Here’s the deal: In a few weeks, all other things remaining the same, workers across the country will be getting a pay raise.
This raise isn’t coming from their company. It’s coming courtesy of the 2017 Tax Reform Act.
Workers will immediately face a fork in the road. They’ll need to make a decision about which path to take into the future.
It’s a choice that may mean the difference between buying a few immediately gratifying items and living a more comfortable retirement.
Employees can either figure things out for themselves, or they can rely on plan sponsors and financial professionals, (see “How Can Fiduciaries Use New Tax Cuts to Nudge 401k and IRA Retirement Savers?” FiduciaryNews.com, January 3, 2018). But there is one thing that’s important — this rare opportunity will exist for only a short time.
While the tax cuts will be seen in every paycheck going forward, the habits that reveal themselves as a result of this sudden pay increase will be formed only once. The moment these habits arise, they become set. The time to influence behavior, then, is now, before it’s too late to change them.
Many expect the fruit of the tax cuts to hit American’s paychecks sometime in February. This means plan sponsors and retirement advisers have only a few weeks to prepare workers for the decision they will soon need to make. Let’s quickly explore the impact of the new tax law on the typical employee and what it might mean for their retirement.
First, it is estimated that, on average, each of us will see roughly a $2,000 annual savings as a result of the new tax law. Granted, this will be reflected in each paycheck. For those getting paid bi-weekly, they’ll see about $70 more in take home pay for every pay period. It’s not much, but it adds up.
But before we get to the “adding up” part, consider this: Right now, most folks are able to survive (no matter how austerely) on their current paychecks. As a result, there might not be an immediate need for that extra $70.
That’s where the fork in the road appears. What shall become of that extra $70?
It’s quite easy to see how the temptation to spend it on something that “rewards” the recipient. After nearly a decade of a stagnant economy, it’s natural for people to want to “finally” buy something the failed economy had kept them from purchasing.
The immediate gratification derived from this act will no doubt be very pleasing if not downright therapeutic.
But what is the real cost of the short-term satisfaction? This is the part where “adding up” comes into play. This is what workers need to look very closely at. This may mean the difference between a more comfortable retirement and a less comfortable retirement. Here’s what I mean.
What if, instead of spending that extra $70, you save it? That’s $2,000 a year that could go into your retirement savings.
Let’s say you earn 8% a year on that extra savings. At the end of 20 years, you’ll have an extra $100,000 in your retirement account. At the end of 30 years, that extra retirement savings surpasses $200,000. After 40 years, you’ll have more than half a million in extra savings.
That $70 a paycheck may not sound like much, but over time it really adds up.