Tag Archives: matching contributions

Retirement and Your 401(k): Changes in 2012

  By petillo | December 11, 2011 - 8:03 am | 401k, commentary, ETFs, financial impact factor radio, financial planning, index funds, IRA, Mutual Fund Investing, Paul Petillo, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025
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“I’ll do more with my retirement plan next year.”  ”I can’t afford to contribute more than I already am.”  ”My 401(k) is confusing/costly/ambiguous/inappropriate.”  ”I’m going to have to work forever, so why bother when I need the money now.” These are collection of statements that both drive plan sponsors crazy and offer fodder for those trying to educate the masses on the value of doing as much as you can (if not more) to secure a retirement that, if you are even paying just a little attention to the chatter, more elusive than it has ever been.

So all of those statements about retirement sum themselves up in a simple “why bother”. As we head into the holidays, arguably the most expensive month we experience in any given year, is why we don’t do more. The lingering aftermath of what the next few weeks bring makes greeting the new year less appealing from a retirement point-of-view. Here’s why you should bother and a couple of simple steps to get closer than you are today.

The Contribution

The advent of the auto-enrollment of new hires into the 401(k) has done two things: it has given those that sponsor these plans a feel-good moment much like the Sally Field acceptance speech and it has given a huge swath of people access to their company’s plan that might have otherwise not bothered. And auto-escalation, the term used for keeping you in the plan and increasing your contribution year-over-year has created a new class of investor, more passively involved in the markets than any previous generation ever was. But the vast majority of those with access to a plan are there for other reasons.

What the 401(k) did was threefold: it allowed corporations to free their balance sheets of the pension, it also, like auto-enrollment created a new class of investor more or less thrust into the process and in tandem with all of those new participants, an unrivaled bull market lasting almost two decades until 2000. And a decade after that first stock market dive, one that many of these newly minted investors had previously never experienced, we are looking at the 401(k) in a new, more skeptical light.

And that skepticism is what confronts both previously enrolled and newly enrolled investors in their 401(k). According to Carl Zimmer; “The past and future may seem like different worlds, yet the two are intimately intertwined in our minds. In recent studies on mental time travel, neuroscientists found that we use many of the same regions of the brain to remember the past as we do to envision our future lives.” We can’t separate what has happened from what we see for ourselves in the future.

Our mental wiring keeps us at bay most of the time. It suggest that we should contribute and yet also suggests that there is inherent and undefinable risk in doing so. We have sought to define risk on numerous occasions (most recently on my daily radio show Financial Impact Factor). Yet we often come up short, scratching our collective heads as to why we need risk and how to convince our past selves it is wise to take it on.

Even without much in the way of risk, not contributing is still not an option. It is better than nothing. But if your approach is based on this something-is-better-than-nothing, you are doing your future a disservice. Yes you might fear the possibility of working longer than any generation ever has. Yes you might see that as a foregone conclusion. But at the center of the debate is the contribution.

You should make more of contribution than you are making now. This statement disregards any level of contribution you might be making, from as little as 3% (the standard auto-enrollment contribution) all the way up to those that make the maximum allowed by the IRS ($17,000 in 2012 with those over fifty allowed to contribute $22,000). In either case, you have underestimated what you believe you will need. For those at low end of the contribution spectrum, five percent will, in almost every instance, not impact your take-home pay (more but still not enough). For those making the maximum contribution, open a Roth IRA, the after-tax plan.

The Match

Employers are gradually returning to a company match. This unfortunately comes at the expense of other benefits previously considered sacrosanct (such as retired and current worker health care benefits). That is no easy hurdle for the average wage earner to jump. They see the cost of simply going to work as costing more than it did just five years ago. And we remember this.

Yet this is not viable excuse to not contribute at least the match offered. For those of us without matching contributions, which is a surprising number of plans in the small business arena, the effort becomes a burden you can bear now or later (when you retire). As I mentioned, 5% is the key minimum contribution. But it is up to you to continue to tweak it upwards, until you find the financial break-even point in your budget. Keep in mind these words: you are making money now, retirement is life based on what you have saved.

The Insurmountable Memory

2011 was a literal roller coaster ride. Had you listened to the pundits, you would have missed every uptick that the market had to offer as you retreated to cash. Yes there were bad quarters that were followed by fully recovered ones. And you would have emerged from such moves with far less than you wanted to have achieved but with your principle intact.

2012 promise much of the same. What will you do differently? What should you do differently? If you are using a target date fund, a mutual fund that seeks to rebalance periodically as you grow older, pick a date a decade or two beyond your retirement target. If you are using index funds, don’t focus too heavily in any one. Spread the indexed investments over a minimum of six funds, If your 401(k) doesn’t offer a large basket of index funds, ask that they be included in the plan. If your 401(k) offer exchange traded funds, use them as well. But be cautious that you aren’t using ETFs that are too narrow. If you are buying company stock with more than 10% of your contribution, back-off a bit.

