MONEY 401(k)s

The Painless Way New Grads Can Reach Financial Security

150612_FF_GradPainfreeSecurity
Steve Debenport—Getty Images

You don’t need to be sophisticated. You don’t need to pick stocks. You don’t need to understand diversification or the economy. You just need to do this one simple thing—now.

A newly minted class of college graduates enters the work world this summer in what remains a tough environment for young job seekers. Half of last year’s graduates remain underemployed, according to an Accenture report. Yet hiring is up this year, and as young people land their first real job they might keep in mind a critical advantage they possess: time, which they have more of than virtually everyone else and can use to build financial security.

Saving early is a powerful force. But it loses impact with each year that passes without getting started. You don’t need to be sophisticated. You don’t need to pick stocks. You don’t need to understand diversification or the economy. You just need to begin putting away 10% of everything you make, right away. And 15% would be even better.

Consider a worker who saves $5,000 a year from age 25 to 65 and earns 7% a year. Not allowing for expenses and taxes, this person would have $1.1 million at age 65. Compare that to a worker who starts saving at the same pace at age 35. This worker would amass half that total, just $511,000. And now for the clincher: If the worker that started at age 25 suddenly stopped saving at age 35, but left her savings alone to grow through age 65, she would enjoy a nest egg of $589,000—more than the procrastinator who started at age 35 and saved for 30 more years.

That is the power of compounding, and it is the most important thing about money that a young worker must understand. Those first 10 years of a career fly by quickly and soon you will have lost the precious early years of saving opportunity and squandered your advantage. That’s why, if possible, I advise parents to get their children started even before college.

Once you start working, your employer will almost certainly offer a 401(k) plan. More than 80% of full-time workers have access to one. This is the easiest and most effective way to get started saving immediately. Here are some thoughts on how to proceed:

  • Enroll ASAP Some companies will allow you to enroll on your first day while others require you to be employed for six months or a year. Find out and get started as soon as possible. Most people barely feel the payroll deductions; they quickly get used to making ends meet on what is left.
  • Have you been auto enrolled? Increasingly, employers automatically sign you up for a 401(k) as soon as you are eligible. Some also automatically increase your contributions each year. Do not opt out of these programs. But look at how much of your pay is being deferred and where it is invested. Many plans defer just 3% and put it in a super safe, low-yielding money market fund. You likely are eligible to save much more than that and want to be invested in a fund that holds stocks for long-term growth.
  • Make the most of your match A big advantage of saving in a 401(k) is the company match. Many plans will match your contributions dollar for dollar or 50 cents on the dollar up to 6% of your salary. This is free money. Make sure you are contributing enough to get the full match.
  • Keep it simple Choosing investment options are where a lot of young workers get hung up. But it’s really simple. Forget the noise around large-cap and small-cap stocks, international diversification, and asset allocation. Most plans today offer a target-date fund that is the only investment you’ll ever need in your 401(k) plan. Choose the fund dated the year you will turn 65 or 70. The fund manager will handle everything else, keeping you appropriately invested for your age for the next 40 years. In many plans, such a target-date fund is the default option if you have been automatically enrolled.
  • Take advantage of a Roth Some plans offer a Roth 401(k) in addition to a regular 401(k). Divide your contributions between both. They are treated differently for tax purposes and having both will give you added flexibility in retirement. With a Roth, you make after-tax contributions but pay no tax upon withdrawal. With a regular 401(k), you make pre-tax contributions but pay tax when you take money out. The Roth is most effective if your taxes go up in retirement; the regular 401(k), if your taxes go down. Since it’s hard to know in advance, the smart move is to split your savings between the two.
  • Get help An increasing number of 401(k) plans include unbiased, professional third-party advice. This may be via online tools, printed material, group seminars, or one-on-one sessions. These resources can give you the confidence to make decisions, and according to Charles Schwab young workers that seek guidance tend to have higher savings rates and better ability to stay invested for the long haul in tough times.

Read next: 6 Financial Musts for New College Grads

 

 

MONEY Retirement

What Italy and Germany Show Us About the Future of Social Security

woman holding Italian and German flags
Shutterstock

Families, not government, may be what rescues retirement.

One of the big questions facing retirement planners is how much to count on Social Security in the decades ahead. The number of Americans past age 65 will double by 2050, part of the longevity revolution that threatens to leave Social Security insolvent by 2033.

