The Economic Policy Institute recently released a report and detailed study posing the question, “Have 401ks failed Americans?” As the United States has shifted from a pension-based retirement society to one in which workers rely on their own 401ks we’re experiencing a first in our history: the majority of workers’ retirement savings are self-directed. That poses new challenges for the nation as a whole. So have 401ks failed Americans?

The study

Initially the report looks good: retirement wealth has grown nearly twice as fast as income in the United States. Unfortunately it’s not the pace of growth that matters but growth in comparison to costs. At the 2x rate retirement savings for Americans are not keeping up with an aging population (talking about you Baby Boomers!) or to offset cuts to Social Security.

The primary culprit according to the study is the decline in participation in company retirement accounts as we’ve shifted from defined benefit (pensions) to defined contribution (401k). The impact is more significant for classes of people which often face additional hardships economically: persons of color, women, and the non-college educated. How bad have things gotten? The median retirement savings for families in their mid-30s is less than $500 while the amount saved for those nearing retirement is a depressing $17,000.

My take on 401ks

There are absolutely some cons to a 401k savings account. It’s not automatic meaning individuals have to make the effort to open it and start saving which means inevitably thousands (or perhaps millions?) of Americans simply can’t be bothered because they don’t know any better. (Yes, you and I know this is insane; in fact, listening to a colleague admit he hadn’t opened his 401k because he “Didn’t understand how those things work,” was part of the inspiration for me to start writing this blog.) Some employers offer mediocre investment options with high fees. Finally, there are class issues that impact a person’s ability to participate in a 401k; the more you earn, the more disposable income you have to invest in your 401k and the more advantage you can take of the tax benefits offered for doing so. That last part is how a family of 3 earning $100,000 each year can pay almost $0 in taxes.

Compared to pensions, however? I’d take a 401k any day. For an aware consumer who is conscious of the need to save for retirement and is utilizing the 10 Step Plan to do so a 401k is a fantastic vehicle for savings. In addition to your employer match and tax benefits, the 401k puts the power of your future into your hands. As long as you know what to invest in it’s a powerful choice for preparing for your retirement, you simply need to do the work to set aside the cash.

Pensions leave the power of managing your money up to a third party. They select the retirement options and you trust that you’ll get paid what you’re owed. And when they mess up or get defrauded? You can have your retirement income cut dramatically with no say late in life when it’s difficult to make up the shortfall in income by working because of old age and health. Here are just a few cases where exactly that happened.

It turns out when you’re not in control of your retirement finances people can do bad things to them at the worst possible time. When it comes to having a 401k versus having a pension I’m much happier with my 401k than relying on someone else to do it all for me and being powerless to stop them from acting nefariously. As designed your 401k does powerfully good things for you.

Are 401ks failing Americans?

My conclusion is no. How we’re failing each other is through our woefully inadequate means of educating one another about personal finance. The 401k can’t do that, but you and I can. We can fight back against financial ignorance by serving as messengers to get the word out: if you have access to a 401k start investing! Here are some helpful links you can share with colleagues to help extoll the benefits of opening a 401k, why they should, and how to maximize their results when they do.

· This article:

· How to lose with your 401k: http://thebillstarkblog.blogspot.com/2016/02/how-to-lose-1000000-on-your-401k.html

· What to invest in: http://thebillstarkblog.blogspot.com/2016/01/what-to-buy-when-buying-stocks.html

· And of course the 10 Steps: http://thebillstarkblog.blogspot.com/2016/01/the-10-step-plan-to-your-financial.html

(Have more sources you think would be valuable? Share them in the comments and I’ll expand the list).

To help extoll the benefits of the 401k I present to you Top 5 Benefits of a 401k to help you make the pitch to friends and loved ones as to why they should take advantage of their 401k.

1. It’s free money

The biggest perk of a 401k is the incentive your employer offers you to take advantage of it. This is usually done in the form of an “employee match” in which your employer will put a dollar into your 401k for each dollar you put in. They usually do this up to a certain percentage of your income.

For example, Bill works for GlobalCorp. He earns $50,000/year and his employer offers a 5% match on his 401k. That means for every dollar he invests into the account up to 5% of his income his employer will double it. When Bill takes full advantage he puts in $2,500 of his money and gets an extra $2,500 from his employer. That’s income on top of his regular salary! If he doesn’t take advantage of his 401k it’s like setting his money on fire. Can you imagine turning down $2,500 from your job for free? You’d have to be crazy! But that’s exactly what you’re doing if you don’t take advantage of your 401k.

