Turn that tax cut into hundreds of thousands of dollars

By Gail MarksJarvis

CHICAGO (Reuters) – When the new U.S. tax law starts giving Dave Calderone extra cash in his paychecks, he will use it to soothe his panic about dying broke.

“Fear is the motivator,” said Calderone, a 31-year-old Chicago salesman who started saving for retirement just four years ago.

The Tax Policy Center has estimated that the new tax law will deliver an average tax cut of $1,200 in 2018. That amounts to a puny $50 per paycheck twice a month.

For a 31-year-old, an additional $1,200 a year could provide almost $200,000 for retirement at 65 if the investments earn 8 percent a year. That yield is roughly the historical average of a balanced fund made up of 60 percent stocks and 40 percent bonds.

Using a tax cut to boost retirement savings could help people struggling to save otherwise. About half of Americans have saved so little they will retire without the money they need, according to research by the Center for Retirement Research at Boston College.

About 48 percent of 25 to 34 year olds have saved nothing for retirement, according to the Employee Benefit Research Institute, and even among those aged 35 to 44, almost 40 percent have no savings.

Many near-retirees are lagging. Although 70 percent of 55 year olds are saving for retirement, only 35 percent have at least $250,000 in a retirement account, according to EBRI. That would give them just $10,000 a year to live on in addition to Social Security. A person risks running out of money in retirement if he or she withdraws more than 4 percent a year, with adjustments for inflation, many academic studies show.

“People get overwhelmed by big numbers like $1 million, but small numbers (even $20 a month) make a difference,” said Ken Hevert, senior vice president of retirement at Fidelity Investments.

That is where a tax cut could help.

An online retirement calculator scared Calderon. He is now putting about 10 percent of his income in a Roth IRA, in line with the standard recommendation to save 10 to 12 percent.

“I’m behind, and I want to make up for the years I missed in my 20s,” he said.

Calderone will be fine in retirement if he bumps up his saving to 15 percent of pay each year. By saving the extra money from this year’s tax cut before he gets used to spending it, he said he will not feel like he is depriving himself.

The bonus may not last. The tax changes expire after 2025 unless renewed. Some taxpayers will get less than $1,200. Some may even owe more. Life changes such as relationships, job and children can all affect tax payments. And, always, investments may not repeat the 8 percent annual gain from the past.

But even increasing retirement savings by just $500 a year, or about $20 a biweekly paycheck, could end up giving a 31-year-old an extra $79,000 for retirement.

So if you have promised yourself to save more someday, the day could arrive in February.

Source: Investing.com

Tags: Social Security