That doesn’t mean benefits would stop abruptly. Under the current system, enough funding would be in place to continue benefits at 77% of the promised level. Of course, anything is possible if laws change. But cuts probably are coming.

Most Americans get that. Among those that have not yet retired, just 20% believe they will receive full benefits when they retire, according to a Pew Research report. Some 31% expect reduced benefits and 41% expect no benefits at all. Presumably, these findings skew along age lines. Most experts believe benefits adjustments will be phased in. Those currently 55 or older likely will see minimal change to their benefits while those under 30 likely will see big change.

The longevity revolution is a global phenomenon, and government pensions are in trouble around the world. Two of the oldest nations on the planet are Germany and Italy and, demographically speaking, they are now where the U.S. will be in 35 years: a fifth of their population is older than age 65. If you think Americans are glum about prospects for collecting Social Security, these nations offer a glimpse of what’s coming.

In Germany, just 11% think they will receive benefits at current levels, 45% think they will receive benefits at reduced levels and 41% expect to get no benefits at all, Pew found. In Italy, only 7% believe they will get full benefits, 29% expect benefits at reduced levels and 53% think they will get no benefits at all. Interestingly, Germans and Italians are twice as likely as Americans to believe this is primarily a problem for government to solve. In the U.S., there is a strong belief that this is a problem for families and individuals to fix, Pew found.

Just 23% of Italians are putting anything away for retirement, vs. 56% of Americans and, perhaps because austerity is in their DNA, 61% of Germans. The most important statistic, though, may be the percentage of young adults (ages 18-29) that are saving. This is the group most likely to see reduced or no benefits in retirement but which still has 40 years or more to let savings grow. In the U.S., 41% of young adults are saving for retirement. In Germany, the figure is 44%. In Italy, just 13% are saving.

What will fill the gaps? Pew found a strong sense of families as backstops in all three countries. Nearly nine in 10 Italians view financial assistance for an aging parent in need as their responsibility. The figure is 76% in the U.S. and 58% in Germany. This sense runs deepest among young adults, perhaps because their parents are now assisting them through an extended period of dependence known as emerging adulthood.

In all three countries, financial help is more likely to flow down to adult children than up to aging parents: about half or more of adults with grown children have helped them financially in the last 12 months. That many or more have assisted grown children in non-monetary ways as well, helping with errands, housework, home repairs or child care. The vast majority says this assistance is more rewarding than stressful; they value the time together.

So family support looms as a large part of future retirement security for many people in graying nations, and that’s fine for families with the wherewithal. But young adults, especially, don’t have to feel victimized by the decline of government pensions. They have many opportunities for tax-advantaged saving through an IRA or 401(k) plan, and decades to let compound growth solve their problems. Workers past 50 can take advantage of catch-up contributions, and for guaranteed lifetime income use a portion of their savings to buy a fixed annuity. Like it or not, personal savings is the key to retiring comfortably—self security in place of Social Security.

 

 

MONEY 401(k)s

The Big Mistake That Most 401(k) Savers Are Making

uneven balance with money on each side
iStock

The average 401(k) plan balance has risen to $100,000. But most workers fail to rebalance, so risks are rising too.

When it comes to saving in your 401(k), doing nothing can often work wonders.

As a recent survey by Aon Hewitt found, some 79% of workers who are eligible for a 401(k) or similar plan are participating, thanks in large part to the do-nothing magic of automatic enrollment. It’s the highest level since at least 2002, when the firm started tracking participation rates. This steady saving helped push account balances to a record high of $100,320 last year, up 10% from 2013.

Still, 401(k) inertia has a downside too. As the survey shows, most workers aren’t paying attention to the investments they hold, which increases the odds they will fall short of their retirement goals.

Take those record balances. Truth is, that 10% growth rate is relatively sluggish, which suggests many participants are invested in an ultra-conservative manner. The S&P 500 stock index jumped 13.5% in 2014, while Treasury bonds produced a 10.75% return. Moreover, only 24% of participants increased the amount they save each pay period, Aon Hewitt found. So even with additional cash going in, the average balance did not keep pace with either the stock market or the bond market.

Granted, a portion of that slow growth can be explained by regular distributions and early withdrawals. Last year, 3.6% of participants took regular withdrawals, up slightly from 3.5% the previous year, the Investment Company Institute reports. Meanwhile, 1.7% took a hardship withdrawal and at year-end 17.9% had a plan loan outstanding, ICI says. But a bigger issue probably has to do with participants leaving too much money in short-term money market accounts. In a lot of plans with automatic enrollment, the money goes into cash accounts that yield well under 1%.