I say this because the world will still be economically evolving in the next year and you should as well. Ignoring risk (which will always be there) and relying on decisions based on what has happened as you form your vision of the future (the greatest deterrent facing most plan participants) have nothing to do with the investments, the plan or the market. Overcoming them is much harder than embracing them – but necessary.

Your 401(k): The Illusion of Free Money

  By petillo | November 8, 2011 - 6:35 am | 401k, college, commentary, financial planning, Paul Petillo, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025, taxes
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I can’t tell you how many times I have seen Richard Thaler’s comment from his book “Nudge” misinterpreted. He suggested that the 401(k) matching contribution offered by your employer was “virtually free”. Taken out of context and misquoted by folks who should know better, the word free stands out and creates the illusion of something for nothing. Fact is, nothing is free when it comes to retirement and if it were, why would everyone be so concerned that we won’t be able to retire when we want if at all?

The simple fact is not as simple as that and making this complex plan seem so doesn’t do any reader justice, young or old. Here is where the conversation derails. You work. You earn money. Once, that was enough. The company you worked for wanted you to stick around for years, even decades and to do this, they enticed you with a pension.

It wasn’t portable however. So this defined benefit plan, so named because you knew how much you would receive in retirement, kept you tethered to the business and if you somehow didn’t want to hang around to collect that pension, your pension stayed, untapped until you retired – in most cases, simply lost. Pensions were the penalty for being mobile.

That concept did in fact work: workers stayed put – for decades. But it didn’t work so well for the employer and certainly not for the highest paid employees. Companies wanted less risk and high paid employees wanted better and broader places to save their money from taxes. And it was taxes that prompted the birth of the 401(k), so named after an obscure line in the tax code. So with this discovery, the pensions went away and the higher paid employees had some place better to stash large amounts of pre-tax income.

So it was never designed with you in mind. But they made it seem as though it was in your best interest. Truth is, you were set loose into the world of investing that many of you up until that point had only haphazardly embraced if at all. Turns out, for the marketplace where stocks are sold, it was a shopping spree. Thousands of new customers joined the sophisticated buyers and sellers in a place that most people largely distrusted.

And these new buyers brought the markets off their long-post-WWII bottom bumping – at the point in time when the 401(k) was introduced in 1978, the Dow Jones Industrial Average was trading around the 740 mark. Within three years, it had gained 150 points – something that might make you think ‘so what’ in terms of today’s market volatility – but that sort of jump and the steady increases in the markets until 2000, gave us the single greatest bull market in history.

So we have thousands of newly minted investors literally throwing darts at whatever mutual fund their company’s plan offered and the return was seemingly guaranteed. The key point the 401(k) plan sought to make was its portability. It was your money. You made it. If you want to move on,you could (and mostly had to) take it with you. It had by default created a mobile workforce the likes of which this country had never experienced – at least on a voluntary basis.

But most businesses saw the short-coming of this thinking and offered a carrot and a stick to workers. If you contribute to your plan, the business would help you out by making a matching contribution, up to a certain dollar amount or even more popular, a certain percentage. You needed to participate in order to get it.

But it wasn’t free. It came with a vesting period that is often not mentioned or simply ignored by the plan participant. This period of “induced loyalty” often extends five years. If you leave prior to that anniversary, some or all of the match they suggested you would get doesn’t leave with you. Sometimes it is 100% of it; sometimes it is broken down into percentages (20% is yours after the first year, 40% after the second and so on).

This does not bode well for the young worker who might be experiencing this veiled offer through rose-colored glasses. They see each job as a stepping stone to the next great-higher-paying-more-lucrative position. And they were told repeatedly that these are the wonder years of investing. And they are and they should be exploited by these young workers match or no match. But all too often, this vesting period is lost on their enthusiasm and the way the plan portrays itself: it actually puts this hypothetical-pre-vesting amount in your account.

Not to beat this deception to death, but the concept of free money often comes at the cost of other benefits, mostly those geared towards older more expensive workers. Early retirement health benefits and reduction in those matching contributions (when times get tough, the worker pays twice) often make senior workers flinch. But younger workers entering the workforce don’t know what they are missing.

Even the plans are seemingly more fluid and cost-effective yet are not. Many 401(k) plans have reined in the fees the funds in the plans charge investors while increasing the administrative costs. (The latter increase is due to the cost of educating you – a fiduciary responsibility they have no intention of paying for even if the government says they must do it; the price is borne by you, the participant.)

