Summer is over. Kids are back in school. It’s time to start thinking about sweaters, pumpkins, and how the holidays will be here before you know it. There’s one more thing you should potentially add to the list: checking in on your 401(k).
Last year, we saw more than 30 percent of investors play catch-up and make last-minute contributions to their 401(k)s. These investors made 10 percent or more of their total contributions for the year in December. In comparison, if this same group of investors had saved and contributed an equal amount each month throughout the year, they would have only needed to make 8 percent of their total contributions each month.
Being late to the party is not necessarily a bad thing. There are plenty of possible strategies for 401(k) investors who want to boost their savings rate in the last few months of the year, and there are plenty of investors who could be saving more. Individuals can contribute a maximum of $18,000 to their 401(k) accounts this year, and investors at the age of 50 or over can make additional “catch-up” contributions of up to $6,000.
However, most investors are not on track to meet that maximum this year. In fact, only 39 percent of investors who track their portfolios with SigFig are on track to max out their contributions to their 401(k) accounts so far.
So who are these latecomers? By and large, younger investors.
Older investors are more likely to max out. Only about 1 in 5 investors under 30 are saving enough to hit $18,000 by the end of the year. Meanwhile, 44 percent of investors in their 30s and 58 percent of investors in their 40s are on track to max out their contributions.
Of course, there are plenty of reasons why younger investors might have trouble saving $18,000 over the course of a year. Younger investors are likely to be making less, and may be saving for other, more immediate goals, like a car or a house—or struggling to pay off student loans.
Unfortunately, delaying saving for retirement will have huge costs down the line. The math is firmly on the side of those who start saving early. If you manage to start saving when you’re 25, and you save $7,000 a year, you’ll have about $1.9 million when you hit retirement age. However, if you max out your 401(k) starting when you’re 25, you’ll end up with almost $5 million. Thanks to the power of compounding, those early dollars—the ones you cannot easily spare when you’re just starting out—are worth much more than any catch-up contributions you might make when you’re in your 50s.
There is still hope though. If, for example, you can’t save much during your 20s, but you start to ramp up your savings in your 30s, you could still end up with more than $3 million by the time you retire. Check out some of these other good reads for more tips around saving for retirement:
An Individual Retirement Account can hold almost anything. Many investors like having wide-open options, but some investors find that much choice overwhelming. Some investors turn to an advisor to try to sort through the vast universe of funds and figure out what to buy. Unfortunately, that advice can be expensive.
SigFig data shows that investors who work with advisors are almost twice as likely to pay load fees for the mutual funds they own: 37% of IRA investors with an advisor pay load fees, compared to 21% of investors without an advisor.
A load fee is a fee paid on the purchase of a mutual fund. It is essentially a form of commission–a fee that goes to the advisor you have paid to help you choose a fund. These fees range widely. The average IRA investor pays 0.46% in fees on their investments, but 28% pay 0.8% or more in total fees. That means a substantial number of investors are paying almost double the average in fees. And even small differences in fees can cut thousands of dollars out of your nest egg over the course of your investing lifetime.
Higher fees might be worth it if the pricier funds that advisors recommend outperformed the market. Unfortunately, they typically do not. Investors who use advisors in their IRAs are paying more, but they are not getting more: the median trailing 1-year net return for investors who use advisors is 1.2%, and the median return for investors who go it alone is 1.5%. Investors who have chosen their own investments are actually doing better than investors who have sought pricey advice. SigFig data has shown this consistently: pricier investments simply do not perform well enough to justify their fees.
SigFig’s analysis shows that some firms are more likely to charge certain types of fees than others. Ameriprise Financial, Edward Jones, and American Funds are at least three times as likely as the average firm to charge a sales commission or a type of fund marketing fee known as a 12b-1 fee.
Wherever the fee is coming from, it is hard to justify paying high fees on investments that simply do not outperform the broader market indices. If your advisor steers you towards expensive funds, it is time to ask a few questions about how they make their money and why they are not trying to control one of the only things you can control about your investments’ performance: how much they cost.
If you choose to work with an advisor, it is best to work with someone who is paid on a fee-only basis, or one that charges a small percentage of assets under management, such as a robo-advisor. Fee-only and robo-advisors do not make commissions from selling you pricey products. Look for advisors who hold themselves to a fiduciary standard, meaning they are legally bound to put your interests ahead of their own. Anyone who is not held to this standard can steer you towards investments that are broadly suitable for you, but not necessarily the best, or cheapest, possible option. As SigFig’s data proves, too many investors are already paying the price for bad advice.
Note: SigFig originally published this article on Daily Finance.
