Choosing a retirement plan can be one of the most important decisions you make as you map out your financial future. Especially now, when Social Security again appears to be in jeopardy while defined benefit plans are already on their way out, a need for reliable options for working people is pertinent as ever. Unfortunately, too many employees put off thoughts of retirement as unfeasible or premature. Lack of planning often leads to hasty decision-making when the time comes to make vital choices about life after work.
That’s why default options are extremely useful for employers to introduce. Simply put, their implementation demonstrates a commitment to the well-being of the workforce that can pay off greatly in the long run. Lifetime Income Default Options offer their recipients a fixed rate of income during the years after retirement, with the option to opt out of the program rather than the need to opt in. Since many people underestimate how long they will live after they retire (and therefore don’t plan on having as much money), this option, helps provide a long-term safety net.
The major dilemma of retirement planning, income level vs. liquidity, is a choice not to be taken lightly. Some people may not be aware of it, but these lifetime income options offer a sort of compromise. To begin, their money is placed into a diversified fund that readjusts along with the market, so income level stays steady while their savings are accrued, then at a preset time (usually at age 48) allocations to a deferred annuity begin, with full conversion achieved about a decade later. This gradual approach helps to neutralize changes coming from interest rate adjustments, typically a driving force in annuity price changes.
The strategy assures employees that they will receive a baseline amount of income in retirement. If they choose, they can adjust their level of savings as they see fit. This saves them from getting locked into a strict amount and gives them the flexibility to spend the amount of money they feel most comfortable with.
These plans have already generated a great deal of interest that only looks to gain more momentum as the word spreads. It’s important not to let stagnation or complacency with existing, less than adequate plans get in the way of your employees’ needs. These plans offer a reliable way for your employees to retire with greater financial stability, and can encourage greater savings pre-retirement. In the end, what’s important is that people are able to use the tools at their disposal for a comfortable and prosperous retirement. A plan that offers employees flexibility while helping to provide for long-term financial safety is a win for them, and a win for you as a leader.
For many, having $1 million saved for retirement sounds like plenty, but when you break down the numbers, what once seemed like a fortune might seem like just passable or maybe even too little to maintain the lifestyle you have or fund the one you want.
Obviously, there’s no single answer for whether $1 million is enough to keep someone afloat during retirement—ostensibly, a frequent first-class jetsetter is going to need much more than that while someone opting for only simple pleasures may be satisfied with less.
If you’re a baby boomer and come out shy of the million dollar mark, know that you’re very much not alone. According to a survey from GoBankingRates, only 22% of individuals ages 55-64 and older have $300,000 or more set aside for the future and about 29% of those over 65 have nothing saved at all.
In fact, most Americans (81%) don’t actually know how much they’ll need to retire. But thanks to some general guidelines and user-friendly retirement calculators, it’s easy enough to estimate your target savings and see whether $1 million will allow you to afford the post-work life of your dreams. But how?
One rule of thumb is to plan on replacing 70-90% of your current income with savings and social security once you leave the workforce. That means if you make the American median annual household income of $55,775, then you should anticipate needing $39,042.50-$50,197.50 per year during retirement. However in an article for AARP, Dan Yu of EisnerAmper Wealth Advisors said that for the first 10 years of retirement, you are more likely to be spending 100% of your current income.
Another way of looking at it is by first calculating the bare minimum of how much you’ll need per year and then working backwards to see how much you need to save. Investopedia recommends using the 4% sustainable withdrawal rate, what they describe as “the amount you can withdraw through thick and thin and still expect your portfolio to last at least 30 years,” as a means of calculation. That means if you have $1 million saved, then your yearly budget will be around $40,000. If your retirement aspirations lean more towards golf resorts than improving your home garden, even with the additional $16,000 or so per year that you’ll receive through social security, $1 million will clearly not sustain you for long.
There’s also the added variable of your expected lifespan. While it may seem bleak to confront your own mortality, you need to calculate your yearly saving and spending with a time frame in mind. According to the CDC, the average life expectancy in the United States back in 2014 was 78.8 years old. But given that more Americans are living past 90, and a 65 year old upper middle class couple has a 43% chance that one or both partners will live a full 30 years more, you may end up stretching your savings for longer than you could have ever imagined.
