Unlike previous generations of people who were planning for retirement, this time around very few have the benefit of guaranteed lifetime income from pensions. We have to rely on our own discipline to save for retirement, and we have to make decisions about what investments we put those savings into.
There are added challenges as well. Because this generation tends to live much longer than previous generations, we have to plan for 25 to 30 years of retirement, possibly longer. It’s no wonder that only one in five workers is confident that they will have enough money for retirement.¹
There are many different types of employer-sponsored retirement plans:
▪ 401(k) plans for profit-making corporations
▪ 403(b) plans for educators, hospital workers and public employees
▪ 457 deferred compensation plans for local government workers
▪ Thrift Savings Plans for federal workers
▪ Solo 401(k) plans for self-employed people
The advantages are great when you participate in an employer-sponsored plan. Not only do your contributions reduce your taxable income, the money you contribute grows without being taxed each year, taking full benefit from compound growth. Unfortunately, because participation in these plans is voluntary, there continues to be low participation. Of those who are eligible to participate in an employer-sponsored plan, only 49% make contributions.²
Many employers also put in their own money to match employee contributions, often up to 6% of employee compensation. One of our clients could not convince her son to participate in his company’s 401(k) plan until she pointed out to him that he was losing the company’s matching contribution. She calculated that he was leaving about $6,000 per year of free money on the table. About 20% of employees whose companies offer matching contributions are not taking advantage of it.³ Don’t let this happen to you.
Even if you’re not eligible for an employer-sponsored retirement plan, everyone can contribute to an Individual Retirement Account (IRA). This year, you can contribute as much as $5,500 into an IRA. If you’re age 50 or older, you can add a $1,000 “catch-up” contribution, bringing the total to $6,500. Like the employer-sponsored plan, your IRA contribution will reduce your taxable income, and grow tax-deferred without an annual 1099.
When time is on your side, even a small annual contribution to a retirement plan can have impressive results. For example, if you’re age 22, and you contribute $2,000 per year from age 22 to age 30 to a Traditional IRA or Roth IRA, that $18,000 will grow to $398,807 by the time you’re 65 (8% per year growth assumption). If instead you started contributing $2,000 per year starting at age 31 and continued those contributions all the way to age 65 (total contributions of $70,000), the account would be worth $372,204 by age 65. In other words, the person who put in $18,000 did better than the person who put in $70,000, just because he or she started a few years earlier and harnessed the power of compound growth. Starting early pays off.
Sometimes, people do a great job of contributing to their 401(k), but then they take loans from it to buy a car or home. Loans from 401(k)s sometimes have very low interest rates, and the interest you pay can go back into your account, so taking a loan can be very tempting. Avoid it if you can. There is an opportunity cost — the interest rate is lower than what you would likely earn in the market, so your retirement account will not grow as quickly. If you don’t pay the money back in time, you will have to pay income taxes and possibly early-withdrawal penalties as well. It’s generally better to create a separate emergency account holding six months to a year of your living expenses. Emergencies always happen, and if they happen when the market is doing well, you won’t be sacrificing growth.
Finally, when it comes to paying for college for your children, restrain yourself from cashing out your 401(k) or suspending contributions. Among financial planners, there’s a saying, “You can borrow money for college, but no one is going to lend you money for your retirement.” For college, there are loans for students, loans for parents, grants, scholarships, financial aid, and work-study. College cost comparisons can be revealing — a college that sounds more expensive initially can end up costing less because it has more financial assistance available.
Retirement is your reward at the end of many years, sometimes decades, of hard work. Like any long journey, you’re likely to get blown off course. Getting there successfully depends on your ability to recover, find your bearings and get back on course.
¹ 2016 Retirement Confidence Survey, Employee Benefit Research Institute.
² Bureau of Labor Statistics, 2016
³ Plan Sponsor Council of America, 2016