Edited and reposted with 2019 updates. This post will cover the key areas of your employer-sponsored retirement plan that you can quickly review and optimize in order to maximize your savings and investment earnings.
First off, I have to ask. Do you have an employer-sponsored retirement account? Unless you are self-employed or work for a very small company, I’m guessing you have at least one. Maybe even a few that you’ve lost track of over the years, a few jobs ago. I know, it’s a hassle transferring your account over. And then you move and forget what company the account was with, forget your login info, et cetera.
For some reason, retirement savings accounts get set up and then forgotten about entirely. Or not set up in the first place. A recent study by Pew Charitable Trusts found that only 52% of millennials with plans available opted to participate. The underlying assumption seems to be that when earnings are small there is no point in saving. Or that if you do save, the returns won’t be seen for over 40 years, so why bother.
The answer to that is quite simple though. Why would you NOT bother? If matching is offered, it’s free money! If not, it’s still building smart financial habits and taking advantage of compounding interest. The younger you start, the better.
That said, why are retirement accounts so neglected? A survey by bankrate.com found that up to 20% of Americans aren’t saving at all. I can only assume that lack of education is the underlying reason.
So let’s make this simple. Let’s look at some easy steps to follow so you can review your employer-sponsored retirement plan and map out what steps you can take TODAY to save more and plan for a financially healthy future.
Step 1: Do you have an employer-sponsored retirement account?
If your answer is yes, great! That should be a resounding yes with lots of exclamation marks. Or maybe even a shouty-case yes. YES!!! Because life is a bit easier with this option, and you probably get some free money.
Employer-sponsored accounts are typically either 401(k) or 403(b) accounts. What’s the difference, you ask?
403(b) retirement plans are typically offered through government or educational organizations, school districts, religious groups, or non-profit companies. There are certain administrative exemptions that apply to 403(b) plans so they are less expensive to offer. 401(k) plans are for organizations that don’t qualify for the 403(b) plans.
To those that are interested, there is a slight advantage of 401(k)’s regarding investment diversity. If the plan is offered through a major investment brokerage firm, such as Fidelity, there are an almost unlimited number of investment options (making it even more difficult to set up and maintain your retirement plan!). On the other hand, there is a distinct advantage to the 403(b) plan. For long-term employees(15+ years), it is possible to make higher contributions.
For the most part, it’s safe to consider these two plans very similar. The shared defining feature of each is that you, the employee, make tax-deferred contributions to the plan. This means that anything you contribute is subtracted from your annual earnings and not counted towards your annual income taxes.
Subsequently, your retirement plan grows, due to continued contributions, interest earnings and investment earnings, as pre-tax dollars. When you begin accessing funds from your retirement account, you pay taxes on all withdrawals, presumably at a lower tax rate, since you are retired and no longer earning your usual income. This money is also counted toward income earned for that year. If you are withdrawing but still working and earning an income, anything you withdraw from you 401(k) or 403(b) is considered taxable income.
Step 2: So you know you have an account. Are you actually using it?
If the answer is no, now is the time to fix that. Even if you are living paycheck to paycheck and don’t believe you can contribute anything, set up the account and have a percentage of your paycheck automatically withdrawn for contributions. It’s possible that by contributing you will lower your overall taxable income, which could save you money by lowering your income tax bracket.
If contributions don’t help your taxes, still contribute. It’s time to plan for your future and clean up your finances. It’s not contributions that are causing you to fall short on money every month, it’s your spending (over-spending) habits that are the real issue. Start contributing and then clean up the monthly expenses and budget. Tough-love, I know.
If the answer was yes, then great! You get another shouty-caps YES!! Move on!
Step 3: Find out what percentage you are contributing
As a new hire you are often presented with a big pile of paperwork and about 10 seconds to determine how to fill it all out. Whatever insurance limits, healthcare benefits and retirement plan contributions you decided upon during your new-hire high, they are probably long since forgotten by now.
So take a moment to access your retirement account and take a peek at what percentage of your earnings you are contributing each paycheck. You can usually access this information through your online HR or your benefits account. Call up HR if you aren’t sure where to find the information.
Step 4: What percentage does your employer match?
Next, you want to know what your employer will match. Many employers with match 50% of your contributions, up to 6% of your salary. This means that if you contribute 12% of your earnings, your company will match half of that contribution, making your overall contribution 18% of your total earnings. That’s FREE MONEY! YES!!!
Step 5: Make sure you are utilizing the maximum matching contribution allowed.
Whatever your company is willing to match, take advantage of every penny. Increase your contribution such that your company is contributing the maximum allowable.
Step 6: Calculate what age you can retire using your current contribution amount.
Let’s say that you are now maximizing employer-matching and your overall contribution is 18% of your pre-tax earnings.
It’s time for a rough calculation of how much money you will have around retirement age. Most brokerage firms will offer a calculator tool, right from your plan account.
For example: My retirement plan is through Fidelity. I can access my Fidelity account information through my employer benefits account, or directly from Fidelity.com. They offer many tools to plan for retirement, including a Planning and Guidance Center. From the main page I can use a calculator to quickly estimate when I will reach certain financial goals.