Where you plan on living also has a massive impact on how far $1 million will get you. While a retiree in Sherman, Texas could lead a nice cushy life for 30 work-free years with a retirement account of just $408,116, a retiree in New York City would need more than 5 times that. SmartAsset calculated that the average retiree in NYC needs $2,250,845 in savings, allocating $47,000 per year for housing alone. Even a nest egg in Brooklyn isn’t much better—that too requires more than $1 million. Perhaps for that reason, New York City isn’t on Forbes list of best places to retire in 2017.
Even with the most careful planning, there are always going to be a few financial surprises along the way that may set you back more than a few pennies worth. Whether they’re negative like medical emergencies and subsequent health expenses or positive, like travel fare to a destination wedding, they’re still taking a bite out of your bank account that may not have been in your original budget. For this reason, it’s important to use the above guidelines and calculation tools as a rough estimate, and be on the safe side by saving more than you think you’ll need.
As the adage goes, “a life without regrets is a life not lived,” but it is also “better to regret what you have done than what you haven’t.” The three biggest regrets of retired baby boomers center on the things they have not done and teach the next generation to make more informed choices.
- Not Saving for Retirement Earlier
A rare absolute rule of finance is that people should start saving for retirement as early as possible, with the best time to start being in one’s twenties. Life expectancies are growing and show no signs of slowing down, so more money is needed to be stretched out for a longer period of time. Starting to save and invest as soon as one enters the full-time workforce can make a dramatic difference in the amount of money that accumulates by the time a person is ready to retire.
Many baby boomers failed to start saving on time and properly because they did not understand just how much money would be needed for their retirement. Some also did not know that receiving social security benefits or taking money out of retirement accounts before it is needed can have tax consequences that can substantially lower savings. Finally, many people tend to forget to adjust for inflation when considering whether they are satisfied with the rate of return on their investments.
- Not Working Less and Traveling More
A study of 2,000 baby boomers commissioned by British Airways revealed that one out of five boomers regrets not doing more traveling around the world. The survey data also indicate that only 9% of American workers get more than nine vacations days per year and that only 37% of Americans took all of their vacation days in 2015, suggesting that working too much may be an issue whose scope extends far beyond just the baby boomer generation.
A 10-year research project conducted by Karl Pillemer, Professor of Human Development at Cornell University, into the lives of 1,200 people aged 65 and older also revealed that lack of travel during one’s youth is a common regret. He writes, “To sum up what I learned in a sentence: When your traveling days are over, you will wish you had taken one more trip.”
- Not Working More
It might sound surprising given the decades of work they’ve done, but more than two-thirds of middle-income baby boomer retirees wish they had worked longer, and not for expected reasons. One might assume that people would want to continue working to keep earning their salaries, but for many baby boomers, wanting to keep working is about the work. People who are passionate about their careers and enjoy their work want to keep doing it. For this reason, many baby boomers return to the workforce on a part-time basis or as consultants. A number of baby boomers also enjoy working during their later years because they find that it keeps them mentally sharp, physically fit, and gives them a sense of purpose.
According to the Investment Company Institute, 401K plan assets reached $4.8 trillion dollars at the end of the first quarter in 2016. That’s nearly 20% of total retirement assets in America (which was at $24.1 trillion).
For 401K plan holders heading into retirement, changing jobs, or leaving a company, a big question looms: what should be done with this type of retirement savings account? Essentially, investors have to choose whether or not to roll the money over into a new account.
Options for rolling the 401K over include putting the cash into a self-directed IRA or transferring it to a new employer’s 401K plan. If workers decide against a rollover, the other options are to leave the account alone or cash out. Before making a decision, investors should look at the pros and cons and choose based on their unique situation.
Rollover Options and Advantages
There are significant advantages to rolling the 401K over to a new employer’s plan or IRA. Most investment professionals advise choosing an IRA, but it’s important for workers to also examine the quality of the new company’s 401K plan (if going to another job).
Pros of the Rollover into a Traditional IRA
Dr. Don Taylor, a retirement advisor and contributor at Bankrate, says that the rollover to a traditional individual retirement account from a former company’s 401K plan can provide “wider investment choices and potentially reduced annual fees and other expenses.” This flexibility makes the IRA an attractive selection, as investors can choose among mutual funds, stocks, bonds, and exchange-traded funds.
