Filling the Bucket

Before we begin this morning, I want to take a moment to congratulate my assistant, Brayden, who passed the CFP Board exam yesterday. We’ve been working together for over three years, and I’m proud of him for accomplishing this goal. Congratulations Brayden!

Today let’s look at maximizing retirement savings. Saving all you can toward retirement might sound like a no-brainer, but the mechanics can catch folks off guard. Next week we’ll discuss RMDs and gifting strategies.

Before we get to this week’s installment, here are some questions to ponder about your financial life so far in 2021. Any “yes” answers are topics to drill down on because there could be planning, investing, or tax issues to consider.

• Have you had any big income changes this year? Maybe you switched jobs, downshifted to part-time, or even retired? Have you started or closed a business?
• Any large expenses on the horizon?
• Have you sold investments or other assets for what you consider to be a large gain or loss?
• Have you inherited money or other assets?
• What’s your financial outlook for next year? Does it include any of the above?

Another question might be, “Have I saved all I can this year toward my retirement?” While trying to do so might seem obvious, actually getting it done can be challenging, and not just financially. The challenges are structural. 401(k) plans weren’t created to be what they are today. The new plan type was latched onto by large employers in the late-1970’s and 80’s who wanted to offload much of the risk associated with running a traditional pension plan. Or at least that’s my take on the history. 401(k) plans have evolved since to become the dominant retirement account type in the country, so we’ll focus on them in today’s post.

Government regulations try to set the stage for employee success by requiring a certain amount of transparency and plan quality, but the reality is far from ideal. The result is that employees have to shoulder much of the burden in terms of figuring out how much they can afford to contribute to the plan, how to invest the money once it’s there, how to manage the account over time, and myriad other rules and regs along the way. This is part of why there’s such a disparity between the long-term performance of more highly educated workers compared with their blue-collared brethren.

Okay, on that note, let’s look at a common structural issue for 401(k) savers – underfunding. I’ve found that it’s not often a lack of affordability at issue, it’s a lack of time. People are busy, they’re stressed, and it can be difficult to get into the nitty gritty of one’s 401(k) plan, especially if it’s one of the many subpar plans out there.

It’s pretty typical for workers to save all year only to find they hadn’t been contributing as much as they thought, or that they could have easily saved more. This is problematic for lots of reasons but approaching year-end the biggest issue is taxes.

As you’re aware, dollars saved into a 401(k) are considered pre-tax, so they come right off the top of an employee’s W-2 income and aren’t taxed by the Feds or the state. These savings won’t be taxed as they grow either and, if you play your cards right, won’t start being taxed until age 72 (or older – some proposals in D.C. would see the minimum age to start mandatory taxable distributions go to 75). These years, or even decades, of tax deferral are huge when it comes to accumulating money for retirement.

Some fuzzy math as I’m writing shows that if you maxed out your 401(k) contributions each year, the additional amount invested from tax deferral could add over $130,000 to your bottom line over 20 years! So, in a real sense, time lost from not maximizing this benefit is time and money you’ll never get back.

The government sets limits on how much you can save into your 401(k) each year. This cap gets adjusted for inflation and is currently $19,500 while those 50 and older can save $26,000 through Dec 31^st. Or you might be part of a SIMPLE 401(k), a less common type, with maximums of $13,500 and $16,500, respectively. Again, this is a cap on what the individual employee can save each year. It doesn’t count money the employer adds as matching contributions. This is also true if you’re self-employed except that you function as the employee and employer, matching your own contributions. I can’t tell you how many people misunderstand this employee/employer dynamic and save less because they were worried about overfunding. Most plans have a mechanism to ensure you don’t overfund your account anyway, so that’s less of a concern. Don’t overthink it, it’s hard enough already!

So, as we get closer to year-end, have you saved all you can into your 401(k)? Maybe you’re trying to hit the annual maximum and are coming up short, even with remaining pay periods. Or you realize you’re sitting on extra cash in your bank account and can afford to contribute more for the rest of the year. A lot of people contribute only a few percent of their pay while they save cash at the bank. Emergency funds are great, but don’t let inertia keep you from retiring better.

I suggest logging into your plan to confirm what you’ve saved so far this year and then try to fill in any gaps.

Good quality plans might only take a pay period to make these changes, so it’s possible to still get several paychecks into your plan if you’re coming up short. Usually you can do this sort of thing yourself. But if your plan is one of the many with a horrible website, you may need to pick up the phone. Something good to remember is that most plans allow you to contribute up to 50% or even 100% of your paycheck to your 401(k). That’s often the only way to get extra money into your plan at year-end since unfortunately they won’t let you simply mail in a check.

However you do it, try to fill up your 401(k) as much as possible this year. It will save on you taxes, add money to your bottom line over time, and get you one (or many) steps closer to being ready for retirement.

Have questions? Ask me. I can help.