Most of us have occasionally daydreamed about early retirement. Have you gone a step further, crunching some numbers to figure out how much money you would need and cutting back on your spending so you can max out your savings rate?
How would early retirement actually work? How would you structure your investments to throw off income for 40 or 50 years? Here are five tips from financial advisors on how to prepare your portfolio for a long retirement:
1. Be ready to take some risk
If your money needs to last 40 or 50 years, it will have to keep growing after you retire. That means you will need to continue investing somewhat aggressively. The exact balance of stocks versus lower-risk investments will depend on your age and risk tolerance, but investment professionals recommend keeping a minimum of 50% of your portfolio in stocks, and some advise 70% or 80%. A risk questionnaire, such as the one by investment firm SigFig, can help you determine what portion of your portfolio should be in stocks, given your investment horizon and risk tolerance.
2. Keep some cash on hand
For younger retirees, financial planners recommend keeping about two years’ worth of living expenses in cash or short-term instruments like money market accounts or CDs. “You don’t want to get in a position where you’re selling into a down market just to maintain your standard of living,” Kresh says. Sitting on some cash will allow you to sell chunks of stocks when the market is strong, not when you have to pay the cable bill.
As for the balance of your portfolio–whatever is not in stocks or cash–the pros recommend shorter-term bonds for now, because interest rates are so low. “Even though the rate is not fair to savers, it’s still something to get a safe return and hedge the risk of the equity side of your portfolio,” says Mickey Cargile, the president of Cargile Investment Management.
3. Do not overspend
The general rule of thumb for someone living off an investment portfolio is to keep withdrawals to 4% a year. Some experts now say that even that is too high, but it is still a reasonable place to start, Cargile says. “Some years it’s going to erode your principal some, and some years it’s going to grow much more,” he says. “If you can withdraw less early on, that’s great,” Cargile adds. In those early years in particular, you still want your total portfolio to be growing faster than you are spending it.
4. Watch out for friends with investment ideas
This is a common trap for people who are successful early in life, says Michael Kresh, CFP, the chief investment officer of Creative Wealth Management: A friend or family member approaches them with a supposedly can’t-miss investment or business idea, and, overconfident because of that early success, they put too much money behind a risky venture. “You think because you’ve been successful early that you can understand other businesses that you have not been involved in,” Kresh says. Even a large nest egg will not last a lifetime if you start throwing money at ill-advised schemes.
5. Find something to do
Investment managers say that being emotionally prepared for retirement is a challenge for their clients at any age–and one that often takes people by surprise. “I think as human beings we weren’t meant to sit around and watch Jeopardy for 30 years,” Cargile says. Idleness may appeal now, when you are stuck in an office, but people who work with retirees say the ones who enjoy their retirement find a purpose for all that free time. “You need to have something to get up for,” says Roger Streit, a certified financial planner with Key Financial Solutions. Volunteering for an organization or cause you are passionate about is one good option, Streit says. “I think it definitely helps to have a cause, to be involved in giving back,” he says.
Retiring at 40 may be nothing more than a pipe dream for most of us, but even those of us who do not plan to retire early should plan for a long retirement. If you stop working at the traditional retirement age of 65, investment managers say you should plan to make your money last about 30 years. That may mean you will need to work, or work part-time, longer–or take some of the tips we just shared.
Note: SigFig originally published this article on Daily Finance.
To save or not to save for retirement is not the question. For most investors, the question that matters is which retirement savings strategy is more beneficial: Roth IRA or traditional IRA.
With a Roth IRA or 401(k), the investor pays taxes on contributions, but once they are 59 ½ or older, account withdrawals, including any gains, are tax-free. With a traditional IRA or 401(k), the investor puts off paying taxes on contributions until they begin making withdrawals. At that time, however, they pay taxes on their contributions and account earnings.
Which strategy makes more sense depends on the investor’s tax bracket and earnings potential, but that does not mean they have to choose one over the other. Thanks to a handful of different strategies, savers can get the benefits of both pre-tax contributions and tax-free gains.
Basic Considerations: Current Income & Future Earnings Potential
When choosing between contributing to a Roth or traditional account, the biggest factors to consider are the income limits for IRAs, your tax bracket, and your future earning potential.
Individual investors whose adjusted gross income (AGI) exceeds $71,000 (or $118,000 for married couples filing jointly) aren’t eligible to make tax-deductible IRA contributions. Individuals whose AGI is $61,000 or lower ($98,000 for married filing jointly) can take the full deduction for their IRA contributions in 2015.
There is one exception; investors who do not have an employer-sponsored retirement account at work qualify for tax-deductible contributions regardless of income.