Like with a traditional 401K employer plan, money can continue to grow tax-deferred in a traditional IRA. That way, investors won’t have to worry about capital gains and dividend taxes each year.
This also allows workers to shop for plans with lower fees, and, if desired, select an IRA with more access to investing tools and management guidance. The IRA can also be withdrawn without penalty for specific purposes, like college tuition or a first-time home purchase (up to $10,000).
Pros of the Rollover into a Roth IRA
Unlike traditional IRAs, Roth IRA contributions are made after income is taxed—with the benefit that earnings are not taxed when withdrawn later. Because contributions are made after income taxation, investors have the ability to withdraw those contributions (not earnings) from the account without fees.
The Roth IRA does not have minimum required distributions after reaching age 70½, unlike 401Ks and Traditional IRAs. This makes it a potentially lucrative investment vehicle into old age and a good option for those looking to set up future generations.
Since the Roth IRA rollover requires a tax payment before transfer, Dr. Don Taylor attests that a Roth IRA rollover makes sense only if investors can come up with the tax fees from a source other than the 401K funds and “expect to be in a lower tax bracket now than when (they) start tapping retirement funds.” This makes paying the taxes now financially beneficial in the long run.
Pros of the Rollover into the New Employer’s 401K Plan
Most employers offer new employees the chance to roll over their old company’s plan. Getting all retirement plans into one place can make saving much more convenient and cheaper.
Investors should compare fees between the two company’s plans, and only roll over their old 401K’s cash if the new employer’s plan has lower fees and/or better investment options. The new company’s plan may even have lower fees than IRA accounts do.
For those that do choose to transfer to the new company’s fund, understand those earnings will continue to grow tax-deferred, and while those funds can be withdrawn after 59½ years old without penalty, workers may have the option to delay required minimum distributions (RMDs) beyond 70½ years old (if still employed at that company).
Traditional benefits of the old 401K still apply at the new company too. Investors are given more protection under federal law, as 401K assets are better protected from claims from creditors than IRA assets are. Many 401K plans provide investors the benefit of being able to borrow against the plan as well.
Options for Those Choosing Against the Rollover
While rolling the account over is traditionally the best choice, everyone’s personal situation is different. In some circumstances, one of the following two options may be the most ideal—or necessary—choice.
Leave the 401K Alone
The first and most common choice is simply to leave the 401K account with the old employer and let earnings continue to rise tax-free. For investors that like their current plan, aren’t paying a lot in fees, and are happy with its performance, this may be the best—and easiest—choice. Prior to doing this, do compare fee charges with other fund options, like the new business’ 401K plan and traditional and Roth IRAs.
In addition to having the benefits mentioned above for 401K plans, there is also a specific benefit for not touching the 401K. For those that leave their employer between the ages of 55 and 59½, they can enjoy penalty-free withdrawals before reaching 59½ (the typical starting withdrawal age).
Before doing this, ex-employees should check to see if their employers allow the money to stay in their old account. Most companies require at least a balance of $5,000
A final choice is the cashout. Most investors don’t suggest this route, as paying taxes on the withdrawal alone could easily cut into 35% of the total amount (depending on the tax bracket). A withdrawal penalty of 10% would also be assessed if younger than 59½.
Additionally, savings would no longer grow tax-deferred, which means investors robbing their future selves. For example, take the case of a worker making $75,000 per year who has a traditional 401K with $50,000 in assets. This worker decides to withdraw it all after quitting the company. In this case, 25% of that amount would be taxed and a 10% penalty would be implemented, leaving the worker with 35% less, or just $32,500. If this money was simply just left in the 401K and continued to grow at a decent rate for one or two decades, this easily turns into a six-figure mistake.
The cash-out option is mostly seen as a last resort for those experiencing a legit financial emergency and can’t access cash from other sources, such as lenders, savings accounts, and family. Only do it if absolutely necessary. Nearly every time, borrowing from other sources makes more financial sense than cashing out retirement savings.
Making the Best Decision with the 401K
While the traditional IRA is commonly seen as the best rollover option for 401K plans with an old employer, everyone’s personal situation is different. Ideally, workers should always research and choose retirement savings plans with low fees and high returns. They should make choices that set them up for long-term financial success.
