Yes, you read that right: 2/3 of Americans are not saving in their 401k account according to this Bloomberg article.
401k’s, and other retirement plans, are crucial to financial security later in life. The fact that two-thirds of people in the U.S. contribute zero dollars to their employee sponsored 401k account worries me.
Especially since many employer’s offer some level of match – so by not contributing, people are literally giving away free money.
Don’t be one of those people
While the Bloomberg article focuses on 401k contributions, I think it highlights a bigger issue with retirement savings and savings in general: It’s not happening like you would expect. Having an employer sponsored retirement plan is one of the easiest ways to save. So if about two-thirds of people are not, it isn’t that far of a stretch to say that two-thirds represents more than just 401k contributions, but retirement contributions and savings in general.
In fact, a recent CNBC article states that nearly 70% of adults have less than $1,000 in their savings accounts and that roughly half of US families have zero retirement account savings.
That’s eye-opening. Please don’t be one of those people. However it’s not too late if you are. There is no time like now to start saving for your future.
What is this 401k thing you’re talking about?
If you already understand what a 401k, or other retirement vehicles like an IRA or 403b is, go ahead and scroll down to the next section. Keep reading if you don’t or if you want a refresher.
A traditional 401k is an employer-sponsored retirement plan that allows an employee to contribute pre-tax income to a retirement account. The pre-tax contribution typically comes directly out of your paycheck so you do not see it in your bank account (which is great!) and lowers the amount of taxes you pay (another bonus!).
Some employers also offer a type 401k that uses after-tax contributions. This type of account is called a Roth 401k. The difference between the Traditional and Roth accounts is the tax treatment. Traditional 401k’s are tax-deferred – meaning funds are taxed at withdrawal. Roth accounts are taxed at the time of contribution and therefore all future withdrawals are tax-free.
Many times, an employer will offer some sort of contribution match to the employee. The type of match varies, but two examples could be: (1) Employer matches 100% of up to 4% of your salary or (2) Employer matches 50% of up to 6% of your salary.
What exactly does that mean? Let’s review the math with a hypothetical salary of $60,000 with paychecks coming twice a month:
Your bi-monthly salary is $2,500 and you contribute 4%. That is $100 of your money being put into a retirement account. Since your employer matches 100% of your contributions up to 4% of your salary, they also contribute $100 to your retirement account. Congrats! You just got yourself a free $100. The total amount going into your 401k account during this period is $200. Done for a full year, that is $4,800 ($200*24) total into your account. And the best part? You only had to put in $2,400 of your own money.
That said, the match changes based on your contribution. If you contribute 2% ($50), then the employer only matches up to that 2%. The point being, the 4% is the maximum amount of match. But just because 4% is the max does not mean that is the max you should contribute. Instead, view that 4% as the minimum amount you should contribute. Otherwise you are giving away free money.
In this scenario, the employer is matching 50% of your contributions up to 6% of your salary. At a 6% contribution rate you would contribute $150 and your employer would contribute $75 ($2,500*6% = $150; $150*50% = $75). The total contribution for that period is $225, or $5,400 annually.
In this scenario, the employer is encouraging you to save more by making the match limit at 6% vs. the 4% in scenario 1. That said, to get the full match in scenario 2 you must contribute more of each paycheck ($150 vs. $100) and your employer ends up contributing less ($75 vs. $100). Regardless of the type of match, you should view the employer match limit as the bare minimum when determining what to contribute.
How much should I contribute?
The advice on this will vary, but many financial institutions will recommend 10-15% of your salary.
If you are at 0%, that 10-15% may seem like a long shot. If this is the case, the first step is to increase that to the employer match amount ASAP. Test your tolerance at this level. How much did that impact your monthly finances? Did it break the bank or did it go unnoticed?
If it broke the bank, consider cutting back on unessential spending. Unessential spending could be things like subscriptions, coffee shops or restaurants, or excessive shopping. Saving for retirement needs to be a priority and I would consider it essential to your monthly budget. That subscription to the magazine that gets tossed as soon as it arrives? Probably not so necessary.
The first step is to increase your 401k contribution to your employer’s match amount ASAP.
If you didn’t notice it, congrats! Consider increasing the contribution again. See what works for you, but continue to push your limits and try to contribute as much as possible.
You may start to withdrawal from a 401k account at 59 1/2 years old. Withdrawals from the account before this age will incur a 10% tax penalty.
Your balance of pre-tax contributions (traditional 401k) will be taxed on the amount withdrawn. This includes all gains earned from the portfolio over time.
Your balance of after-tax contributions (Roth 401k) will not be taxed at all upon withdrawal. All gains are tax-free.
For you early retirement folks, the Roth Conversion Ladder is a process to avoid the 10% early withdrawal penalty. It take’s time and careful planning to make it happen, so it’s not for everyone and is a topic that will be covered in detail another time.
The cost of not saving
Let’s get into some numbers now. What does it really cost by not saving for retirement?
Depending on how much you are (or are not) saving, and of course taking into account the time horizon, the cost of not saving ranges from thousands to millions:
Numbers behind the graph: $60k salary, growing at 2% inflation each year; 7% investment return; no employer match contributions considered
Charts like this do a nice job of showing the power of time in the market and compound interest. You can see the gap in total account balance become more substantial as time goes on. But the gap isn’t just limited to 40 year time frames. Here is a 15 year view of the same data:
This really highlights the impact that higher levels of contributions have over a relatively short time frame of 15 years.
One more… This time a table. It’s not as pretty as a chart is, but it puts numbers behind those lines that you see above:
In this scenario, saving 5% a year for 20 years, with returns at a reasonable 7% each year, can lead to a nest egg of ~$150,000. Increase that savings percentage to 15% and the nest egg could be ~$450,000, or 3x the amount.
For those young enough, 30-40 years of 20% savings could result in a retirement balance of over $3 million.
That’s a lot of cash.
So how much does it cost to not save? It can literally be the difference between a comfortable retirement and a non-existent one, and thousands to millions of dollars.
That last section got a little dire, but I wanted to stress the importance of saving for retirement. It’s one of those things that requires immediate attention. Not tomorrow, not next week or next year. Right now.
The cost of not saving ranges from thousands to millions of dollars.
The simplest way to save is to set automatic contributions. If you have an employer sponsored retirement plan, set them up in there (if you don’t know if you do, ask). If you work for yourself or a small company, consider an IRA.
Also, when choosing investments, keep it simple. Think low-cost and long-term. Exposure to entire markets is preferable to a single stock. Many retirement plans and financial institutions offer mutual funds that do just this. For a great resource on simple investing and a three-fund portfolio, check out the Bogleheads Wiki.
Bringing this full circle, about two-thirds of us here in the US are not saving in our employer-sponsored 401k, and half of all families don’t have any retirement savings whatsoever.
If you’re saving under 10-15%, consider increasing that a bit if possible. If you aren’t saving at all, it’s time to start.
If you have any questions or comments about how you can start saving more or just start saving in general, reach out through the comment section below or through the contact form.
Would love to help or just hear your story!