The Cost of Procrastination

A month or so ago I was referred to a young anesthesiologist who is in dire need of establishing some sort of financial plan. After meeting with him briefly, I quickly discovered that other than a $300,000 mortgage on a home whose current market value was not substantially more than that, he can hardly rub two nickels together.

Between repaying his school loans which total almost $125,000, a monthly mortgage payment of more than $2,200 (without taxes and insurance), two automobile payments, and starting a family, now more than ever, he needs to start thinking about funding his retirement. At present, about the only thing he does have going in his favor is the fact that, because he is 35 years old, he has ample time on his side before retirement.

At the hospital where he is currently employed, he is eligible to participate in the hospital’s 401(k) retirement program and can make annual employee contributions up to $17,000. To date his has not participated in the program because he says he is not familiar with the mechanics of the hospital’s retirement program and its benefits.

At this point I suggested that he needed to start disciplining himself to participate in such a program for the expressed purpose of sheltering some of his income from current taxation and begin building a retirement nest egg. Because he has saved nothing for retirement thus far, it is critical that he start doing so as soon as possible. So the question becomes, how do you convince someone who has been in school nearly his whole life that he needs to begin saving money for an event that is 25 years hence (i.e., retirement) when he has just begun his career and retirement is the furthest thing from his mind?

The only way I could think to explain the rationale was to illustrate how much it is going to cost him each year he procrastinates in starting a retirement program and the advantages he foregoes by not taking advantage of a current tax deduction.

Let us assume that Dr. Smith has just turned 35 and would like to be in the financial position to retire when he turns 61 in 26 years. Let us further assume that he decides to participate in the 401(k) program at his place of employment and begins making monthly contributions into such a plan which averages a 7% annualized rate of return on a tax-deferred basis. We will assume that he has the option of investing in equity and fixed-income-based investments within the plan, which should enable him to achieve that 7% annualized tax-deferred rate of return over the foreseeable future. In addition, we will make the assumption that his $17,000 annual contribution will be indexed for inflation annually by a 2.5% annual cost of living adjustment. Additionally I will assume that his employer, the hospital, makes no contributions on his behalf.

First of all, assuming that Dr. Smith is in a 30% income tax bracket, he will currently save (or defer) approximately $5,100, or .30 x $17,000, annually in income taxes. Therefore, participating in such a program is really only costing him net $11,900 annually, not $17,000. If he didn’t participate in the program and took the $17,000 as salary, he would have to pay additional yearly taxes of $5,100 on the income he did not contribute to the plan, which would only leave him $11,900 in after-tax dollars!

Secondly, because all monies grow tax-deferred, there will be no current taxation on earnings or on capital appreciation until such time as he begins withdrawing an income at retirement (after age 59-and-a-half or beyond). Under the above assumptions it is projected that he will have accumulated almost $1,668,000, which, assuming that he lives 25 years beyond retirement and his outstanding balance continues to earn 7% annually on a tax-deferred basis, this will produce an annual income stream of approximately $9,200 monthly adjusted for inflation through age 85.

However, if he procrastinate and does not begin this program for another five years (until he reaches age 40) he will only have accumulated approximately $1,230,000 at retirement. In other words, waiting five years will cost him nearly $438,000 in additional savings at retirement and reduce his monthly income retirement stream from $9,200 to $6,800 monthly or nearly $990,000 over a 25-year retirement time horizon!

Please refer to the following:

Let’s think about the above for a second. Dr. Smith foregoes nearly $1 million in retirement income, which would have cost him only about $90,000 to fund in pre-retirement contributions over a five-year period! Can you think of a worse business decision? I can’t!!!

Also, I might mention that these so-called qualified retirement plans offer not only tax-deferral on current income but also creditor protection — the best of both worlds in today’s economic environment.

Additionally, these retirement programs go by different designations depending on the type of institution you work for. For instance, in Dr. Smith’s case, because he is employed by a for-profit institution, the plan designation is a 401(k). If his employer was a not-for-profit hospital he would be given the opportunity to participate in a 403(b) retirement program. There are also institutions such as the Veteran’s Administration and a few other government-run agencies that allow you to participate in a 457 retirement program.

In either case, the rules are similar. You can elect to defer for tax purposes $17,000 annually from your income if under age 50. Once you attain age 50 there is a catchup provision that allows you to defer an additional $5,500 annually. In future years these amounts will be indexed for inflation allowing for higher annual contributions. Also, some employers offer matching dollars for participating in such a program!

The bottom line is that regardless of your income, you cannot afford to not participate in such a program, and if you do, begin participating the day you become eligible to do such at your place of employment!

Please keep in mind that the above numbers are estimates based on certain assumptions and are to be used for illustrative purposes only!

Thomas R. Kosky is a principal of the Asset Planning Group, Inc., in Coral Gables, Fla. The company specializes in investment, retirement and estate planning. In addition, Tom has also taught graduate level corporate finance in the Executive & Health Care Executive MBA Programs at the University of Miami in Coral Gables, Fla., for more than 20 years. Mr. Kosky welcomes your inquiries and comments. He may be reached directly at (305) 666-5198 or via email at TRKosky@aol.com.