Thus, it’s advised to also analyze the financial advantages and disadvantages of rolling over to the Roth IRA, transferring to another company’s 401K plan, and leaving the money with the old 401K. Once workers have a clear picture of what makes the most financial sense, they can go through with the decision—and watch their nest egg grow to its highest potential.
A majority of America’s small business owners are not saving for retirement. Many know they should, but feel that saving will hurt their business. According to David Deeds, Schulze Professor of Entrepreneurship at the University of St. Thomas in Minneapolis, small business owners do not save because they consider the business their retirement plan. “The plan is that when they retire, they are either going to transfer the business to a family member in exchange for a share of future wealth or a buyout or they are going to sell it off and turn that into cash.”
However, many circumstances may prevent the sale of a small business. Even if the business can be sold, the sale may not provide enough income to cover one’s entire retirement. Entrepreneurs may also have to retire earlier than they expected due to health problems or other unforeseen events.
Having a well-rounded retirement plan can help protect entrepreneurs against these and other risks. Here are five things small business owners need to know to plan their retirement effectively.
First, know the numbers. Small business owners should calculate how much money they will need to live on in retirement. Factors such as where they want to live (a pricier home or a modest apartment), how they want to spend their time (traveling or working part-time), and healthcare costs play an important role in this assessment.
Once they have an idea of how much they will need, entrepreneurs should get a valuation of their business to see if its sale or transfer is a viable retirement option. As part of their valuation, small business owners should consider whether the business can operate without their involvement. If it cannot, it may be difficult to sell or generate income from it once the business owner retires.
Next, determine a goal. This might seem elementary, but the power of having a firm vision for the future of a small business and retirement cannot be overstated. Entrepreneurs who set firm goals take steps to make sure their goals are met. This helps them find the best tools to save and also prepares them to wind down the business when it is actually time to retire.
Know the best tools. Business owners do not need to move significant amounts of money from their business in order to start saving for retirement. Investing just a little bit can help entrepreneurs save on their present-day taxes until they make withdrawals in retirement. There are four main instruments to choose from.
SEP-IRA: Like a traditional IRA, this retirement plan is tax-deductible. For returns filed this year, small business owners can contribute up to 25% of their income or $54,000. A SEP-IRA is a great retirement plan for sole proprietors because it is self-directed, but the 401(k) described below offers similar benefits but may be more cost effective due to lower administration fees.
Simple IRA: This plan is designed for entrepreneurs who employ 100 or fewer employees. Like for a 401(k), contributions are taken directly from employee paychecks and are pre-tax. Contributions cannot exceed $12,500 in 2017, but employees who are 50 or older may contribute up to $15,500.
Solo 401(k): This plan is for sole proprietors but may include the proprietor’s spouse. Proprietors may contribute up to 25% of their salary plus up to $18,000 ($24,000 for people aged 50 or older), but the total contribution may not exceed $54,000. A spouse who works in the business may also contribute the same amounts.
Simple 401(k): Small businesses with 100 or fewer employees may utilize this plan. Owners and employees have the option to contribute up to $12,500 this year, or $15,500 for people aged 50 and older. This plan also allows for borrowing against it and making penalty-free withdrawals to cover financial hardship.
A sole proprietorship, a partnership, limited liability company, or corporate can qualify for every plan except the SEP-IRA.
Keep investments simple. Most small business owners should probably invest in a globally diverse collection of low-cost index funds. An index fund invests broadly across entire markets like the U.S. stock market, U.S. bond market, and developed foreign stock markets.
Another option for simple investment is a target-date fund, which automatically adjusts the balance of fixed-income investments based on age and the selected date.
Diversify all investments. Diversification does not apply only to the retirement plans described above but to any asset a small business owner may choose to invest in. Getting all of one’s savings or investments caught in one basket can be risky.
This is especially true of home ownership. The real estate market is cyclical, so it can yield high returns or unexpectedly big losses. Small business owners who place most of their net worth in their home are cautioned to spread their wealth around.
Put it all together. With their numbers as their foundation and their goals in mind, small business owners have terrific opportunities to save for retirement. By utilizing the tools we describe to invest in a diverse portfolio, more small business owners can effectively build their wealth without hurting their present-day business growth.