who waits until age 31 to begin saving. Since actual retirement illustrations are based on a variety of factors such as annual contributions, salary growth and earnings, we will illustrate the Rule of 72 by investing $5,000 one time. Employee A makes a one-time investment at age 22, while Employee B waits until age 31 to invest, assuming an interest rate of 8%.
As Exhibit 1 illustrates, by waiting to invest, Employee B has missed out on one cycle of compounding. That one missed compounding cycle costs Employee B far more than $5,000 over the course of a career. The Rule of 72 and the concept of compounding are significant to financial well-being and workplace retirement plans since, in today’s volatile markets, many investment professionals believe a 5% or 6% investment return is to be expected over the next decade. However, this single-digit return can still render significant earnings over time when an individual invests early in their career.
The Importance of Longevity
Since we know that time is on the side of our recent graduates, it is important to note that employees need to plan on working well into their mid-60’s to allow their retirement accounts time to grow to provide ample income for retirement.
For example, an employee with an accumulation of $500,000 at age 55 could have $1,000,000 at age 67 (assuming a 6% return). These additional working years make a significant impact on the individual’s retirement income. Under the 4% rule, where an investor takes 4% of their accumulation annually, retirement income would be $20,000 at age 55 ($500,000 x 4%= $20,000). At age 67, retirement income would be $40,000 ($1M x 4%= $40,000). The 4% rule assumes an employee’s investment balance will support these withdrawals over an extended period of time (e.g., 25, 30 years). Taking retirement income at age 55 not only reduces the likelihood of the savings making it through retirement, but also provides significantly less income than waiting until age 67. Additionally, waiting until age 67 allows the participant to receive the Social Security benefit without penalty as well.
How does an individual make it to age 67 without tapping their retirement account? Physical and mental health comes into play. Taking care of oneself during their working career allows individuals to work longer and continue contributing to their retirement savings longer, as well. Lifestyle choices that are made in one’s 30’s and 40’s impact long-term health, which directly affects an individual’s ability to continue working and earning income in their 50’s and 60’s. So, when considering a long-term investment strategy, individuals should add another factor to the equation: the “smart play” of personal health and longevity. By remaining employed until age 65, individuals have better health insurance options, since Medicare becomes available and Medigap supplements are more affordable than pre-65 health premiums that are not subsidized by an employer. Even if the “pre-retirement job” does not have a 401(k), contributions can be made to an IRA or the money earned can be used to pay living expenses, while the retirement funds remain untouched and continue to grow.
Manage Your Money or it will Manage You
Managing money means not taking on too much debt and paying it off in a reasonable amount of time. Asset-backed debt, such as a home mortgage or car loans, is often necessary, but should be kept under control (i.e., “don’t bite off more than you can chew”). As individuals prepare to retire, paying off debt becomes a key strategy. An employee with no home mortgage at age 55 is more likely to earn enough money to cover living expenses without accessing retirement funds than someone who continues to carry a mortgage.
Our students were engaged and eager to learn how to plan for their long-term financial goals. Many pointed out how technology can assist in making savings and budgeting easier, and I often heard students say, “There’s an App for that!” While technology can certainly help to make savings and goal planning easier, embracing these financial concepts and lifestyle choices at an early age helps to embed them into one’s way of life.
Those well beyond their college graduations can also benefit from a reminder of these concepts, as financial and personal well-being are important topics for everyone.
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. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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