While many Americans look forward to their retirement years, saving for this time period can bring a lot of stress. A majority of workers participating in a 2017 AARP survey said they felt that they did not have enough saved for the various expenses, both expected and unexpected, that come with retirement. Part of this problem may relate to the hidden fees associated with retirement accounts, especially 401(k)s.
Often, people do not even know they are paying fees on their 401k, or have little choice in paying them, as their plan is selected by their employer. According to financial expert Robert Hiltonsmith, these fees can cost the average two-earner family more than $150,000 over a lifetime, an amount that accounts for nearly a third of all investment returns.
Understanding the Incredible Impact of Fees on Retirement Savings
Most people saving for retirement do not understand the impact that fees can have on their accounts. In fact, paying a single percent less in fees for an investment over the course of a lifetime can translate to enough money for an additional 10 years of retirement.
Consider three people who all invest $100,000 and achieve a rate of return of 8 percent. One person invests in an account with 1-percent fees and eventually achieves a total of $761,000. Another puts their $100k into an account with 2-percent fees. During the same time interval, this account will only grow to $574,000. The third person invests in an account with 3-percent fees. This account ends with $432,000. These figures demonstrate how seemingly small increases in fees can cut into overall savings.
In 2015 a law professor at Yale published a study concluding that a surprising number of 401(k) plans focus on high-fee funds, and ultimately recommended that employees pay close attention to the fees they pay.
Instead of putting money into plans with high fees, employees may be better off investing in a retirement account outside of their employers’ that will conserve a much higher percentage of their investment for the future. Pew Charitable Trusts has also researched this issue, noting that fees lower the amount of money available for compounding and thus have a reverberating effect on growth through the life of the investment. Unfortunately, many people think that fees are an inevitable part of saving for retirement, but this is not the case.
Pushing through the Confusing Language of Fee Disclosures
Often, 401(k) plans bury the nature and number of fees in pages upon pages of statements and then use undecipherable names to describe them. Since 2012, retirement plan companies have been required to declare the amount and purpose of fees, but that does not mean they do not try to confuse the average investor. Even savvy investors may feel lost in a 30-page disclosure document designed to discourage people from asking questions. Phrases like “asset maintenance fee” and “required revenue fee” seem legitimate, but they actually just refer to revenue sharing and commissions.
To determine if you are paying too much in fees, you will first need to know what an appropriate amount is. In general, fees should be less than 1 percent, but many finance professionals note that they have seen fees as high as 3.25 percent. Some plan managers will try to justify a higher rate by saying that a small company needs to pay higher fees until they grow larger—this is not the case. Ideally, it should be under 1 percent, regardless of the size of the company.
Viewing Employers as a Key Partner in Fee Negotiations
The regulatory changes that took place in 2012 made employers responsible for the plans they select for employees on a fiduciary level. Employers have a duty to select plans solely for the benefit of their employees and are required to review fee disclosure documents within 90 days of receiving them. During this time period, it is possible to make changes to the plan. Company owners and managers can actually face rather significant fines if they do not review the disclosure since it is considered disregard for the welfare of employees both now and in the future. In other words, employees are not alone when it comes to negotiating for better fee structures and should view their employers as partners in this struggle.
Employees should advocate for a joint disclosure assessment with their managers to make sure that the plan is the best for the future. When people take the time to learn what the fees mean and how they may be unnecessary, they can argue for a fairer structure and ultimately put everyone in a better position for retirement.
While historically people could count on Social Security and pension plans to provide a comfortable income during retirement, people today need to save and invest as they prepare for life after work. Luckily, there are wide variety of retirement plans available. However, understanding which vehicle is the best option can be confusing. Learning more about the specific advantages and disadvantages of various plans can help people figure out what they need for their particular retirement needs and goals. One way to categorize retirement plans is to consider those sponsored by employers versus individual retirement accounts.
Retirement Plans Sponsored by Employers
A great way to start saving is through employer-sponsored plans. The most basic employer-sponsored retirement account is the defined-contribution plan, typically a 401(k). A defined-contribution plan involves payroll deductions that go directly to an individual account within the company plan. Ideally, your company will match your contributions, which means that your employer will also put money into the account, up to a certain amount and based on how much you elect to contribute.
Employer-sponsored accounts are generally easy to set up, since the contributions are usually deducted directly from your pay each pay period. They’re also easy to maintain, because the plan administrator handles most of the statements and disclosure. In addition, 401(k) contribution limits are typically higher than those for individual retirement accounts—not to mention the fact that any employer matching is free money. Furthermore, contributions to 401(k) plans reduce your taxable income now. However, you’ll pay taxes on withdrawals from traditional 401(k) accounts during retirement.