Future earnings potential, on the other hand, plays a role choosing between Roth and traditional IRA options. A Roth IRA or 401(k) does not give you an upfront deduction, but the earnings grow and can be withdrawn tax-free. “Someone in an entry level job working on their MBA, who will have the opportunity to amass significant savings over time, is better off paying taxes upfront,” says Christine Benz, director of personal finance at Morningstar. But if you have already reached your peak earnings level and find yourself in a higher tax bracket than you believe you will be in upon retirement, the upfront deduction of a traditional IRA account may make more sense.
Mix and match to get the most out of an IRA
“If you put a thousand financial advisors in a room, [a third of them] will tell you to put everything in pre-tax [accounts] and a third will tell you to put it in a Roth. I’m in the camp [that says] do a little of both,” says Larry Rosenthal, a Certified Financial Planner and president of Rosenthal Wealth Management Group.
Additionally, as your tax bracket and income can change over time, so too should the way you save for retirement.
Most people in the 25-to-35 year age range are typically on the lower side of their potential earnings and may benefit from a Roth IRA, says Rosenthal. The ideal time to begin saving in a traditional IRA is once an investor moves to a higher tax bracket (assuming they still qualify for the deduction), so they can take advantage of a bigger write-off.
401(k) considerations: Roth or Traditional
Increasingly, employers are beginning to offer a Roth option within their 401(k) plans. This can be a boon to investors who are phased out of Roth IRA contributions, but believe that their tax bracket will be higher in retirement. “The Roth 401(k) doesn’t have any income restrictions, so it’s a good way to get some tax-free growth if you can’t contribute to a Roth IRA,” says Robert Brokamp, senior advisor at The Motley Fool.
Backdoor IRA rollover
Roth IRAs have income eligibility requirements that may disqualify higher earners from contributing:
Roth IRA eligibility for 2015:
- Individuals with AGI between $116,000 and $131,000 and married couples filing jointly who earn between $183,000 and $193,000 qualify for a reduced contribution.
- Those with AGI higher than the upper limits above do not qualify for Roth contributions.
One way around those requirements is a backdoor Roth IRA. With this strategy, investors contribute to a traditional nondeductible IRA, which is available to anyone regardless of income, and then convert that to a Roth.
There is, however, a caveat to this strategy for investors who already have assets in a traditional or rollover IRA (with assets that have not yet been subject to taxation); the taxable portion of the conversion will be prorated over all IRA assets. In order to take advantage of the backdoor Roth conversion, the investor will need to convert all other IRA accounts to Roth. This may present an investor who has a large pre-tax IRA balance (including any rollover IRAs) with a sizable tax bill. Before taking any steps, it’s best to consult with a tax professional, such as a CPA.
How are you doing, financially? Are you satisfied with the state of your finances?
Think about your answer to that question and what drove it. If you are like most people, you were probably thinking about your day-to-day financial health — your ability to pay your bills and buy the occasional movie ticket or latte.
A recent study from the Center for Retirement Research at Boston College found that people’s subjective assessments of their own finances are based on those day-to-day measures. That’s true even for people who are financially literate. Having a little financial education makes you slightly more likely to worry about not having a retirement plan at all, but it makes you no more likely to worry about having an inactive retirement plan that you’re not currently contributing to. As long as you can pay your rent or mortgage, not putting money away for the future won’t trouble you.
In other words, you can’t count on yourself to worry enough about retirement to actually prepare for it. It’s just too far away to focus on. It is better to automate your savings, so you only have to think about it once. Here are three simple steps you can take to make investing automatic:
1. Max out your contribution to your 401(k).
Most savers don’t manage the maximum allowable 401(k) contribution of $18,000. In fact, average deferral rates have actually fallen in the past few years, partly because most plans that automatically enroll workers start them off saving just 3 percent of their paychecks. Check your own deferral rate, and max out if you possibly can.
2. Add an IRA.
If you are already maxing out your 401(k) and you have some more wiggle room in your budget, consider setting up an IRA or Roth IRA. You can save another $5,500 a year this way. Figure out how much you can contribute to this account, and look into setting up an automatic investment plan. Most funds will waive minimum initial contribution requirements if you use this option, so you don’t need a lot of cash on hand to start an account, and you won’t have to keep remembering to contribute in the future.
3. Automate your contributions to your regular brokerage account.
Don’t wait until the end of the quarter, or the end of the year, to decide how much you can afford to put away. Assuming you have already funded an emergency account and have all your monthly bills covered, why let money languish in an ordinary savings account, earning today’s meager interest rates, when you could invest it and put it to work for you? By setting up an automated contribution to your brokerage account every month, you won’t be tempted to spend the money, and you will take emotion out of your decision to invest. The money will automatically flow into whatever asset allocation you have decided is best for your long-term goals.