Looking beyond account balances, Aon Hewitt’s data highlights another worrisome trend—only 15% of 401(k) savers did any sort of rebalancing last year, one of the lowest trading rates on record. Rebalancing is a fundamental aspect of long-term investing. Say your target asset mix is 60% stocks, 30% bonds and 10% cash. Once a year you should sell just enough of the funds that grow fastest (lately, stocks)— and add enough to the laggards (cash and bonds)—to restore your target mix. This time-tested strategy ensures you will buy low and sell high over the long haul and maintain the right level of risk in your portfolio.

Two years ago, stocks rose 32% and bonds fell 9%. The prudent move would have been to sell some stocks and buy some bonds, which would have let you benefit from the bond market’s rally last year. Stocks also rose last year by 13.7%. So if you haven’t rebalanced in the past two years, you probably hold a lot more in stocks than you originally intended, which means you may suffer worse-than-expected losses when the next bear market arrives.

The low level of rebalancing activity is only partly explained by the stunning rise of target-date funds, which automatically adjust holdings as you age. About 70% of 401(k) plans offer target-date funds and 75% of plan participants invest in them, according to T. Rowe Price. Stripping those and similar funds out, Aon still found that only 19% of participants rebalanced.

Add it all up, and it’s clear that workers now realize that they must save, and they want to know more about managing their money. But many are held back by inertia and concerns that they don’t know what they are doing. That’s why most heartily embrace plan features like automatic enrollment and automatic escalation of contributions. Aon Hewitt says workers would also benefit from better access to online tools and advice, and a simplified lineup of investment options.

The Holy Grail, though, may be a guaranteed lifetime income product, such as a deferred fixed annuity (for a portion of your portfolio), inside all defined contribution plans. These reduce the risk of failing to rebalance while giving workers something most sorely lack—an income stream other than Social Security that will never run out. Slowly, these income products are coming, Aon Hewitt says, as leading-edge companies better understand the laws and their responsibilities for what is a fairly new investment option.

Read next: How the New-Model 401(k) Can Boost Your Retirement Savings

MONEY health insurance

Why Too Many Health Insurance Choices Are Costing You Money

pills
David Malan—Getty Images

Consumers are bewildered by dozens of health plan options—and they're making expensive mistakes. Insurers could learn from 401(k) plans.

It’s time for health insurance plans to take a page out of 401(k) playbooks. People need simpler choices, as well as guidance that will nudge them toward the best plan for their needs.

That’s what 401(k)s are designed to do—though it took years for plans to evolve. As the traditional employer-managed defined benefit pension began to disappear, the early generations of 401(k)s and other defined contribution plans presented workers with new and complicated sets of investment choices.

Employees were so overwhelmed that many did nothing, leading Congress to pass reform laws to simplify 401(k) decisions, including providing default plan choices and using auto-enrollment—putting employees into plans unless they opt out. Today many employers are going a step further by turning 401(k)s into pension-like plans, removing the need for decisions unless workers choose to make them.

But health insurance is still stuck in an old-school 401(k) world. Obamacare exchanges have created extensive menus of plan choices that many consumers don’t understand. The exchange concept has also become popular among employer plans for both current workers and retirees. Exchange providers, led by big employee-benefits firms, are signing up lots of health insurers to offer employers and their workers extensive sets of plan choices.

The confusion extends to Medicare, as consumers are often required to choose among 30, 40 or more Medicare Advantage plans or Part D prescription drug plans. They are simply overmatched by the task, research shows.

As with 401(k)s, the primary problem consumers face with health insurance choices is that they don’t understand how the policies work, studies show. Nor do they understand the industry jargon—in the case of health insurance, that may mean even basic terms like deductibles and co-payments.

Consider this alarming study: A Fortune 100 company offered 48 new health insurance plans to more than 50,000 employees. All of the plans were offered by the same health insurer and offered identical coverage. They differed only by premiums, deductibles and other cost-sharing variables.

In roughly 80% of their selections, workers made bad decisions—opting for the low-deductible but high-premium plans that cost them more money yet provided no additional insurance protection. Lower-income and female employees made particularly bad choices.