All you need to do is enter your annual base salary and your pay frequency, then Fidelity will step you through the calculations.
Another great calculator to try is the Vanguard Retirement Income Calculator.
And if that still isn’t what you’re looking for, head over to Personal Capital, enter in all your banking, investment and debt accounts, and review your overall net worth and retirement projection.
Step 7: Can you afford to increase your percentage?
Did you just discover that you won’t have enough money to retire when you wanted to?
Think about how much more you could contribute without feeling the effect on your monthly expenses. Use a retirement calculator tool to play around with the numbers and see what that extra percent or three will cost you per paycheck. To start out, you want to feel the pinch.
Next, enter the age you want to retire at and check how much would you need to be contributing now. Could you make it work?
Also, I’m not sure what the state of social security benefits will be when it comes time to my retirement age. I’m not factoring it in at all, whatever the benefit ends up being I will consider a bonus.
Here’s why I’m not counting on social security. Social security funds are expected to be depleted in 2034. Some ways to prevent this, or at least slow it down, is by lowing benefits paid and raising the full retirement age up to 69 years. This means that not only will you have to wait to receive any benefits until you are 69 years old, but even then you will likely only receive three quarters or less of what you were expecting. Additionally, above average earners making more than $85,000 per year as a single or $170,000 per year as a couple will no longer see the cost-of-living adjustments. To read more you can look over the Harvard Political Review Takeaways From the 2018 Social Security Trustees Report.
However, you do want to factor in other investments. Additional savings accounts, retirement accounts, business investments, and real estate investments all provide income revenue.
While it’s nice to assume that your cost of living expenses will drop during retirement, after all your mortgage will be significantly lower or even paid off all together and you will likely be in a lower income tax bracket. However, even if that home is paid off, there are still maintenance and repair costs (which increase with the age of the home) as well as property taxes, which typically continue to rise. With an overabundance of leisure time comes more entertainment and travel expenses. And of course, with aging comes increasing healthcare costs.
To play it safe, assume that you will want between 80% – 100% of your current income to be comfortable in retirement. My goal is early retirement, which means I need to find a way to replace all of my expenses with supplemental income from investments and passive earnings.
Step 8: How much do you need to contribute to make your retirement goal?
Now it’s time to get real. How much do you actually need to be contributing in order to meet your retirement goals? You may be surprised.
Better to be surprised now than when you are close to retirement and suddenly realize, a bit too late, that you are nowhere near as prepared as you thought you’d be.
Step 9: Maximum contribution is $19,000. How close are you to these numbers?
The most you can contribute to your 401(k) or 403(b) is $19,000. If you are age 50 years or older, you are allowed a “catch-up” contribution of an additional $6,000, making your maximum allowable contribution $25,000 for 2019.
Of note, employer contributions are on top of this amount. Be sure to maximize every dollar that your employer will contribute.
So, how close are you to reaching this maximum? Not very? You aren’t alone.
According to the Vanguard How America Saves 2017 Report, only 4% of individuals earning <$50,000 per year max out their 401(k), only 11% of individuals earning $50k-$100k per year and for higher income >$100k per year, only 32% contribute the maximum allowable.
Step 10: Review finances and work to increase your contribution.
If your eyes are glazing over and you now feel like your retirement plan is a disaster that needs a complete overhaul, take a deep breath. You are in the right place, reviewing your accounts and learning the steps to make improvements. The best time to start is now.
Realize where you are now, then you can take steps to make improvements.
Some steps to increase your savings rate and be able to improve your retirement plan contributions:
- Visit How To: Track Your Personal Finances
- Once you have done this, visit The Beginner’s Guide to Creating a Budget You Can Actually Stick To
- Read about what your savings rate is and why it is important at How To Calculate Your Savings Rate and Why You Need To
Step 11: What to do when you max out your contributions and are ready to invest more.
First off, kudos! Once you reach this point, you are on your way to financial independence or even early retirement if you so choose. (YES!!!)
Secondly, there are circumstances where it is better to contribute to your tax deferred account and also a taxable account. This is where you want to consider your overall taxes, and where you expect your taxes to be when you retire. You’ll want to review your personal situation with a CPA for individualized answers.
That being said, if you still have money left over, here’s some suggestions:
Invest in low-cost exchange traded funds (ETF’s). You can read more about my favorite ETF here.
Use a high-interest online savings account to save money to be used for other forms of investments. This could be funds used for starting your own business or real estate investing.
Bonus Step: Review investment fees
This is the hidden cost of retirement plans. It took me about an hour of digging around in my online account to figure out what I was paying in fees every year. And I wasn’t happy when I finally figured it out!
Management fees are what you get charged, typically as a percentage of your investments, for the active management of your investment portfolio.
For example: I have an IRA that I inherited from my late husband. It is actively managed through Morgan Stanley. I was told long ago to not touch this account because the individual professional that is managing the investments is really talented and doing this as a family favor. Normally, this individual is so skilled that they only manage high value accounts. Sadly, mine doesn’t even come close, but, they were willing to continue managing my small IRA. This means that I don’t have to think about how to diversify my portfolio, or figure out which stocks I want to buy or sell. I don’t even need to think about what industry or type of investing I want to do, such as domestic vs foreign stock, or high tech vs pharmaceutical industries.
