(A Little More) Room to Grow

 Several years ago, we had in mind that it would be fun to get an aquarium for our home, and (even) I got excited at the prospects of filling it with a variety of all kinds and sizes of exotic fish. 

Sadly, those hopes were dashed when I discovered that , despite the massive displays of what appeared to be whole schools of fish in similarly sized tanks at the pet store, our specific-sized tank would only support a handful of the fish I had hoped to display. Apparently, the more fish you want to have (that live), the bigger the tank you need. The reason: they need room to thrive and grow.

At long last the IRS last week announced the new contribution and benefit limits for 2022. Considering the run-up in inflation this year, expectations were similarly high for increases in those limits. And sure enough, among other things, the 401(k) limit was bumped $1,000 (to $20,500) and the defined benefit plan limit rose from $230,000 to $245,000, though the limit for catch-up contribution held level at $6,500. 

At the outset, it’s worth remembering that these adjustments only reflect increases in the cost of living—basically an acknowledgement that the costs of living in retirement change over time, that they increase due to inflation—and that they are timed in such a way that those increases must accumulate to a certain level before that acknowledgement in the form of increased levels kicks in.

But since industry surveys[i] suggest that “only” about 9%-12% currently contribute to those levels, does it matter? And why don’t more people max out on those contributions? Well, cynics might say it’s because only the wealthy can afford to set aside that much.[ii] But Vanguard’s data suggests that only about half (56%) of even those workers making more than $150,000 a year maxed out their contributions. If these limits and incentives work only to the advantage of the well-off, why aren’t more maxing out?

Limit ‘Ed’

Those who look only at the outside of the current tax incentives generally gloss over the reality that there are a whole series of benefit/contribution limits and nondiscrimination test requirements. These rules are, by their very design, intended to maintain a balance between the benefits that these programs provide between more highly compensated individuals and the rest of the plan participants (those rules also help to ensure a broad-based eligibility for these programs). Almost assuredly those limits are working to cap the contributions of individuals who would certainly like to put more aside, if the combination of laws and limits allowed.[iii]

But let’s think for a minute about a group that doesn’t get nearly enough attention: the group— millions of working Americans, in fact—who are not wealthy by any objective measure, but earn enough that Social Security won’t come close to replicating their pre-retirement income. These middle and upper-middle income individuals apparently aren’t the concern of those who want to do away with the 401(k)—but these are the individuals who in many, if not most, situations, not only make the decision to sponsor these plans in the first place—they make the ongoing financial commit to make an employer match.

If nothing else, allowing those contribution limits to keep pace with inflation—like the right-sized aquarium—provides us all not only with a little more room to grow our retirement savings—but reminds us (all) of the opportunity to do so.

- Nevin E. Adams, JD

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[i] According to Vanguard, during 2020, 12% of participants saved the statutory maximum dollar amount of $19,500 ($26,000 for participants age 50 or older). Fifty-six percent of participants with an income of more than $150,000 contributed the maximum allowed. 

[ii] Setting aside for a minute that $20,000/year likely won’t make much of a dent in the replacement rate for a wealthy individual.

[iii] For some additional validation of the impact of these limits, see “Upside” Potential.

5 Things You May Not Know About Roth 401(k)s

I made the switch to Roth for my retirement savings years ago – and I have long counseled younger workers, who were likely paying the lowest tax rates of their working lives, to do so as well.

Pre-tax treatment has, of course, been the norm in 401(k) plans since their introduction in the early 1980s. On the other hand, the Roth 401(k) wasn’t introduced until the Economic Growth and Tax Relief Reconciliation Act of 2001, and even in that legislation wasn’t slated to become effective until 2006 (and at that time was still slated to sunset in 2010).

Despite that late start, according to a variety of industry surveys (Plan Sponsor Council of America, Vanguard, PLANSPONSOR), roughly 60% of 401(k) plans now offer a Roth 401(k) option, and PSCA data shows that 28.6% of 403(b) plans already allow for Roth contributions. Participant take-up, which just a few years ago hovered in the single digits, is now in the 15-20% range.

