People are funny when it comes to saving for retirement, college, and medical care. For whatever reason, they allow the arbitrary limits set by the government on what can be deducted from taxes and other factors dictate how much they put away. If you can put $2000 in an IRA account, they put just $2000 away for retirement. If their employer only matches the first 3% they put into a 401k plan, they put away on 3%.
You wouldn’t do this withfood. If you had a food account that only let you put $500 into it per year and deduct that $500 from your income for taxes, you wouldn’t just put away $500. You would put away however much you needed for food and just pay taxes on the amount over $500. You let the need dictate how much you save, not tax laws.
But wait, it gets worse. In her article, The 401K Crisis is Getting Worse, Katrina Combs talks about how people in industries such as the food service industry don’t put away anything for retirement because many of the jobs don’t offer a 401k plan. She quotes Tim Egan who says that he has almost no savings for retirement at age 56 who says, “The restaurant business is what I’m good at, but few owners, especially of small places, offer retirement benefits, no matter how much money you help them earn.” So…. She also quotes IRS statistics: “Only 8 percent of taxpayers eligible to set aside money in an IRA or Roth IRA did so in 2010, according to the IRS.”
So basically, because people are working for companies that don’t offer a 401k plan, people are not saving for retirement. (And don’t even get me started on people who work for companies that offer a 401k plan who choose not to use it, or who cash out their 401k plans to do something foolish like a kitchen upgrade or pay for a wedding.) When you work for a company, they are paying you based on what your skills are worth to them. Whether they choose to pay it all out in salary, or pay it out in salary and benefits, is really immaterial. In fact, if they pay you entirely in salary, it gives you the freedom to spend the money as you choose rather that take the benefits offered.
If they give you a salary of $50,000, you can choose to put $5000 away into an IRA, or even into a set of mutual funds in a taxable account. No one is stopping you. Why should your employer need to give you $45,000 and then match your contributions up to $5000 (still $50,000 for them) into a 401k for you to think about your own retirement? Are we so weak-willed that we need an incentive to prepare for something we all will need someday? Put on your big boy pants and do what you need to do so that you won’t end up eating Alpo at age 70.
The same holds true if your employer doesn’t offer a match for their 401k at all, as many have stopped doing since about 2008. Just because they aren’t matching your contributions anymore doesn’t mean you can now spend your whole paycheck and not worry about tomorrow. This is why it is wise to put away 10%-15% of your paycheck regardless of what match your company provides. If you put away 7% because you get a 3% match, and then they stop matching, you would then need to find another 3% of your paycheck somewhere to put towards your retirement. This is difficult to do if you’ve already gotten a set of payments that eclipses all of your take home pay as most people do. It is easier to start out without the money in the first place.
So now that we’ve dispelled the notion that you need a 401k plan to save for retirement, or even that you need to worry about deductibility of your savings, what is a plan for retirement? Well, I would follow these steps:
1. Determine how much you need for retirement. A good way to do this is to figure out how much you’ll need in today’s dollars per year to enjoy the lifestyle you want and put that into an interest rate calculator at 5% for the time between now and retirement. Then, take that number and multiply by 30. That is the account balance that will provide the income you need to generate the income you want at retirement. If this is too difficult, just plan on putting away 15% of your gross salary. If you have a pension plan at work, reduce your yearly income needs based on the payment you will get from the pension (as HR to calculate for you).
2. If you have a 401k plan at work, plan to put away whatever percentage of your salary the company will match. For example, if they match the first 5%, you’d put 5% there.
3. Next, start an individual IRA and put away as much as you can there ($5500 per year currently). If you don’t have a 401k from work, you would start with the IRA.
4. Next, if your 401k plan at work offers low-cost mutual funds (less than 1% fees and broadly diversified funds), up your contributions to the limit or the amount you plan to invest for retirement, whichever is less.
5. If your plan at work really stinks (fees of 3% on all of the funds and they are really limited, or you only can invest in company stock, for example), or if you still have money left over after maxing out your 401k, open a taxable mutual fund account and invest in index funds.
So there you have it. If your company offers a plan and especially if they have a match, take advantage so that you can get all of the money that the company offers. Also, take advantage of tax savings by using the 401k plan and an IRA if you can. If there is no 401k plan, still take advantage of the tax advantages, but don’t stop saving just because you can’t deduct past a certain contribution. DOn’t let the government or your employer dictate how much you save for retirement. It is up to you to plan for your own future.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
