The following is a staff writer post from MikeS. He is a married father of 2. So, with the cat, he ranks number 5 in the house. He loves numbers and helping people. Please leave any questions or comments below for either Mike or Crystal.
With the recent 2016 benefit announcement by my company, I needed to do some modeling. Specifically, I needed to model out the impact of the 401k change. The company was going to be moving from a pay period match to an annual lump sum match. After some fierce employee backlash, the company changed its mind, but not before I had gotten to run through some numbers in Excel.
My Retirement Analysis
I knew that changing the timing of the 401k matching contributions from a pay period match to an annual match wouldn’t be good for me. The question was, how severe would the impact be?
I kept my first pass at the impact pretty simple. I kept my salary constant and just wanted to see the lost interest over the next 25-30 years. I kept the investment return constant at 9%. The impact in the first year was about $400. By the end of the 25 year time cycle, that $400 had increased to roughly $32,000. Not horrible I thought, but I wanted to use my actual retirement model to see the full impact.
In my full retirement model, I vary my salary and contribution over time, increasing both. The salary increases would come into play with the matching change. As my salary increases over time, the larger company contributions would be earning less interest. When I modelled out the change this time, the result was a final balance roughly $100,000 less. Now, that is a lot of money, but when compared with the total account value, it isn’t too bad. That $100,000 only represented about 2% of the total account value. I would certainly rather have that 2% in my hands, but it wouldn’t prevent me from retiring.
Playing with My Retirement Model
While I was in my model, I decided to look at changing a couple of assumptions and seeing the impact of those changes. The one change that I was curious to model was increasing my contribution rate every year. When I first built my model, I assumed that I would be increasing my contribution rate by 1% every year. That is the best case scenario, but the reality of life has been intruding on that scenario.
So, I decided to see what would happen if I didn’t increase my contributions at all from the current 8% that I contribute now. The result was about a $1.3M decrease in the total account value. That’s a nearly one-third drop from the original forecast number. I was somewhat surprised by the magnitude of the impact.
The second change I modeled out was a change to the investment return. My previous assumption was for a 9% average return over the next 25-30 years. I decided to see what dropping that by 2% would do to the ending balance. Using the 7% investment return resulted in an ending balance that was $1M lower, than the original 9%.
This didn’t really surprise me too much, the loss of 2% compounding of the next 25-30 years was going to have a pretty big impact.
Now, if I combine the two changes, lower investment return and no contribution increases, the impact is huge. There is about 50% less in the new estimate compared with the old estimate.
All of these estimates are wrong. I know that, but they at least give me an idea of what I can expect should certain things happen. Most things are out of my control, like the inflation rate, investment return and salary increases. The one thing I can control is my contribution rate. It probably won’t happen every year, but when I can I’ll increase my contribution rate. I’ll do that by keeping an eye on my expenses and minimizing them whenever I have the chance.
How is your retirement plan shaping up?