Suppose you don’t have a 401(k). Will you be able to retire?
Of course would be the answer we all want to hear, but When? is the question we are really asking ourselves these days? Most 401(k) investors, or those who have access to a company-sponsored plan, tend to approach the subject somewhat differently than those that do not have these plans. Even with the vesting period, folks who have access to these plans tend to start earlier, think they will need more than those who don’t have access to the plan ($800,000 is what 401(k) investors assume they will need, compared with only $500,000 for those without), and, because of that, are slightly more optimistic that they will be able to retire at some point.
But we all assume that our companies will have a 401(k) and that we will use it. Most of the people who do not have access tend to be part-time workers, small-business employees, or younger workers. This doesn’t mean that if they had one, they would use it; it is actually this group that tends to be less interested in the future, focused on the here and now, rather than on some point down the road.
Which would lead you to believe that 401(k) investors are more confident about their retirement future?
401(k) investors are definitely more focused on it. Confidence is another thing altogether. Just over half, at least according to the surveys I have read, of the investors who have 401(k)s are confident they will have enough to retire on at sixty-five. This might be due in part to the fact that this group is more likely to use more than just that plan to accumulate wealth. Some use Individual Retirement Accounts as well as their 401(k) and tend to have keener outlook on their whole financial picture. I am speaking about the majority of these folks but certainly not all. There are still far too many folks who either don’t contribute, contribute too little, or simply set-it-and-forget-it.
Those without a 401(k) will need to expend more effort but in some cases, they might actually be able to make more than their 401(k) counterpart. Because they are not locked into a company-sponsored plan, they can shop for the best deal and look for the best investments. Some 401(k) plans are too expensive and if they lack the company match, they might even be such a bad deal as to push potential investors away.
What we all know is that people without a 401(k) use IRAs. Suppose you have a 401(k)—can you use an IRA as well?
Absolutely, and this is why they are more confident about their retirement future. One of the best methods to get to that point is to utilize all of the tools in the toolbox. If you have a 401(k) with a company match, you should be meeting that match times two. This means you should be making, in most cases, a pretax contribution of 6 percent of your pretax income. This actually means you are getting 9 percent contributed to the plan—6 percent by you and 3 percent by your employer. That threshold of 6 percent will leave you with about the same take-home pay as if you made no contribution at all. So now you are 9 percent ahead of those who don’t have a plan.
These investors will tend to look for some additional places to invest such as an IRA. The money you put into these accounts can be set up in the same way as your 401(k) plan by having a regular contribution taken from your savings account each month. Granted, this is after-tax cash, but when you do your taxes at the end of the year, you will be able to deduct a portion of it against your earned income. Keep in mind, the most savvy among these investors chose the Roth IRA to do this sort of investing outside of the 401(k). A Roth IRA is not tax deductible like the Traditional IRA, but the money put in it is yours.
And, of course, as with all types of retirement plans, there are contribution limits—right?
I’m not saying that the vast majority of these plans would abuse them, but there are limits to the contributions. For either the traditional or the Roth IRA, you can contribute up to $5,000 with an additional $1,000 allowed if you are older than fifty-five. If you make more than $105,000 as a single filer or $166,000 and married filers, this gradually phases out. It is then that you can turn to a traditional IRA. After five years, distributions from the Roth are possible; but in a traditional IRA, you have to wait until you are fifty nine and a half years old, and you must begin taking distributions by seventy and a half years old. That shouldn’t stop focused investors from opening a taxable account using mutual funds as well. Index funds, because they are tax-efficient, should be used in these types of taxable accounts.
Here’s one many of us rarely consider. You make the contribution to your employer-sponsored plan. How long before it is actually invested?
The rules are sort of fuzzy concerning this. Your company actually has about fifteen days (which is actually about three weeks) to make the contribution, and once it is made, how soon the investment company makes the contribution to the actual investment is even more vague. Large companies do a pretty good job of getting the money moved quickly but the temptation to hold that cash for a short period may be too great to avoid. The longer they hold the money, perhaps in a short-term note, the more they can make. The best you can do is ask. To my knowledge, this is not one of the reforms Congress is looking at—but it should be.