August’s issue of Money Magazine asks: Are You Doing The Right Things (For Retirement)? Although a bit mundane, it’s offers a quick gut check. Here are the questions and my answers:
1) Are you maxing out your 401(k)?
I think I put in $10,000 last year, which wasn’t the max. This year I haven’t been on pace for the $15,500 maximum either, but I do plan on reaching it by year’s end. I’ll need to run the numbers to see how much I’ll need to increase my contributions in order to catch up in time.
Maxing out a 401(k) does seem like a tall order for the average U.S. household though, considering the median income is about $46,000 a year.
2) Are you keeping tabs on your progress?
Yup, every month. Next update is coming up soon.
3) Are you grabbing every tax break you can?
This is mostly directed at IRAs. I’m probably not going to be eligible for a Roth IRA this year due to the income restrictions. However, I will likely fund a non-tax-deductible IRA, which has the potential to be converted to a Roth in 2010. Otherwise, I’ll settle for the watered-down tax advantages and stick some bonds in there. 🙂
4) Have you created a safety net?
In an addition to an emergency fund (they say 3 months), the article states you should have adequate life and disability insurance. Life insurance is something I definitely want to get within the next year, and definitely before we buy a house.
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Have you looked into using a healthcare flexible spending account? Most people can at least put enough in for meds and any copays they will have during the year. This will reduce your taxable income. My husband has to get some dental work done and since we will be having a baby this month, we will be able to increase our contribution, so we plan to calculate how much his dental work will cost and put that much into the flexible spending plan.
I am sure you have heard of this site, but I have been using http://www.networthiq.com/ One would usually use this in addition to Money, Quicken, or whatever software they use to track net worth. It is fun to browse around the site.
As far as life insurance, my husband and I just use our group life from work (we elected a little bit extra). Since we both make good money, we could last for a while paying our mortgage with this life insurance and one salary if anything should happen to one of us. I had always thought the general rule of thumb was that life insurance is most necessary when you have children to support. We are having a baby (our first) this month, so we will be looking into purchasing our own term life insurance.
Eek. I do not have a 401(k) plan available at my current workplace, so I had to answer “no” to #1.
I do max out my Roth IRA every eligible year and keep an emergency fund, though. :^)
I recently finish, “The Retirement Decision”. http://www.amazon.com/Retirement-Decision-Achieve-Financial-Independence/dp/1419526952
I found it to be a really good book on how much you should have when you retire and how far behind (or ahead) you are now. Perhaps you could review is someday.
Dont take life insurance if u dont have kids 🙂
u dont want ur spouse to be filthy rich with u dead rite? Dammit, i think i just opened up a can of worms here.
I don’t know about filthy rich, but if your spouse depends on your income or your services like childcare (or the other way around), I don’t think life insurance is a bad idea.
Although we do want kids some day, I’d like to cover at least part of any mortgage too.
When I asked my tax guy about opening a non-deductible IRA, as you mention in item #3 of your post, he said, “If you are maxing out your Roth IRA’s you cannot contribute to any other IRA.” This is my situation. He added that I should consider a tax-deferred annuity which basically gives you the same tax advantages as a non-deductible IRA but the contribution allowed is unlimited.
Since I have no clue what these annuities are, it’s time for some Internet research! Jonathan — any opinions on this particular investment vehicle?
Your blog is great, by the way. Thank you!!
I think it’s smarter to look at a percentage not a value number. If 15,000 is the limit and your making 30,000 dollars, I wouldn’t expect that person to max it out. I believe it’s a better idea to put in at least 15%, not a certain dollar value.
Yuck! What an awful “gut check”! Not that any of these are bad things for someone to do, but I really take objection to numbers 1 & 3. It is not always necessary to MAXIMIZE these to reach your retirement goal. What I find missing would be “Do you know what your retirment goal is?” and then #2 makes even more sense. Maybe maximizing in #1 & #3 is necessary, but maybe it clears up resources for other financial goals and objectives.
Rick, you accountant is correct. Your max contribution to IRA’s combines both your contribution to taditional and Roth IRA’s. Annuities are tax deferred, and should you need to access that money prior to age 59 1/2 you face the same penalties as an traditional IRA. Another alternative would be to find investment programs that provide tax harvesting methodologies or are very tax efficent. Doing your research is a very good idea. If you are looking for a place to start, I’ve written about annuities on my blog. (sorry for the shameless plug). Oh, one last thing… non-deductible IRA’s can be an accounting nightmare. If you do open one, keep it in a separate account from your deductible IRA or else you may never be able to untangle the accounting requirements.
I’m curious how to max max my 401k. My employer only allows 10% pre-tax & 10% after-tax. I was told after-tax 401k contributions are not tax beneficial, therefore to avoid them.
10% of income. = $7500 year. Ideas?
I think #1 is should be more like “Are you taking advantage of your 401k to the fullest extent that you should?”
CNett – I was capped out like that at my last job too. I could only give 14% of my $50k salary. I couldn’t find a way around it myself, although you could ask HR about raising that cap.
Wow, I can only describe point #1 as completely wrong, even for the equivalent RRSPs here in Canada.
