What is a deferral and why should I increase it?
Employee deferrals, also known as salary reductions, are the most common way to contribute to employer-sponsored retirement plans like 403(b)s. These contributions are pre-tax, meaning they come out of your paycheck before taxes are calculated. Many people start with a smaller contribution to see how it impacts their take-home pay. While automating these contributions is a great way to save consistently, it can also lead to complacency. It's easy to get comfortable with a set contribution amount and forget to adjust it over time as your income or financial goals change.
Maximize your contribution
Make sure you know the exact terms of your plan and the cap amount you can contribute each year. If you haven't been contributing the maximum amount allowed, increasing your deferral each year can help you catch up and take full advantage of the tax benefits and growth potential of your retirement plan.
Compound your savings
Compound interest is the concept of earning interest on both your principal and accumulated interest. By consistently increasing your contributions, you're giving your investments more time and potential to grow exponentially through compound interest.
Gain tax advantages
Understand the tax advantages of deferring pre-tax dollars to your retirement plan. The tax savings you receive help now, and at retirement. First, you won’t pay taxes on the amount you contribute to your retirement plan. Your taxable income for the year will be reduced by the amount you contribute to your plan. Second, the earnings on your retirement plan are able to grow tax-free until you withdraw them, giving you more saving power over time. Many times, investors are in a lower tax bracket when they are ready to start using the funds, meaning you will pay a lower tax rate than you would currently.
Evaluate your goals
By not evaluating your plan and adjusting your contributions, you may not be able to reach a meaningful retirement benefit by the time you retire. Gradually increasing your deferral each year is a great way to ease closer to your plan’s maximum contribution amount, without shocking your paycheck.