What Type of Retirement Planner Are You?
Retirement planning has changed. A lot of companies no longer offer retirement savings plans that provide a reliable stream of income like pensions, and Social Security is not likely to cover your financial needs in retirement. Do you have a plan to make up the difference?
A company-sponsored plan like a 401(k) is the answer for millions of Americans. However, since it’s up to the employee to participate, determine how much to contribute and manage the plan efficiently, the individual’s plan success can vary.
You can save up to $19,500 in a Traditional 401(k) in 2021. If you are 50 years old or over, you can save an additional $6,500.
Moreover, the money is taken out pre-tax, which can lower your overall tax bite in the year it is contributed. Not only that, but your contributions grow tax-deferred until you withdraw them at retirement. That includes appreciation, dividend reinvestment and any capital gains.
Finally, many companies offer matches on their employee’s contributions of up to 100 percent. If you are contributing 3 percent of your salary and your company has a 100 percent match, your employer will contribute 3 percent as well. The total annual contribution to your 401(k) is thus 6 percent of your salary.
Essentially, if you are entitled to a company match and don’t contribute to your 401(k), you are leaving free money on the table.
This is the basic make-up of how a 401(k) plan works.
Inconsistencies come into play when people either don’t contribute, don’t contribute enough or mismanage their plan.
As a financial advisor in Annapolis, MD, we see people fall in one of 4 common situations when it comes to their 401(k). Are you like Claire, Jack, Susan or Bobby?
Claire Exceeds the Match on Her 401(k)
“Claire” makes a comfortable salary. Her company offers a 100 percent match on employee contributions up to 6 percent of her salary. But Claire contributes 10 percent of her salary to her 401(k). The contribution is roughly $18,000 per year, well within the allowed limit. She earns the match on 6 percent of her contribution but does not earn a match on the remaining 4 percent.
Claire is doing an excellent job of saving for her retirement. She is taking advantage of the tax and savings benefits of her 401(k). Claire is taking some good steps for her retirement planning, but she could benefit from talking to a financial advisor to see if there are other strategies she may want to incorporate into her overall retirement plan.
Jack Takes Full Advantage of the Match for His 401(k)
“Jack” works at a company that also offers a 100 percent match on employee contributions of up to 6 percent. Jack understands the benefits of his company’s match. He makes $100,000 per year, which means that if he contributes 6 percent per year, he contributes $6,000. His company contributes another $6,000, for a full-year contribution total of $12,000.
As a result, Jack contributes 6 percent, to fully benefit from the match. This, too, is an excellent retirement savings strategy.
Jack is making a good start on his savings. If life changes, Jack should talk with a financial advisor to make sure his strategy still works. Read our recent blog post: When is it Time for a Financial Review?
Susan Contributes to Her 401(k), But Not to the Full Match/Benefit Offered
“Susan” contributes to her 401(k), but feels she can just contribute 2 percent. She is a single parent with substantial student loan debt. Her goal is to pay off this debt over the next 12 months. She doesn’t feel she can afford the full 401(k) contribution because of the payments she is now making in order to achieve her debt reduction goal.
Her company offers a 100 percent match on up to 6 percent of employee contributions. Susan makes $150,000 per year. At that rate, her 2 percent contribution equals $3,000. The company does match it, so her total yearly contribution is $6,000.
Were Susan able to contribute 6 percent to her 401(k), her total contribution would equal $9,000 per year. The company would match that $9,000, making the total contribution $18,000, rather than the current $6,000. That equates to a difference of $12,000 being applied toward her retirement savings. Susan not only is forfeiting the actual savings amount but also any potential growth on those assets over time.
Susan should discuss her debt reduction strategies with a financial advisor. A financial advisor can review earnings and expenditures with Susan and create a custom plan for paying off her debt. If she can balance the payments on her student loan debt with the savings, considering the interest rate on the debt, she may then be able to raise her 401(k) contribution to receive the full match and still make progress on her debt reduction. A simple conversation can also help alleviate the stress that having debt is creating by making a plan.
Bobby Doesn’t Contribute to His 401(k)
“Bobby” has been working at the same company for five years. He is entitled to a 100 percent match of up to 6 percent of his salary, but has yet to contribute at all.
Bobby is 25. He doesn’t fully understand his company 401(k) and doesn’t feel he needs to worry about retirement savings “yet.” He’s trying to save $50,000 for a down payment on a home and making that his first financial priority. He doesn’t feel he can afford to contribute to a 401(k) until he’s reached his savings goal.
Bobby’s commitment to saving for his first home is commendable. But he shouldn’t neglect retirement savings at this stage. Because 401(k) contributions grow tax-deferred over time, even a small contribution can grow into something potentially much larger if it is continually invested over the next four decades.
In addition, because Bobby is entitled to a match, he is also leaving behind money he could have had applied to his account!
Bobby should work with a financial advisor with two key goals.
The first is to understand the benefits of 401(k)s on taxes and retirement savings. Even though he thinks he can’t afford contributions, he might be pleasantly surprised to see that pre-tax contributions don’t take as much out of his paycheck as he thought.
The second is to arrive at a workable plan that addresses both his short-term goal of buying a home and his long-term goals, like retirement.
Even a 2 percent contribution of his $50,000 salary would mean $1,000 in his retirement fund, to which his company would add $1,000. At the end of the year, Bobby would have a total of $2,000 that could be dedicated to growing for his retirement over the next 40 years.
If you find yourself in a situation like Bobby’s, let’s talk. The financial advisors at Scarborough Capital Management can review your salary, expenditures and assets and recommend a 401(k) strategy that works for you, in addition to other cash management strategies.
The Bottom Line
Whatever type of retirement planner you are, a financial advisor can help. If you’re not sure how to get started, schedule a complimentary conversation with the team at Scarborough Capital Management, and get a discussion started.