The amounts of wasted money often equaled 40% or more of the employee’s annual premium expenses. Employees who chose low-deductible plans paid $631 more on average in premiums, but saved only $259 a year in out-of-pocket costs compared with available higher-deductible plans.

Even more discouraging, when researchers went back and told employees about their mistakes, it had very little effect. More than 70% of employees did not understand insurance well enough to make an informed choice. Further, it had never occurred to the workers that their employer would include lousy choices in its plan offerings, the researchers found.

Improving insurance literacy is crucial in helping employees understand how to make better choices. But as behavioral research with 401(k)s has shown, the most effective solution is to reduce the number of plan choices and their complexity.

“The promise of recent reforms that expand choice and aim to increase provider competition is premised on the assumption—challenged by our research—that enrollees will make sensible plan choices,” the researchers concluded.

So how can you be a better health care consumer? Justin Sydnor, one of the researchers and an economist at the University of Wisconsin business school, suggests the dreaded school math-class crucible: the story problem. First consider how much you expect to spend on health care. Then calculate whether your total payments would be higher with a low-deductible plan or a high-deductible plan. Asking people to compare premiums with out-of-pocket expenses helped set his research subjects on the right course.

If you’re not sure how to estimate your future health care spending (and that’s true for most people), run several calculations based on varying medical costs, Syndor says. For example, what would your out-of-pocket costs be if your health expenses were, say, $2,000 or $5,000 or $10,000 over the next year? You also can seek help from their employer’s health plan administrator or from the free counseling available for Obamacare and Medicare enrollees.

Philip Moeller is an expert on retirement, aging, and health. He is co-author of The New York Times bestseller, “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” and is working on a companion book about Medicare. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: Americans with Obamacare Are Still Afraid of Big Medical Bills

MONEY 401(k)s

How the New-Model 401(k) Can Help Boost Your Retirement Savings

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Betsie Van Der Meer—Getty Images

As old-style pensions disappear, today's hands-off 401(k)s are starting to look more like them. And that's working for millennials.

If you want evidence that the 401(k) plan has been a failed experiment, consider how they’re starting to resemble the traditional pensions they’ve largely replaced. Plan by plan, employers are moving away from the do-it-yourself free-for-all of the early 401(k)s toward a focus on secure retirement income, with investment pros back in charge of making that happen.

We haven’t come full circle—and likely never will. The days of employer-funded, defined-benefit plans with guaranteed lifetime income will continue their three-decade fade to black. But the latest 401(k) plan innovations have all been geared at restoring the best of what traditional pensions offered.

Wall Street wizards are hard at work on the lifetime income question. Nearly all workers believe their 401(k) plan should have a guaranteed income option and three-in-four employers believe it is their responsibility to provide one, according to a BlackRock survey. So annuities are creeping into the investment mix, and plan sponsors are exploring ways to help workers seamlessly convert some 401(k) assets to an income stream upon retiring.

Meanwhile, like old-style pensions, today’s 401(k) plans are often a no-decision benefit with age-appropriate asset allocation and professionally managed investment diversification to get you to the promised land of retirement. Gone are confusing sign-up forms and weighty decisions about where to invest and how much to defer. Enrollment is automatic at a new job, where you may also automatically escalate contributions (unless you prefer to handle things yourself and opt out).

More than anything, the break-neck growth of target-date funds has brought about the change. Some $500 billion is invested in these funds, up from $71 billion a decade ago. Much of that money has poured in through 401(k) accounts, especially among our newest workers—millennials. They want to invest and generally know they don’t know how to go about it. Simplicity on this front appeals to them. Partly because of this appeal, 40% of millennials are saving a higher percentage of their income this year than they did last year—the highest rate of improvement of any generation, according to a T. Rowe Price study.

With a single target-date fund a saver can get an appropriate portfolio for their age, and it will adjust as they near retirement and may keep adjusting through retirement. About 70% of 401(k) plans offer target-date funds and 75% of plan participants invest in them, according to T. Rowe Price. The vast majority of investors in target-date funds have all their retirement assets in just one fund.

“This is a good thing,” says Jerome Clark, who oversees target funds for T. Rowe Price. Keeping it simple is what attracts workers and leads them to defer more pay. “Don’t worry about the other stuff,” Clark says. “We’ve got that. All you need do is focus on your savings rate.”