Maxing out a 401(k) does seem like a tall order for the average U.S. household though, considering the median income is about $46,000 a year.
Hear, hear. It’s also a tall order for anyone with alternate investments on the go: saving for a home, pursuing a higher education, starting their own business, etc. I mean these people are already “saving for retirement” in their own way, why should they also be maxing out?
I’m with Art Dinkin’ here, how about we just re-write the three bullets with useful information:
1. Do you have clearly identified retirement goals?
2. Are you investing enough money to achieve your retirement goals?
3. Are you tracking the progress regularly?
4. Are you still meeting your other investment goals (EF, Education, Home, etc.)?
There, now we can just fill it with slightly different content every time and run it on MSN money every 4th or 6th month 🙂
CNett,
401(k)’s are subject to rules designed to prevent the highest income earners from reaping most of the benefits while the rank and file employees get little. What sometimes happens is in order to keep the plan within the testing limits and ratios, employees with professional level incomes are limited in their contributions.
Unfortunately, Jonathan, it is often not a cap HR just puts into place. The executives would rather see this restriction lifted too. The only was around it is to get the rank and file employees to contribute higher percentages of their wages (by the way, this the origin of the employer match… an incentive for the lower paid employees to contribute more so the executives could max out!)
If you’re going to be over the Roth contribution limits, then there’s really no excuse for falling short of the max on 401(k) contributions. You should also look very seriously at a SEP-IRA if you don’t have one (as you know, you can fund it with a percentage of your self-employment income).
Art – In the rules that you mention, the definition of ‘highly-compensated employee’ (HCE) for 2006/2007 is making over $100,000. Cnett is at $75k, well under this limit. He is not an HCE.
The law states that the average contributions of highly compensated employees, as a group, cannot exceed the average contributions of nonhighly compensated employees, as a group, by more than about 2 percent.
As a NON-HCE, the company should be allowing CNett to contribute even more! 🙂
FCN – You’re correct, of course. I already have my SE 401k that is capable of taking even more than $15,500. But I’m waiting until the end of year to do this for cash-flow reasons.
A couple maxing their 401(k) making the median would only have 15,000 a year to live on.
Not much, for sure.
Jonathan – Thanks for clarifying the HCE rules. I am aware of them, but I do not keep up on the limits of them. The TPA’s I work with take care of that part for me. 🙂 So why else would an employer limit the employee’s contribution? There is nothing to lose for the employer.
Does anyone know a website that will (estimate) how much my take home pay will be if i increase my 401k contribution from X% to Y%?
Thanks
Joby – Try PayCheckCity.com
Must be nice to have these concerns. Mine are mostly, Rent, Food, Utilities and Health/Dental bills.
I’m hoping I die before it’s time to retire.
Regarding life insurance, KeyBank recently sent me an offer for a free $3,000 life insurance policy “at no cost to me”. What is your take on these policies?
Jonathan,
Don’t you get nervous about putting a lot of money into your 401K when you know that if the stock market goes down far enough, you can lose money form your retirement savings?
It seems to me like with everyone using 401Ks and IRAs for retirement savings, the effects would be seriously magnified if the stock market were to crash. Not only would the stock market have crashed, but lots of people would have lost their retirement savings, making the situation far worse for the economy. Whereas if people had their retirement savings in federally insured accounts, if the stock market were to crash, people would at least not lose their retirement savings onto the bargain, right?
Hey Amanda;
The “retirement savings” dying in a crash has been mentioned numerous times on the blog (and elsewhere) and it’s the reason that you’re supposed to slowly shift out of stocks as you approach retirement. Johnathan is in his 20’s (?) and thus quite a way from retirement. What you’re fundamentally talking about is diversification and Jonathan has lots of details on that stuff. What it basically amounts to is that most investors balance their monies between High-risk stocks and Low-risk bonds, money markets, etc.
As to the Federally Insured accounts (FDIC, I assume), they’re not really all that good. You see, if the Federal government insures lots of banks and all of these banks go under b/c the market crashes, then you’re in the same spot as before. The government would have to ask the Federal Reserve Banking Corporation (the Fed) to print some more money and the FRBC will “put it on the tab” so to speak. So now the government will owe the guys who printed the money and you’ll owe the government in added tax dollars for all of people who lost money in “the crash”.
Federally insured accounts pay the least interest (by their very nature) and don’t generally perform significantly better than inflation (kind of by their naature). On a grand scale, the hundreds of billions in retirement funds are part & parcel with fueling the american economy. These billions in investments are allowing new companies to spring up and existing companies to expand. If 90% of the populace moved their retirement funds into federally-backed securities, then the other 10% would be cleaning up on their retirement funds b/c all of the companies would be desperate for the investment dollars and the prices would go up until the 90% started realizing that maybe they could afford to risk a little money
It’s a whole elastic process and tons of material has been written about your very question. Hunt around this blog under “Investment” for lots more information.
Amanda – It’s all about time horizon. In the short term, the market is driven by tons of things – greed, lies, guesses, hedge funds, speculation, terrorist events…
In the long term, stock market return is driven by two things: dividends and revenue growth. As your time horizon gets longer and longer, the variability decreases. Even a crash is survivable.
See here for more information.