So free is only an illusion. Yet the specter of retirement looming in the future is not. Neither is the upside of investing early and often and using more money than you can afford. Young workers are on a predictable path: college debt and independence followed by family and homes followed by college and retirement. Putting away now before these financial burdens take control of your life is wise and prudent.

Putting more than the “match” away is also wise. In most instances, 5% of your pre-tax income will not impact a single dollar of that precious take-home pay. Ten percent is a do-able burden and can be lived with. More would be awesome.

Thaler was right, this matching money is “virtually free”. But it isn’t without a cost.

Starting Early with Retirement Plans and then Stopping

  By petillo | March 8, 2011 - 5:41 am | 401k, college, financial planning, index funds, IRA, personal finance, Repercussions: A Retirement Review, Retirement Planning Target 2025
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Signs of economic recoveries usually come with signs of increased hiring. Increased hiring usually spells opportunity for those among us who are young and either unemployed, unlaunched or worse dissatisfied with the job they have. Older workers share the same needs and even similar emotional tugs as younger workers but they tend to have different agendas when involved in the job search. Yet optimistic employment numbers also give way to mistakes when those opportunities present themselves as a chance for new and/or different employment.

Let’s start with those that are currently unemployed or underemployed. If you have failed to find the job of your dreams, chances are the news about an uptick in hiring has you feeling a great deal more optimistic about your prospects. Probably your parents feel that way as well. Even though most of the experts I spoken with suggest that just getting a job, any job is preferable than trying to be selective, that doesn’t mean you should approach the subject as if you were desperate. There is a very good chance that if you land the position, you will be employed with that company for at least five years.

Five years is the blink of an eye in terms of your youth. But it can be critical for your retirement plan. While some college graduates think about this aspect of the job, few would turn down a position if the employer did not offer some sort of retirement plan such as a 401(k). Currently, only about 59% of the employers do and if small business is the engine of job creation, you probably will be finding your next job amongst those employers.

So should your job choice depend on the presence of this sort of plan? Experts say no. Take the job that is offered, applying the get-a-foot-in-the-door attitude. But it doesn’t hurt to ask if they have a plan and if so, can you see what is offered. This, many experts suggest is not only prudent but shows foresight.

What should you be looking for? While the underlying investments are important, at the application stage you are most interested in the Investment Policy Statement. Contained in this document is the vesting schedule. This schedule varies widely but most offer a period in which you will be able to contribute to your plan, a time frame of when the matching contributions begin and more importantly, how much you get to keep before you are fully vested.

Some vesting is locked into a five year schedule. The first year may come with no matching contribution. The second with a matching contribution but should you leave the company, you would only be able to keep 25% of the match. And in this sort of plan, with each year you stay, the vesting schedule adds another 25% until you hit 100% in the final year. Some give you matching contribution that fully vests in the final year of the five year period. In other words, the match won’t be yours until you stay for five years.

Why is this important? If you leave that new job so much as one day before you are fully vested (or even partially in the case of the graduated vesting period), you will lose every penny of your employer’s contribution to your retirement plan. Yet, knowing about this also has consequences. For instance, far too many new hires are finding out (often after the fact) that their employer doesn’t match any contribution in the first year don’t contribute to the plan either. It’s your money and you get to take it with you should the job not work out. So investing even before you are vested is still a good idea. Put 5% away no matter what.

 

Even of the employer match is not what you had in mind, you should contribute. Actually, you should be contributing up to twice what the employer contributes as a rule. If they contribute 3%, you should be putting away 6%. If they offer 6%, which is about the maximum  most employers offer, you should be putting away 12%.

Suppose they don’t have a plan? Don’t squander these wonder years just because your employer doesn’t offer a plan. Most smaller businesses want to but simply don’t feel as though they can afford to. This doesn’t make them bad employers or even not worth applying to; it means that you need to negotiate enough of a salary to allow you to find an Individual Retirement Account (or IRA) on your own.

Suppose you have a job and another one comes along? You can avoid the three biggest mistakes of this decision by doing the following: do not cash out your 401(k) plan (in many instances, if the balance is below a certain level, usually $5,000, they will make you take it with you), do not necessarily accept the rollover plan offered by the old 401(k) (the funds in these plans are often more expensive than the ones tucked inside your 401(k) – buy a Vanguard S&P 500 index fund until you decide what to do and even if you don’t decide, you will have a good fund for the long-term) and lastly, make the rollover in a timely fashion (in many cases, your new 401(k) will accept your previous plan’s balance – if not, roll it over as instructed in the previous scenario).

Go forth and find the job you always wanted (and your parents wanted you to have). But don’t forget that these are key years for earning solid footing for a future you may not even be able to imagine.