Even as 401(k) plans add features like auto enrollment and annuities to better replace traditional pensions, target-date funds are morphing too and speeding the makeover of the 401(k). These funds began life as simple balanced funds with a basic mix of stocks, bonds and cash. Since then, they have widened their mix to include alternative assets like gold and commodities.

The next wave of target-date funds will incorporate a small dose of illiquid assets like private equity, hedge funds, and currencies, Clark says. They will further diversify with complicated long-short strategies and merger arbitrage—thus looking even more like the portfolios that stand behind traditional pensions.

This is not to say that target-date funds are perfect. These funds invest robotically, based on your age not market conditions, so your fund might move money at an inopportune moment. Target-date funds may backfire on millennials, who have taken to them in the highest numbers. Because of their age, millennials have the greatest exposure to stocks in their target-date funds and yet this generation is most likely to tap their retirement savings in an emergency. What if that happens when stock prices are down? Among still more concerns, one size does not fit all when it comes to investing. You may still be working at age 65 while others are not. That calls for two different portfolios.

But the overriding issue is that Americans just don’t save enough and a reasonably inexpensive and relatively safe investment product that boosts savings must be seen as a positive. With far less income, millennials are stashing away about the same percentage of their earnings as Gen X and boomers, according to T. Rowe Price. That’s at least partly thanks to new-look 401(k)s and the target-date funds they offer.

Read next: 3 Ways to Build a $1 Million Nest Egg Despite Lower Investment Returns

MONEY retirement planning

3 Ways to Build a $1 Million Nest Egg Despite Lower Investment Returns

Andy Roberts/Getty Images

Whether your retirement goal is six figures or seven figures, it's harder to achieve in today's market—unless you have a plan.

A new Transamerica Center for Retirement Studies survey found that $1 million is the median savings balance people estimate they’ll need for retirement. And many savers have been able to reach or exceed that goal, according a report last year by the Government Accountability Office showing that some 630,000 IRA account owners have balances greater than $1 million.

But most of these people accumulated those hefty sums in an era of generous investment returns. Between 1926 and 2014, large-company stocks gained an annualized 10.1%, while intermediate-term government bond returned 5.3% annually, according to the 2015 Ibbotson Classic Yearbook. During the go-go ’90s annualized gains were even higher—18.2% for stocks and 7.2% for bonds. Today, however, forecasts like the one from ETF guru Rick Ferri call for much lower gains, say, 7% annualized for stocks and 4% or so for bonds. Which makes building a seven-figure nest egg more of a challenge.

Still, the goal remains doable, if you go about it the right way. Here are three steps that can increase your chances of pulling it off.

1. Get in the game as early as possible—and stay in as long as you can. The more years you save and invest for retirement, the better your chances of building a big nest egg. Here’s an example. If you’re 25, earn $40,000 a year, receive annual raises of 2% during your career and earn 5% a year after expenses on your savings—a not-too-ambitious return for a diversified portfolio of stocks and bonds—you can accumulate a $1 million account balance by age 65 by saving a bit more than 15% of salary each year. That’s pretty much in line with the recommendation in the Boston College Center For Retirement Research’s “How Much Should People Save?” study.

Procrastinate even a bit, however, and it becomes much tougher to hit seven figures. Start at 30 instead of 25, and the annual savings burden jumps to nearly 20%, a much more challenging figure. Hold off until age 35, and you’ve got to sock away more a far more daunting 24% a year.

Of course, for a variety of reasons many of us don’t get as early a start as we’d like. In that case, you may be able to mitigate the savings task somewhat by tacking on extra years of saving and investing at the other end by postponing retirement. For example, if our hypothetical 25-year-old puts off saving until age 40, he’d have to sock away more than 30% a year to retire at 65 with $1 million. That would require a heroic saving effort. But if he saved and invested another five years instead of retiring, he could hit the $1 million mark by socking away about 22% annually—still daunting, yes, but not nearly as much as 30%. What’s more, even if he fell short of $1 million, those extra years of work would significantly boost his Social Security benefit and he could safely draw more money from his nest egg since it wouldn’t have to last as long.

2. Leverage every saving advantage you can. The most obvious way to do this is to make the most of employer matching funds, assuming your 401(k) offers them, as most do. Although many plans are more generous, the most common matching formula is 50 cents per dollar contributed up to 6% of pay for a 3% maximum match. That would bring the required savings figure to get to $1 million by 65 down a manageable 16% or so for our fictive 25-year-old, even if he delayed saving a cent until age 30. Alas, a new Financial Engines report finds that the typical 401(k) participant misses out on $1,336 in matching funds each year.