As long as you make sure to choose low-fee options in each of these accounts, set it and forget it is the best way to save. You can’t count on worry to motivate you, so you should instead take responsibility for your retirement saving out of your own fallible hands.
The end of the year is always a good time to go over your finances and make sure you’re on track to meet your financial goals. It’s time to make plans for the upcoming year–but also to make sure you’ve done everything you can this year to get on a sound financial footing for the future.
One thing you probably haven’t done is max out your 401(k). Most people don’t. According to Vanguard’s annual How America Saves report, only 12% of retirement plan participants maxed out their contributions in 2013, and only 14% of savers over 50 who had the opportunity to make additional “catch-up” contributions took advantage of it.
It won’t come as a surprise that older and more affluent investors are more likely to maximize their 401(k) savings. In a recent data analysis of data from investors who track their portfolios with SigFig, we found that 60% of 40 to 49-year-old investors are on track to contribute at least $17,500 to their 401(k) plans in 2014 (the maximum contribution limit this year, though the amounts in the analysis include employer matching contributions, where applicable), compared to 24% of investors in their 20s. At the same time, only 8% of investors with household income of $50,000 or lower were maxing out contributions, compared to more than 67% of investors earning $200,000 or more.
But maxing out your 401(k) isn’t the only way to maximize it and the end of the year is just the right time to do that. If you’ve set up automatic deferrals and then forgotten all about your 401(k), now is the time to see how much you’re really saving, how close you are to your goals, and whether you need to make any changes to maximize your savings and minimize your costs.
Here are eight ways to get there:
1. Getting a bonus or a raise? Pay yourself first.
If you get a bonus this year, consider contributing some or most of it to your 401(k). Same if you’re getting a raise: pay yourself before you’re tempted to spend it.
Some plans will automatically treat your bonus the same as your base pay, deferring the same percentage as is usually taken from your salary. Others won’t. Ask your HR department or plan administrator how yours will be treated. Just don’t accidentally go over the maximum 401(k) contribution limit for the year — you’ll end up being taxed on that money twice.
2. Put your last paycheck (or two) straight into the plan.
Giving cash for the holidays may make Emily Post cringe, but being on the receiving end of a cash gift isn’t so bad. If you have some cash to spare, why not put your last check or two for the year into your 401(k) plan? Call your HR department or 401(k) plan manager and have them temporarily bump up your contribution percentage. You can go as high as 100% of your pay, as long as you stay under the maximum for the year. You can scale that amount back down later.
3. Learn from last year’s tax return.
Why worry about taxes now when you have until April next year to file for 2014? If you got a tax refund this April, that means your withholding is too high. You can change it so you’re paying less in taxes with each paycheck going forward and — this is key — start putting that money in your 401(k) now. The result: instead of giving an interest-free loan to the IRS, you’ll be putting that money to work for you right away.
4. Are you eligible for the Saver’s Credit?
If you earned less than $30,000 in 2014 as an individual (or $61,000 as a married couple filing jointly, or $45,000 as a head of household), you’ll be able to claim a tax credit on up to $2,000 ($4,000 for married couples filing jointly) contributed to a 401(k) or IRA. Your income may not allow you to max out your 401(k) contributions, but you will get a little bit of help in the form of the Saver’s Credit. Make sure you claim it.
5. Review your 401(k) contribution level.
If you were automatically enrolled in your plan, check how much you’re actually saving. Most plans with automatic enrollment set deferral rates at 3%, and that’s low. Increase that rate if you can.
Think you’re still too young to be concerned about retirement savings and have other bills to worry about? It’s hard to save when you’re young and you’re not earning much yet. But every dollar you put away today will likely be worth much more than a dollar you put away ten or twenty years from now, because it has more time to grow.
6. Review your 401(k) fund choices and expenses.
Do you know how much you’re paying in fees on your 401(k) investments? Analyzing fees in investors’ 401(k) accounts, we found that the average user was paying more than they needed to. In other words, while most plans have low-cost options available, many investors aren’t taking advantage of them.
7. Maximize your 401(k) company match.
It’s the 401(k) advice you see everywhere: If your employer offers a matching contribution, make sure you’re saving enough to get all of it. It’s free money. Go get it. And if your employer doesn’t offer a match, it’s time to ask for one. According to a recent survey by Aon Hewitt, 98% of employers who offer a 401(k)-type plan offer an employer match. If your employer doesn’t do this, they’re behind the times, and that’s a competitive disadvantage.
8. Maxed out your 401(k)?
Congratulate yourself for a job well done this year! But don’t stop there. It’s time to talk to an accountant or simply research your IRA or Roth IRA contribution eligibility. Consider it a gift to your future self.