401(k) Plans are here to stay
When companies started 401(k) plans in the early 1980’s and they grew in popularity, conventional wisdom emerged that it would serve as a panacea to help seniors in retirement. Company pensions were on the way out and the investment vehicle under the IRS code enabled income to be removed from paychecks pre-tax and have it matched by employers. In an era many worried about the future of Social Security being there in full, the 401(k) would be perfect for the baby boomer retirees of the future.
The investment plans, however, aren’t viewed by some in the same way today. The 401(k) experiment has been called a disaster by some who say with a combination of the retirement plans and Social Security, baby boomers haven’t saved enough and won’t be able to maintain their existing lifestyles in retirement. That will mean a smaller home, cheaper apartment for those who rent and even the need for some to keep working when they hadn’t planned to do so.
The plans have also come under fire by some because of their hidden fees that many 401(k) participants didn’t even know they were paying. During the Great Recession, many firms eliminated their contribution to the plans, cut them back or ended the plans all together.
Despite some people questioning the relevancy of the investment vehicles, financial analysts said they won’t become obsolete and will continue to remain important for retirement planning.
“I think a 401(k) is one of the great options that you have as an employee and whether you’re older or young, it’s important to have a long-term investment vehicle to save for retirement,” says Audry Baptiste, president of the Financial Planning Association of Nevada. “There’s a lot in the news that relates to their relevancy, but I don’t think they’re going anywhere. I have stressed that it’s important to contribute to a 401(k), especially if the employer is contributing. You have to take advantage of the free money. You’re not only saving for retirement, but getting the advantage of saving on taxes through tax deferrals.”
A few companies may do a 100 percent match up to 6 percent of the income contributed by the employee but many do either 50 percent of 6 percent or 100 percent up to 3 percent, said Scott Thoma, an investment strategist at the St. Louis headquarters of Edward Jones. While many analysts say many employees fail to participate or don’t contribute enough in their plans, there are plenty who take advantage of them and that should keep 401(k) plans and important part of anyone’s retirement strategy in the future.
One of the biggest threats to 401(k) participation came during the recession in 2008 and 2009 when some companies stopped matching employee contributions as a way to cut expenses during the economic slowdown. Since the economy has rebounded, many firms have restarted their matches because they know it’s important to employees, and they want to retain them.
“I’ve had some small business that have done away with them all together or still arent’t matching,” Baptiste says. “But most restarted them when the economy improved because in order to maintain a qualified workforce and encourage people to stay.”
What many Americans nearing retirmement or who have retired have missed out on was the creation of the Roth 401(k) in 2006 that enabled employees to make contributions to the plans after they’ve been taxed. Instead of getting taxed on proceeds when they’re removed from the 401(k) starting at 59.5, those proceeds grow tax free under the Roth 401(k).
Younger employees have taken advantage of that investment vehicle the most because many are in a lower tax bracket today and stand to benefit the most when the most if they retire at a higher tax bracket, Thoma says. There are benefits to have retirement accounts that are both tax free and tax deferred, he says.
“If you can tell me what tax rates are going to be, then I can tell you which one is the most important to be in,” Thoma says. “If you know 100 percent your tax rate in retirement is going to be lower than what it is now—if you’re at a 25 percent or 35 percent tax bracket today and in retirement you think you’re going to be at 15 percent—continue to put one in a traditional 401(k) because the deduction today is worth more than than taxes you’re paying in retirement. Don’t use a Roth.”
When people remove money from their retirement accounts, it’s great to have flexibility between tax deferred accounts and those that aren’t, Thoma says. In a year, a person doesn’t take a lot of deductions, it’s best to remove money from a Roth account. It’s great to have flexibility depending on what the tax rates are, he says.
“Roth 401(k) is not a younger versus older decision, but it’s about looking at tax rates pre-retirement and post-retirement,” Thoma says. “It’s impossible to predict, but it’s important to have flexibility.”
Some seniors are taking advantage of the opportunity to catch up on their 401(k) before they retire, Baptiste says. Rather than only contributing the $17,500 limit, they’re allowed to add $5,500 a year once they reach 50.
“People are doing it if their financial siutation allows it,” Baptiste says. “Someone earning $50,000 a year isn’t able to save the maximum, but those making six figures a year can without a dent in their lifestyle.”
While people have to wait until their 59.5 to take out funds from their 401(k) without facing a ten percent penalty, some choose to do an early withdrawal without penalty if they retire from their company at 55, Thoma says.
It’s best to allow the money to grow as long as possible, especially for those who continue to work or don’t need extra funds for retirement and don’t want to get pushed into a higher tax bracket, the federal governmetn requires people to begin taking money out of the retirement accounts at 70.5.
If they don’t cash out the assets, many people leave the money in their former employer’s plan, transfer the assets into an IRA account. Many choose the IRA route because adults have more investment choices that are dictated by them instead of the employer plan.
“You see people move it when they want to have more investment options and buy individual stocks or bonds or work with a financial advisor,” Thoma says. “There’s always going to be some trade off. You have to look at fees and expenses, but you have to understand what you’re receiving.”
There have been changes in the 401(k) industry that’s requiring more disclosure and full transparency of underlying fees, but that awareness will help employers shop around for the best plans that employees want, Baptiste says. The 401(k) will remain an important option to people to invest because of the importance it’s serving many Americans now in supplementing their living expenses, he says.
“No matter what you hear, the 401(k) isn’t going anywhere,” Baptiste says.