There are plenty of other ways to bulk up your nest egg. Even if you’re covered by a 401(k) or other retirement plan, chances are you’re also eligible to contribute to some type of IRA. (See Morningstar’s IRA calculator.) Ideally, you’ll shoot for the maximum ($5,500 this year; $6,500 if you’re 50 or older), but even smaller amounts can add up. For example, invest $3,000 a year between the ages of 25 and 50 and you’ll have just over $312,000 at 65 even if you never throw in another cent, assuming a 5% annual return.

If you’ve maxed out contributions to tax-advantaged accounts like 401(k)s and IRAs, you can boost after-tax returns in taxable accounts by focusing on tax-efficient investments, such as index funds, ETFs and tax-managed funds, that minimize the portion of your return that goes to the IRS. Clicking on the “Tax” tab in any fund’s Morningstar page will show you how much of its return a fund gives up to taxes; this Morningstar article offers three different tax-efficient portfolios for retirement savers.

3. Pare investment costs to the bone. You can’t force the financial markets to deliver a higher rate of return, but you can keep more of whatever return the market delivers by sticking to low-cost investing options like broad-based index funds and ETFs. According to a recent Morningstar fee study, the average asset-weighted expense ratio for index funds and ETFs was roughly 0.20% compared with 0.80% for actively managed mutual funds. While there’s no assurance that every dollar you save in expenses equals an extra dollar of return, low-expense funds to tend to outperform their high-expense counterparts.

So, for example, if instead of paying 1% a year in investment expenses, the 25-year-old in the example above pays 0.25%—which is doable with a portfolio of index funds and ETFs—that could boost his annual return from 5% to 5.75%, in which case he’d need to save just 13% of pay instead of 15% to build a $1 million nest egg by age 65, if he starts saving at age 25—or just under 22% instead of 24%, if he procrastinates for 10 years. In short, parting investment expenses is the equivalent of saving a higher percentage of pay without actually having to reduce what you spend.

People can disagree about whether $1 million is a legitimate target. Clearly, many retirees will need less, others will require more. But whether you’ve set $1 million as a target or you just want to build the largest nest egg you can, following the three guidelines will increase your chances of achieving your goal, and improve your prospects for a secure retirement.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY Personal Finance

Oh No! Needing a Fridge, Rubio Raids Retirement Account

Larry Marano/Getty Images

Dipping into retirement savings to fund an everyday expense is a common but costly error.

If Florida Sen. Marco Rubio intends to lead by example, he’s off to a rocky start. The Republican presidential hopeful raided his retirement account last September, in part to buy a new refrigerator and air conditioner, according to a recent financial disclosure and comments on Fox News Sunday.

In liquidating his $68,000 American Bar Association retirement account, Rubio showed he’s no Mitt Romney, whose IRA valued at as much a $102 million set tongues wagging coast to coast during the last presidential cycle. Rubio clearly has more modest means, which is why—like most households—if he doesn’t already have an emergency fund equal to six months of fixed living expenses he should set one up right away.

He told Fox host Chris Wallace: “It was just one specific account that we wanted to have access to cash in the coming year, both because I’m running for president, but, also, you know, my refrigerator broke down. That was $3,000. I had to replace the air conditioning unit in our home.”

Millions of Americans treat their retirement savings the same way Rubio did in this instance, raiding a 401(k) or IRA when things get tight. Sometimes you have no other option. But most of the time this is a mistake. Cash-outs, early withdrawals, and plan loans that never get repaid reduce retirement wealth by an average of 25%, reports the Center for Retirement Research at Boston College. Money leaking out of retirement accounts in this manner totals as much as $70 billion a year, equal to nearly a quarter of annual contributions, according to a HelloWallet survey.

Rubio’s brush with financial stress from two failed appliances probably won’t set him too far back. He has federal and state retirement accounts and other savings. And let’s face it: The whole episode has an appealing and potentially vote-getting Everyman quality to it. Still, it is not a personal financial strategy you want to emulate.

 

 

MONEY Ask the Expert

How to Get a Double Dose of Tax-Deferred Savings

Investing illustration
Robert A. Di Ieso, Jr.

Q: When I turn 70½ I’m required to start withdrawing funds from my 401(k) and pay taxes on it. I don’t need this money to live on. Is it too risky for me to invest it? – Dolores

A: What you’re referring to are required minimum distributions (RMD), which generally begin in the calendar year after you turn 70½.