In contrast, with a Roth 401(k), your payroll contributions are made after taxes, so your withdrawals during retirement are tax-free. A Roth 401(k) also has no income restrictions, unlike a Roth individual retirement account. Which you choose (traditional vs Roth 401(k)) basically depends on whether you think you’ll be in a higher income tax bracket during your retirement. Roth 401(k)s are often recommended for younger investors, who tend to fall in lower income tax brackets, but there may be good reasons for older investors to consider Roth 401(k)s as well. A financial advisor can help you make the best decision.
There are some drawbacks to defined-contribution plans, the most obvious of which is greater restrictions on investment choices. With an individual plan, you have much more control over where your money is invested. In addition, employer-sponsored plans often come with high management and administrative fees, which can take a significant chunk out of your savings. New employees should also make note of any waiting period before they can make contributions, as this is common. You may also have to wait until you’ve been with your company for a certain period of time (say, a year) before your employer will match your contributions.
Individual Retirement Accounts
The other main option when it comes to saving for retirement is the individual retirement account (IRA), which can be set up through banks, brokerage firms, and other financial institutions. These accounts hold various investments, from stocks and bonds to cash and mutual funds, reserved for retirement. Several different types of IRAs exist, each with its own tax and contribution rules, so it’s important to look through all the options. As with a 401(k) plan, you can select a traditional or Roth IRA, with Roth contributions made with after-tax income, in order to avoid taxation upon withdrawal during retirement. You can contribute to both a Roth and traditional IRA in the same year, provided that you qualify for both.
The main advantage of IRAs is the fact that you’re in the driver’s seat and make all the decisions, whether that means personally or choosing a professional to do so. Furthermore, an IRA comes with a very wide range of investment choices, so it becomes easier to diversify. However, there are some downsides, too. IRAs in general have lower annual contribution limits, although these limits increase once you turn 50. Contribution limits depend on your modified adjusted gross income. Furthermore, even traditional IRA contributions are not always tax-deductible. (Roth IRA contributions are never tax deductible.) The deductibility limits for traditional IRAs depend on your income, as well as your tax filing status and access to workplace retirement plans.
General Guidelines for Deciding on Retirement Contributions
The exact savings strategy you should use will depend on your individual circumstances, but some general guidelines can help you determine your contributions. For the most part, you should first take advantage of any workplace retirement plan that comes with employer matching. Outside of the 401(k), these plans might include 457(b)s, 403(b)s, and defined-benefit plans, which work much like a pension.
Once you’ve maxed out your 401(k) contributions, or at least the matching available from your employer, it might be time to consider an IRA. Additionally, people who do not have a retirement plan through their company should focus on an IRA. Here, the most important decision is whether a traditional or Roth IRA is more appropriate. Determining this will involve making some predictions about your tax status in retirement. People who will fall into a lower tax bracket in retirement will benefit the most from a traditional IRA. Furthermore, people who are self-employed or who own a small business should recognize that specialized accounts exist for them, including the solo 401(k) and specialized IRAs.
One of the most common questions people ask their financial advisors is, when should I start saving for retirement? Virtually across the board, financial advisors will say that you should start as early as possible—ideally when you’re in your 20s and have just launched your career.
Of course, there’s no reason to despair if you didn’t start a retirement fund right out of college. Not everyone in their 20s has the foresight to start saving for something decades in the future, especially since many employers do not offer a savings-matching program. If you started saving for retirement later in life, the situation certainly isn’t hopeless, but it is a bit more urgent. You’ll need to save more and be more focused to meet the same goals, since you’ll have less time to achieve them.
However, if you start early, you’ll enjoy a wide range of benefits, including the increased flexibility that compounding interest provides. You’ll also be able to take more chances with your investments, because you’ll have more time to recover from losses. Another major benefit of starting early is that it instills good habits early on.
When you start to plan for retirement in your 20s, you’ll learn several lessons that will serve you well for the rest of your financial future. These include:
Learning the value of compounding.
If you’re in your 20s, you have a lot of time before you retire and can use this to your advantage. Making money grow over the course of 40 years is much easier than achieving the same thing in half that time. Even when your money just sits there, over time it can double, triple, or quadruple. The best way to understand the value of compounding is to think about the math behind it.