Here are five other things you may not know about the Roth 401(k):

To allow designated Roth contributions, a plan also has to offer traditional pre-tax 401(k) contributions. 

A plan can only offer designated Roth contributions if it also offers traditional, pre-tax elective contributions. Oh, and they can be offered by either a 401(k), 403(b) or 457 plan.

You can auto-enroll designated Roth contributions. 

The plan must state how the automatic contributions will be allocated between the pre-tax elective contributions and designated Roth contributions.

You can “catch up” on a Roth basis. 

Individuals can make age-50 catch-up contributions as a designated Roth contribution to a designated Roth account.

You have to include Roth contributions in the 401(k) plan annual nondiscrimination testing. 

Designated Roth contributions are treated the same as traditional, pre-tax elective contributions when performing annual nondiscrimination testing. Moreover, just like other elective deferral, they must be included when calculating the top-heavy ratio each year. You cannot allocate forfeitures, matching or any other employer contributions to any designated Roth accounts.

You can take loans from designated Roth accounts. 

As long as the plan permits, you can identify from which account(s) in your 401(k), 403(b) or governmental 457(b) plan you wish to draw your loan, including from a designated Roth account.

Retirement plan education has long had as a basic tenet that individuals will be paying lower tax rates in their retirement future. Of course, tax rates – and future income levels – are hard to predict. Both can rise more than anticipated in the future – and a Roth option can provide some essential flexibility to diversify tax treatment, as well as investments.

- Nevin E. Adams, JD

For more information, see Retirement Plans FAQs on Designated Roth Accounts from the IRS.

6 Things Boomers Need to Know About Saving for Retirement

Several weeks back, I wrote a column entitled, “5 Things Millennials Need to Know About Saving for Retirement.” But what about those at the brink of retirement?

Retirement seems close — perhaps too close for the comfort of Boomers, some of whom have already begun cycling into retirement. In fact, the youngest element of this cohort (born in 1964) is now already 51, and it’s said that 10,000 Boomers roll into retirement every day.

That said, whether you’ve been saving or not, or not saving enough — here are six things Boomers need to know about saving for retirement.

1. Social Security won’t be as much as you think it will be.

When you were your kids’ age(s), you too were likely disdainful about the long-term prospects for Social Security (and hey, your kids weren’t around for the real funding crisis back in the early 1980s!). That said, you’re not only close enough to collecting; many of you are probably in the age group where when politicians talk about making changes, they’re careful to assure you that yours won’t be changed.

However, even if one assumes that the program remains largely unchanged from what it pays today, if you retire at full retirement age in 2015, your maximum benefit would be $2,663 a month, according to the Social Security Administration. Those who retire at age 62 (and many of today’s workers do, not realizing that waiting can translate into larger benefits) in 2015, your maximum benefit would be $2,025; and if you retire at age 70 in 2015, it would be $3,501.

Now those amounts are based on earnings at the maximum taxable amount for every year after age 21. In other words, that’s probably more than most of us would get. In fact, the average monthly Social Security retirement benefit for January 2015 was $1,328. Note that the maximum benefit depends on the age a worker chooses to retire, among other things — and that assumes that the current questions regarding Social Security’s longer-term financial viability are addressed, and/or that current benefit levels aren’t reduced.

2. Not everyone has a pension, and you probably don’t. And if you do, it probably isn’t a full pension.

Now, by “pension” I mean the traditional defined benefit (DB) pension plan, one that, in the private sector anyway, was largely employer funded. According to the nonpartisan Employee Benefit Research Institute (EBRI), in 2011, just 3% of all private-sector workers participated only in a DB plan, and 11% had both a defined contribution (DC) plan and a DB plan. So, only something like 14% of workers in the private sector still have a traditional pension plan (even then, it doesn’t mean there’s no reason for concern; see “3 Pervasive Retirement Industry Myths”).