Being hands off like this comes with a price. The individual or company that is managing my portfolio needs to be paid for their efforts. They are paid in the form of management fees. How much is this fee? Believe it or not, I have no idea. I have combed through my account and all the associated documents and I can’t find even the mention of management cost, fee, or expense ratio.
My current employer-sponsored 403(b) account through Fidelity is much clearer. I originally set it up during orientation and went with a standard target retirement fund. This is a managed fund that balances your portfolio with both stocks and bonds in a percentage to match your level of risk. The sooner you will be retiring, the more conservative (higher percentage of bonds). I chose a target fund to retire in 2045 beacause I wanted to be more agressive. It included 53% domestic stock, some international stock, 7% domestic bond, 3% foreign bond, some cash and assorted other allocations. It was well balanced and more conservative than just going with 100% US stock market choices. The expense ratio was considered low at 0.09%.
Not sure what the expense ratio means? Here is Fidelity’s definition:
Exp Ratio (Gross)
Expense ratio is a measure of what it costs to operate an investment, expressed as a percentage of its assets, as a dollar amount, or in basis points. These are costs the investor pays through a reduction in the investment’s rate of return. For a mutual fund, the gross expense ratio is the total annual fund or class operating expenses directly paid by the fund from the fund’s most recent prospectus (before waivers or reimbursements). This ratio also includes Acquired Fund Fees and Expenses, which are expenses indirectly incurred by a fund through its ownership of shares in other investment companies. If the investment option is not a mutual fund, the expense ratio may be calculated using methodologies that differ from those used for mutual funds.
So now I know that I was paying 0.09% of my investment towards management fees. This seems like very little. But when you think about the 4% rule of retirement, you are giving up almost a full percentage point of that just to fees. That 4% is what will cover all of your monthly expenses in retirement. Do you want to give up 1% of that? I know I don’t.
I switched my investment holdings to the closest option to a Vanguard total market ETF. The expense ratio is now 0.02%. This is significantly better than the original 0.09%, and even better than my unknown Morgan Stanley IRA account, which is likely somewhere in the 3% range. I’ll let you know when I finally unearth that hidden fee.
Wondering why I chose to invest in Vanguard’s total market exchange traded fund? Check out The 12 Financial Rules You Need To Live By.
The days of relying on a pension plan for retirement are past. Additionally, I don’t think social security benefits will make up a major source of retirement income either. Perhaps because our parents and earlier generations experienced trust in their employers to provide a comfortable retirement, education in personal finance is still nonexistent for many. But where does that leave us? In a report by the Economic Policy Institute (EPI), nearly half of American families have no retirement savings at all. The blinders need to come off. Ultimately we are in charge of our future and our finances, it’s up to you to properly educate yourself and plan for the day when you don’t want to work anymore.
When will that be? That is entirely up to you.
And that is so powerful. So long as you plan, anyway.
So here is a recap of what you can do, right now, to review your employer-sponsored retirement plan and find out whether you are on track or not. If not, there is never a better time than right now to fix it.
- Find out if you have an employer-sponsored plan.
- Assuming you do, are you using it?
- What percentage of your pay are you contributing?
- What percentage does your employer match?
- Increase your contribution to utilize the maximum that your employer will match.
- Calculate what age you can retire, assuming 80-100% of current monthly expenses, and contribution amount from step 5.
- Can you afford to increase your contribution even more?
- Calculate how much you need to contribute in order to reach your retirement goal.
- Could you increase your contribution to the maximum allowable $19,000?
- Review your finances and work to improve your savings rate and contribution.
- Invest additional savings after your maximum contribution.
It may seem like an impossible stretch to save more than the maximum allowable contribution of $19,000. The majority of American’s don’t even have more than $1,000 saved. But can you really afford not to? If you dream of early retirement, this is probably what it will take.
If you aren’t on track for retirement, there are plenty of ways to aggressively grow your wealth. Real estate investing (REI) is my favorite. Check out the REI category here.
In my 10-Year Goals I map out how I intend to accelerate my earned income, passive income and wealth. Without these goals, relying solely on my pre and post tax retirement plans, I’m on track to retire when I’m 62. That’s not good enough. By adding other income streams and assets, I plan to speed this up so I can retire by 45. And I’m starting late in the game as a single parent in a high cost of living area. Had I known what I know now, I could have planned to retire in my 30’s.
All it takes is a clear plan. Review where you are now so you can determine what you need to change in order to achieve your financial goals.
So hop to it! Take some time and review your retirement plan.
Go review your employer-sponsored retirement plan. Follow the 11 Steps outlined in the Recap and explained in detail in the body of this article.
Once you’ve followed the steps, let me know how it went. This is a great way for readers to start discussions, ask questions and find the answers. This isn’t an easy process, which is why it is so often neglected. Don’t make that mistake!