As a hypothetical situation, imagine you save $6,000 toward retirement each year until the age of 65 at a 7-percent rate of return. If you start saving at age 45, you will have about $246,000 in the account when you reach retirement age. If you begin saving at 35, the account would have about $567,000. However, starting at the age of 25 means you’ll amass nearly $1,198,000. In other words, starting at 25 nearly quintuples the final amount saved, compared to starting at 45. This happens even though you would only contribute an additional $120,000, or $6,000 annually, for the 20 years between age 25 and 45. This math underscores that your savings depend not only on how much you contribute, but also on how long you’ve been contributing.
Understanding how to maximize employee benefits.
Employers often provide some sort of retirement benefit for full-time employees. Most commonly, you’ll have access to a 401(k) plan through your company. Understanding these accounts and how they work sooner, rather than later, will make it easier to use them strategically down the line, when choosing the right investments becomes extremely important. When you start contributing to your 401(k) early, you’ll have some time to play with the account without serious consequences.
A 401(k) typically rises and falls with the stock market and continues to grow over time. Money for the account is taken directly out of your paycheck, so you never see it. If you’re lucky, your employer will match your contributions to the account at some percentage—this can be a major boon and add up quickly. Plus, this matching is essentially free money, so it makes sense to take advantage of it. Some employers will offer profit-sharing instead, which means that a portion of the company’s profits is put into your 401(k) account, reducing your tax liability.
Keeping meticulous records and budgets.
People save money when they spend less than they bring in. The concept is simple, of course, but it’s a lesson many of us learn the hard way. However, saving for retirement will encourage you to become more discerning with your money, and you’ll soon learn to keep track of exactly where it goes. This skill will become more important over time, especially when it’s time to save for a down payment on a house or pay off a big debt. Ideally, people in their 20s should strive to live on about 85 percent of their income and save or invest the rest.
Keeping track of spending has become simultaneously more and less difficult. It’s easier than ever to buy things today; sometimes it only takes a few taps on a screen or one click of a button. Because of this, impulse spending can be hard to avoid.
At the same time, technology does a lot of the recordkeeping for us. Most of us no longer have to spend time adding and subtracting columns of numbers to balance a checkbook. In addition, smartphone apps can help track your spending; basic spreadsheets on your desktop computer are also effective. Whatever method you use, keeping track of spending can help you stay out of debt or pay off a large debt that must be wiped out before you can begin saving for retirement in earnest.
The Bottom Line: When it comes to saving for retirement, there really is no such thing as too soon. People who start saving early will set themselves up for success down the line by learning critical lessons about finance and investing. In addition, starting to save early, even if only a small amount, leads to significant gains because of compounding interest. If you think you can’t save, re-examine your finances to see if you can cut back on spending in some places. Putting aside even a little bit of money each month will help you establish a lifelong habit that will pay off enormously in the end.
Retiring well requires implementing a set of plans that will last. Making these arrangements can feel cumbersome and bring up awkward family conversations, but it doesn’t have to be that way. Goldstone Financial Group’s owner and principal Anthony Pellegrino built his career on helping clients achieve financial success and make lasting plans that put families at ease. His commitment to legacy plans has ensured that his clients can enter their golden years with a champagne toast.
Why is a legacy plan so important? Studies show that traditional estate plans are 70% likely to be lost by the second generation and 90% by the third. Many clients have panicked reactions to this information, but there’s no need to start hoarding cash in your mattress. What you’ve done in an estate plan can be easily incorporated into a legacy plan that will last for generations.
Here are the top 5 ways to build a legacy plan.
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Anthony Pellegrino | Goldstone Financial Group
A 1% fee doesn’t seem like much at first glance. After all, basic math tells us that it would only claim a single dollar out of a hundred or ten out of a thousand. To a new investor or aspiring retiree, signing over one or even two percent of a portfolio’s earnings might seem like a reasonable — or even small! — price to pay for enjoying the remaining 99% later in life.
A 1% cost might not look like much — but appearances can be deceiving. When it comes to investments, administrative expenses that may have seemed almost negligible at first can burgeon into costly financial demands. Mutual funds are particularly notorious for their plethora of so-called “hidden fees,” which often carve a significant portion of a portfolio’s future value away in a series of small cuts. Worse, these costs are often applied internally and may not be visible on your monthly statement; if you don’t go out of your way to investigate your accounts, you may never know precisely how much of your profits minor fees claim each year.