Even if you can afford to keep your money parked in your retirement plans, the Internal Revenue Service insists that you start withdrawing money annually from your retirement accounts once you reach a certain age.

“It typically starts at 3% to 4% of the value of your account and goes up from there,” says Gretchen Cliburn, a certified financial planner with BKD Wealth Advisors headquartered in Springfield, Mo. You can estimate your RMD using a worksheet from the IRS.

Fail to withdraw the minimum and you’ll face a hefty penalty – 50% on the amount that should have been withdrawn, plus regular income taxes.

“Where things can get confusing is if you have multiple accounts,” says Cliburn. “I recommend consolidating accounts so you avoid missing an RMD.”

To add to the confusion, you can take your first distribution the year you turn 70½, or postpone it until April 1 the following calendar year – though you’ll need to take double the distributions that year. Likewise, if you’re still working, you’ll need to take RMDs on your IRAs, but you can delay taking distributions on your 401(k) or other employer-sponsored plan until the year after you retire.

Now, what should you do with that distribution?

“The answer really depends on your situation and your goals for that money,” says Cliburn. “Will you use it to support your lifestyle over the next 10 or 20 years, or do you want it to go to future generations?”

“If you want to hang onto those funds, your best bet is to open a taxable investment account and divide the distributions into three buckets,” she says. One bucket can be cash; another bucket might go into a balanced mutual fund, which owns stocks and bonds; the final bucket might go to a tax-efficient exchange-traded stock fund, such as one that tracks the S&P 500.

Just how much goes into each bucket depends on your other sources of income. “If you have a guaranteed source of income, you may feel more comfortable taking on a little more risk,” says Cliburn.

If you’re absolutely certain that you won’t need these required minimum distributions to live on — and that you have other funds to cover your retirement living expenses — then you could use the distributions to help others, and possibly get some tax savings.

You need earned income to contribute to a Roth IRA. But you could, for example, help your children fund a Roth IRA (assuming they qualify). You can gift any individual up to $14,000 a year before you have to file a gift tax return. They’ll make after-tax contributions to the Roth, but the money will grow tax-deferred. Withdrawals of principal are tax-free — provided the account has been open at least five years — and all withdrawals are tax free after the account holder turns 59½.

Another option is to open or contribute to a 529 college savings plan. The money grows tax-deferred and withdrawals for qualified education expenses are exempt from federal and state tax. Depending on where you or your children live, there may be a state tax deduction to boot.

A tax-free charitable transfer is another possibility, though you’ll need to wait to see if so-called qualified charitable contributions, or QCDs, are renewed for the 2015 tax year. Taxpayers didn’t hear about last year’s renewal until December.

Assuming it’s a go, it’s a sweet deal. Last year, IRA owners age 70½ or over were able to directly transfer up to $100,000 per year from their accounts to eligible charities, sans tax.

MONEY Financial Education

The Surprising New Company Benefit That’s Helping Americans Retire Richer

chalkboard with graph showing increase in money over time
Oleg Prikhodko—Getty Images

Financial education at the office is booming—and none too soon.

Like it or not, the job of educating Americans about how to manage their money is falling to the corporations they work for—and new research suggests that many of those employers are responding.

Some 83% of companies feel a sense of responsibility for employees’ financial wellness, according to a Bank of America Merrill Lynch Workplace Benefits Report, which found the vast majority of large companies are investing in financial education programs. Among other things, companies are using the annual fall benefits re-enrollment period to talk about things like 401(k) deferral rates and asset allocation, and enjoying impressive results.

Workers are responding to other programs too. Another Merrill report found that retirement advice group sessions in the workplace rose 14% last year and that just about all of those sessions resulted in a positive outcome: employees enrolling in a 401(k) plan, increasing contributions, or signing up for more advice. Calls to employer-sponsored retirement education centers rose 17.6% and requests for one-on-one sessions more than doubled.

So a broad effort to educate Americans about money management is under way, including in government and schools—and none too soon. This year, Millennials became the largest share of the workforce. This is a huge generation coming of age with almost no social safety net. These 80 million strong must start saving early if they are going to retire. Given this generation’s love of mobile technology, it’s notable that Merrill found a 46% increase in visits to its mobile financial education platform. That means employers are reaching young workers, who as a group have shown enormous interest in saving.