2. Yes you can afford it

The number one complaint I’ve heard from peers who “can’t” invest in their 401k is, “I can’t afford it right now.” That’s likely the result of deadly lifestyle creep as their spending habits grow to soak up every dollar they earn and if they don’t take the effort to manage that lifestyle creep they’ll never invest. That’s how you lose $1,000,000 on your 401k.

Let’s consider it in a different light using the Bill example from #1 on our list. If Bill were to claim he couldn’t afford to invest in his 401k he’s effectively saying that for every dollar he is paid at work he has to spend everything down to the last nickel. At 5% match he’s giving up just 5% of each dollar he earns (that’s a nickel) in order to get $2,500 from his employer. Five nickels? That’s five pennies from each dollar you earn! When was the last time you stopped to pick up a penny you saw on the street? Pennies are so maligned to the American consumer there’s even talk of getting rid of them permanently. Check out what John Olliver had to say on the matter.

Pennies are so hated we don’t even stop to pick them up! Investing in your 401k asks as little as just a few pennies per dollar you earn in order to fund your retirement. Even the most cash strapped amongst us can afford a few pennies to make sure our future is taken care of, particularly when our employer will give us more pennies for free just for doing it.

3. Every dollar you don’t put in your 401k costs you money

Your 401k has a special ability: it lets you count your investment against your income. Every dollar you put into your 401k reduces your tax burden on a 1:1 ratio. For Bill, who was earning $50,000 yearly, when he puts his $2,500 into his 401k the government counts that income against his tax burden. Instead of taxing him on $50,000 they tax him for $50,000 - $2,500, or a total of $47,500. As a single filer Bill pays 25% in federal income tax meaning that $2,500 he saves for retirement also saves him $625 in taxes. Net result? He has $2,500 in savings for retirement, plus $2,500 from his employer, plus $625 he didn’t have to pay to the government. That’s nearly $6,000 in savings from just putting aside a few pennies from each paycheck!

If Bill hadn’t put that money aside into his 401k he would have missed the match from his employer costing him $2,500 and he would have paid the $625 in taxes! That means poor Bill goes from making $2,500 to actually losing $625 when we subtract the full amount that decision costs him! Even if you don’t account for the employee match (which is bad math when you’re planning for the future; that’s money you’re leaving on the table) Bill is paying a fee of $625 in taxes to get his $2,500 from his employer. That means he only winds up with $1,875! That should put to rest any claims from people who say they can’t afford to set aside for their 401k; at those rates you can’t afford not to.

(A quick aside on taxes: your 401k saves you taxes going into your account, but eventually you’ll pay them on the way out. I’m not accounting for those taxes in this comparison because you’ll pay them after you’ve grown your initial investment and when you’re no longer working. You’re likely going to pay a lower tax rate when you’re done working than when you are working meaning instead of paying 25% taxes Bill is likely to be paying closer to 10-15%, a considerably savings even if he does eventually pay some tax on his 401k).

4. You can pass down a 401k

I have a friend who is Italian. His father worked 40 years in official capacity building up a pension that would ensure he could retire and provide for his family in comfort. One year after he retired that man died. His pension? Gone. While his wife was able to claim half benefits for the extent of her lifetime the 40 years of contributions he made to take care of himself and his family after he retired were gone the instant he passed away. Forty years of work, one year of benefits, and then nothing. Pensions may have some benefits but one of them is definitely not being able to pass them down to your heirs.

Your 401k? That’s all yours baby! When you open the account it should require you to designate a beneficiary (when you’re planning your estate make sure you understand how your will’s beneficiary designations are impacted by your 401k listed beneficiaries, or if there is no impact).

5. Your 401k is YOURS

Your 401k follows you as an employee. It doesn't belong to your employer, and when you leave your place of employment it follows you. In addition you get to choose which funds from the provided options you want to invest in (and you already know what to buy when buying stocks). If you ever decide to change employers you also have the option to roll your 401k over into a new retirement account with a wider plethora of options. You have the control and power to make the decisions you want about your retirement with your 401k and that's powerful, so take advantage of it.

Spreading the Word

Has the 401k failed Americans? Perhaps in policy and design it doesn't serve many of us as well as a pension we had no choice to participate in. But we can impact that. Spread the word to your colleagues, send them to this article to learn more about what's at risk when they don't take advantage of their 401k (or send them to ANY article you think may make a difference wherever it's at on the web!), and get people onboard with harnessing the most powerful force in the universe. To help spread the word and start the conversations here's a handy infographic on 401ks. You can also reach out in the comments with additional thoughts or questions.

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The Bill Stark Blog

Thursday, March 17, 2016

Has the 401k Failed Americans?