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By Daniel P. Mahoney, PhD, and Brian W. Carpenter, PhD

Upon entering the workplace, emerging CPAs should immediately begin exploiting their understanding of the “time value of money.” Too often, young professionals think that the knowledge they acquired during their college years applies exclusively to the professional work environment. They need to realize (and the sooner the better) that much of their newfound business acumen can be applied in ways that, quite literally, pay huge dividends. Case in point: the prudent funding of one’s employer-sponsored 401(k) or 403(b) plans.

Many employers offer employees a “matching contribution” with respect to defined-contribution plans. Commonly, an employer will match somewhere between 25 percent and 50 percent of the employee’s contribution up to a set percentage. For example, an employer may offer to match 25 percent of the employee’s contribution up to a maximum employee contribution of 6 percent. Thus, an employee who takes full advantage of such a structure would see a 7.5 percent contribution to his or her plan.

One must not underestimate the value of any plan that offers a matching employer contribution: to forego an employer’s maximum matching contribution is to willfully turn down an offer of “free money.” Young professionals, however, should make themselves keenly aware of a plan’s vesting requirements, since many employers require that the employee remain with the firm for three to five years before the employer’s contribution is fully “vested” (when the employer’s match becomes a permanent component of the plan). A common misstep among entry-level employees is to assume that retirement issues are only relevant to those approaching the end of their careers. The benefits of compounding reveal otherwise. By taking an early-start approach to contributions and taking full advantage of matching contributions, the full impact of compounding is realized.

The following hypothetical scenarios involve Amanda, a 23-year-old entry-level employee of a prestigious accounting firm. They illustrate the importance of getting an early start on retirement security.

Amanda has an annual salary of $60,000. To put things in perspective for Amanda, she should perhaps first be made aware of a very simple, yet profound, fact: time can be a significant ally of the young investor. At age 23, if Amanda invests just $1 today (and assuming an annual rate of return of 5 percent compounded annually), that $1 would have grown to $8.56 after 44 years (a presumed retirement age of 67). However, if she were to wait 10 years until age 33 to make that $1 investment, the value of the savings at age 67 would be $5.25. Similarly, if she were to wait until age 43 to begin, the return would be only $3.23 at age 67. Finally, if she were to wait until age 53 (as, sadly, many individuals actually do before preparing for retirement), the $1 investment would be worth just $1.98 when Amanda reached age 67.

Retirement investing should be systematic, taking place over a period of years. So change the assumption from a one-time $1 investment to annual contributions of $1. If Amanda begins making annual contributions of $1 at age 23, she will have accumulated $158.70 at her retirement age of 67. In contrast, her accumulated retirement savings will be dramatically different if she were to wait until age 33, 43, or 53 before beginning the $1 annual contribution, in which case the accumulated savings would be $89.32, $46.73, or $20.58, respectively.

To make the example more realistic, change the $1 contribution to an annual contribution of 6 percent of her $60,000 salary ($3,600). If she begins making such contributions at age 23, she would have $571,320 at age 67. If she were to neglect to take advantage of the time value of money to the point where she waited until age 53, she would accumulate only $74,088 by age 67. Such stark illustrations become even more dramatic when one considers that Amanda will enjoy regular salary increases on which she could base her 6 percent contribution, as well as the fact that she can – and should – take full advantage of her employer’s matching contribution. Thus, even more realistically, a 25 percent employer match of Amanda’s 6 percent contribution would result in an accumulation of $714,150, assuming she were to prudently begin at age 23. (Note that the $142,830 difference between the $714,150 and $571,320 is the “free money” mentioned previously).

Additionally, Amanda should consider the important fact that, for those under age 50, the Internal Revenue Code permits a maximum annual contribution of $18,000 to one’s tax-deferred retirement plan. If she wants to take advantage of all available retirement savings incentives and she feels it is economically feasible for her to do so, Amanda should arrange for payroll deductions beyond the 6 percent assumption offered in this scenario. To do so would not only add significant value to her ultimate retirement savings, it would result in a reduced level of taxable income during her years of employment.

Emerging CPAs should take advantage of their knowledge of the time value of money from the beginning of their careers to maximize their potential retirement savings.

Daniel P. Mahoney, PhD, is a professor of accounting at The University of Scranton. He can be reached at daniel.mahoney@scranton.edu.

Brian W. Carpenter, PhD, is professor of accounting at The University of Scranton. He can be reached at brian.carpenter@scranton.edu.