To continue our example — one dollar out of a hundred isn’t much of a loss. However, the primary financial drain to your account isn’t the initial deduction, but the opportunity cost posed by losing that dollar. By giving it up, you sacrifice its potential to compound and grow as an investment asset. For robust retirement accounts, these 1–2% fees could end up costing a retiree hundreds of thousands in lost profits. In 2018, analysts from Nerdwallet applied these average fees to a hypothetical millennial and found that over 40 years of saving, the investor would lose more than $500,000 to average charges.
Let’s break this down further.
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Investment Advisory Services offered through Goldstone Financial Group, LLC a Registered Investment Advisor (GFG). GFG is located at One Lincoln Centre, 18W140 Butterfield Rd., 14th Floor, Oakbrook Terrace, IL 60181, Telephone number — 630–620–9300.
Good news for retirees: Social Security benefits are scheduled to increase 2.8 percent in 2019, the biggest bump since the 3.6 percent increase in 2012.The average beneficiary – who received about $1,405 a month in 2018 – can expect to see just over $39 more each month, or about $468 more over the course of the year.1
Such cost of living increases are meant to cover household expenses that rise due to inflation. However, if you can absorb those additional costs, you could think about redirecting that additional payout toward helping to meet your long-term financial goals. For example, an emergency savings account or a life insurance policy designed to pay for funeral expenses. If you would like help with this, please give us a call.
There are a few more updates to Social Security for 2019. For one, the supplemental benefit paid to those who are blind or disabled will increase to $771 from $750 per individual; to $1,157 from $1,125 for couples. Second, if you’re currently working while receiving benefits, you can earn a bit more before those benefits are reduced. Moving forward, you may now earn up to $17,640 before $1 is deducted for every $2 you earn. In the year before you turn your full retirement age, you may earn up to $46,920 before $1 is deducted for every $3 you earn until the month you reach your full retirement age. And third, for those who are still working and have not yet started receiving benefits, the maximum amount of earnings subject to the Social Security tax will increase to $132,900 from $128,400.2
Some advocate eliminating the earnings cap to keep Social Security solvent in the future. That’s because the brunt of taxes dedicated to Social Security comes from lower-income earners, while high earners avoid this tax on earnings above $132,900. In fact, due to the increase in income disparity in the United States, a much higher level of earned income is now exempted from this payroll tax compared to the 1980s – $300 billion in 1983 versus $1.2 trillion in 2016.3
Other changes in addition to eliminating the taxable income cap have also been proposed. One option, which could benefit both the Social Security fund as a whole and individual retirees, is encouraging retirees to delay claiming Social Security benefits. For every year delayed, one’s benefits increase 8 percent. Those who wait to take the benefit until age 67 receive about 43 percent more a month; those who wait until age 70 receive about 75 percent more in lifetime monthly benefits.4
Social Security benefits – both funding and payouts – can be complex. It is worthwhile to stay abreast of the policies, changes and strategies that can help maximize benefits. For additional information, try out this quiz – which also gives a detailed explanation of the correct answers to help you become better educated about Social Security.5
Content prepared by Kara Stefan Communications.
1 John Wasik. Forbes. Nov. 2, 2018. “5 Things You Should Know About Social Security Changes.”https://www.forbes.com/sites/johnwasik/2018/11/02/5-things-you-should-know-about-social-security-changes/. Accessed Nov. 9, 2018.
3 Sean Williams. USA Today. Nov. 9, 2018. “Why the Social Security program will never run out of cash.”https://www.usatoday.com/story/money/2018/11/09/when-does-social-security-run-out/38452267/. Accessed Nov. 9, 2018.
4 Knowledge@Wharton. Oct. 3, 2018. “Delaying Social Security: How Lump Sum Payments Can Help.”http://knowledge.wharton.upenn.edu/article/delay-social-security/. Accessed Nov. 8, 2018.
5 Matthew Frankel. USA Today. June 2, 2018. “47% of American pre-retirees failed this basic Social Security quiz. Can you pass it?”https://www.usatoday.com/story/money/personalfinance/retirement/2018/06/02/pre-retirees-failed-basic-social-security-quiz/35343701/. Accessed Nov. 9, 2018.
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We are an independent firm helping individuals create retirement strategies using a variety of insurance products to custom suit their needs and objectives. This material is intended to provide general information to help you understand basic retirement income strategies and should not be construed as financial advice.
The information contained in this material is believed to be reliable, but accuracy and completeness cannot be guaranteed; it is not intended to be used as the sole basis for financial decisions. If you are unable to access any of the news articles and sources through the links provided in this text, please contact us to request a copy of the desired reference.