October 2021
Barbara O’Neill, Ph.D., CFP®
Distinguished Professor and Extension Financial Management Specialist Emeritus
Rutgers Cooperative Extension
Contrary to popular belief, it is possible to invest “on a shoestring” with small dollar amounts ($1,000 or less). Some investments can be purchased in increments of $25 or $50 or less (e.g., $10 per paycheck invested in an employer retirement savings plan).
The best place to start investing is with a tax-deferred employer plan (e.g., 401(k), 403(b), etc.) because contributions are deductible on federal income tax returns (e.g., a worker with a $35,000 salary who makes a $3,000 contribution only pays federal tax on $32,000). All of these plans provide tax-deferred growth of principal and investment earnings and the amount invested is deducted directly from a worker’s paycheck.
The minimum amount invested in employer retirement savings plans can be as low as $10 or 1% of pay per paycheck. Another advantage is employer matching: available at many workplaces. This is a tremendous gift of “free money” that should not be passed up.
For those already contributing to a tax-deferred employer retirement plan, consider saving more (e.g., increase from 2% to 4% of pay). The best time to “kick it up a notch” is when you receive a raise or a household expense (e.g., car loan, child care) ends. Be sure to adjust your tax withholding on Form W-4 to account for the extra deduction so you’re not over-withheld.
With compound interest, contributing just 1% more of pay ($400 on a $40,000 income) annually can provide tens of thousands of dollars more for retirement. Below are some specific examples of investment growth from saving just one percent more of your salary:
- Worker Age 35 - $40,000 annual income - Saving 1% more of salary per year will grow to $74,240 by age 65.
- Worker Age 45 - $50,000 annual income - Saving 1% more of salary per year will grow to $33,003 by age 65.
Note that younger workers (more time) and those at higher salary levels (1% of a higher number) stand to accumulate the most by saving an extra 1% of their salary. The examples given above were taken from the 401(k) Booster Calculator by Advantage Publications and assume an 8% average annual return on investments and 4% average annual pay increases.
Once a 401(k) is funded, at least to the maximum amount (e.g., 6% of pay) matched by an employer (reason: “free money”), consider an Individual Retirement Account (IRA) for additional savings. The maximum annual contribution in 2021 is $6,000 ($7,000 if age 50+), but you don’t have to invest it all at once.
Tax deductibility of traditional IRA contributions depends on access to a qualified employer retirement plan and household adjusted gross income (AGI). Roth IRAs do not allow taxpayers to take a deduction for their contribution BUT earnings can be withdrawn tax-free if a person is 59 ½ and invests in a Roth IRA for at least five years.
Other recommended “shoestring investing” practices are: investing in a SEP or Keogh plan with self-employment income, investing windfalls (e.g., retroactive pay, holiday bonus checks), and dollar-cost averaging (regular investments made at regular time intervals, such as $50 per month invested to buy mutual fund shares).
Compound interest is not retroactive so get started today!