“There is not a single good reason—none—that should prevent any American from gaining the knowledge and skills needed to build a healthy financial future,” writes Richard Cordray, director of the Consumer Financial Protection Bureau, in a guest blog for the Council for Economic Education. His agency and dozens of nonprofits are pushing for financial education in grades K-12 but have had limited success. Just 17 states require a student to pass a personal finance course to graduate high school.

That’s why it’s critical that corporations take up the battle. Even college graduates entering the workplace generally lack basic personal money management skills. This often translates into lost time and productivity among workers trying to stay afloat in their personal financial affairs. So companies helping employees with financial advice is self serving, as well as beneficial to employees. Some argue it helps the economy as a whole, too, as it lessens the likelihood of another financial crisis linked to poor individual money decisions.

 

 

 

 

MONEY Ask the Expert

How to Save For Retirement When You Don’t Have a 401(k)

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: The company I work for doesn’t offer a 401(k). I am young professional who wants to start saving for retirement but I don’t have a lot of money. Where should I start? – Abraham Weiser, New York City

A: Millions of workers are in the same boat. One-quarter of full-time employees are at companies that don’t offer a retirement plan, according to government data. The situation is most common at small firms: Only 50% of workers at companies with fewer than 100 employees have 401(k)s vs. 82% of workers at medium and large companies.

Certainly, 401(k)s are one of the best ways to save for retirement. These plans let you make contributions directly from your paycheck, and you can put away a large amount ($18,000 in 2015 for those 49 and younger), which can grow tax sheltered.

But there are retirement savings options beyond the 401(k) that also offer attractive tax benefits, says Ryan P. Tuttle, a certified financial planner at Connecticut Wealth Management in Farmington, Ct.

Since you’re just getting started, your first step is to get a handle on your spending and cash flow, which will help you determine how much you can really afford to put away for retirement. If you have a lot of high-rate debt—say, student loans or credit cards—you should also be paying that down. But if you have to divert cash to pay off loans, you won’t be able to put away a lot for savings.

That doesn’t mean you should wait to put money away for retirement. Even if you can only save a small amount, perhaps $50 or $100 a week, do it now. The earlier you get going, the more time that money will have to compound, so even a few dollars here or there can make a big difference in two or three decades.

You can give an even bigger boost to your savings by opting for a tax-sheltered savings plan like an Individual Retirement Account (IRA), which protects your gains from Uncle Sam, at least temporarily.

These come in two flavors: traditional IRAs and Roth IRAs. In a traditional IRA, you pay taxes when you withdraw the money in retirement. Depending on your income, you may also qualify for a tax deduction on your IRA contribution. With a Roth IRA, it’s the opposite. You put in money after paying taxes but you can withdraw it tax free once you retire.

The downside to IRAs is that you can only stash $5,500 away each year, for those 49 and younger. And to make a full contribution to a Roth, your modified adjusted gross income must be less than $131,000 a year if you’re single or $193,000 for those married filing jointly.

If your pay doesn’t exceed the income limit, a Roth IRA is your best option, says Tuttle. When you’re young and your income is low, your tax rate will be lower. So the upfront tax break you get with a traditional IRA isn’t as big of a deal.

Ideally, you’ll contribute the maximum $5,500 to your IRA. But if you don’t have a chunk of money like that, have funds regularly transferred from your bank account to an IRA until you reach the $5,500. You can set up an IRA account easily with a low-fee provider such as Vanguard, Fidelity or T. Rowe Price.

Choose low-cost investments such as index funds and exchange-traded funds (ETFs); you can find choices on our Money 50 list of recommended funds and ETFs. Most younger investors will do best with a heavier concentration in stocks than bonds, since you’ll want growth and you have time to ride out market downturns. Still, your asset allocation should be geared to your individual risk tolerance.

If you end up maxing out your IRA, you can stash more money in a taxable account. Look for tax-efficient investments that generate little or no taxable gains—index funds and ETFs, again, may fill the bill.

Getting an early start in retirement savings is smart. But you should also be investing in your human capital. That means continuing to get education and adding to your skills so your earnings rise over time. Your earnings grow most quickly in those first decades of your career. “The more you earn, the more you can put away for retirement,” says Tuttle. As you move on to better opportunities—with any luck—you’ll land at a company that offers a great 401(k) plan, too.

Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.

Read next: Quick Guide to How Much You Need to Retire

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