That said, you’ve been in the workforce long enough (and during the right time) that you might actually have a pension, or at least a piece of one. Here’s the thing: People talk like the Millennials invented rapid job turnover, but the reality is that job tenure statistics have been relatively consistent going all the way back to the 1950s. What that means is that lots of workers who were “covered” by a pension plan didn’t work at those employers long enough to vest in that pension, or at least not long enough to vest fully. So, look back through your work history, check and see if those employers offered a pension. And you might want to check out thismissing pension tool from the Pension Benefit Guaranty Corporation (PBGC).

3. You won’t be able to work as long as you think.

I’m sure there are days when you would love nothing more than to be able to stay in bed (or at least not go to work). But industry surveys continue to suggest that not only do people expect to work longer, their retirement savings calculations seem to depend on it.

You hear people talk about 65 as the “normal” retirement age, even though it’s no longer that, even for Social Security benefits (aside from the reality that many still start collecting at age 62, unless you were born before 1943, your normal retirement age is 66 or older — you can check yours out here.)

Meanwhile, EBRI’s Retirement Confidence Survey (RCS) has consistently found that a large percentage of retirees leave the workforce earlier than planned — 49% of them in 2014, for example. Many who retire earlier than they had planned often do so for negative reasons, such as a health problem or disability (61%), though some state that they retired early because they could afford to do so (26%).

The bottom line: You probably shouldn’t count on being able to work as long as your finances may require. And that may require cutting back in the here-and-now in the interests of the there-and-then.

4. You could be missing out on ‘free’ money.

When you started working, if your employer offered a DC plan, you had to fill out a form in order to participate (you probably even had to wait a year), make investment choices, etc. These days a growing number of employers automatically enroll eligible workers in these plans, direct their savings into a default investment alternative, and even automatically increase that initial deferral rate each year. But even among those employers, most only automatically enroll new hires, not existing hires. And that could mean that even if you work for one of those employers, you might have been overlooked by these “auto” enrollment programs — and you might still need to go get one of those enrollment forms (or visit the plan’s website).

Your savings may well be matched by your employer (see “6 Things 401(k) Participants Need to Know”), so even if you’ve missed out on years of the opportunity to save and have those savings matched, there’s no time like the present to start — and start as aggressively as you can. After all, time is — literally — money.

5. You can use catch-up contributions to catch up.

Thanks to a provision in the tax code, individuals who are age 50 or older at the end of the calendar year can make annual catch-up contributions; up to $6,000 in 2015 and 2016 may be permitted by 401(k)s, 403(b)s, governmental 457s, and SARSEPs (you can do this with IRAs, as well, but the limits are much smaller). The bottom line: If you haven’t saved enough, these catch-up provisions can help. You can find out more here.

6. It’s not too late to start.

The reality is, without a sense of where you stand, what resources you have available, what your needs are and how long you have to prepare, it’s impossible to figure out the best way forward. But it starts with figuring out how much you’ll need. And for that, you might check out EBRI’s Ballpark E$timate — it’s free and easy to use. Then gather up those 401(k) statements, those IRA accounts, check for missing pension balances, and start saving!

- Nevin E. Adams, JD

"Retirement Ready" Resolutions

As the New Year begins, we are often of a mind to think about making a fresh start. If you are an individual, you may (finally) be ready to be serious about saving for retirement - or you may have mailed in that last tuition check - or crossed that age 50 threshold where you can start "catching up" on retirement savings. If you're an employer, you may well have established new goals for your retirement plans this year—a new threshold for participation, perhaps—or maybe you’ve just rolled out a new fund menu for your participants.

But whether your plans - or your programs - have undergone change or not, this is a good time of year to help participants reexamine their savings goals—and perhaps even some of their “bad” retirement savings habits.

Here’s a short list of “resolutions” that can help you get started.

___ Resolve to participate in your workplace retirement savings plan.

If you are not already saving for your retirement in your workplace program, you are missing out on one of the most important—and easiest—ways of making sure that you are on track for a financially secure retirement. Unless, of course, you have a rich (old) uncle.

___ Resolve not to miss out on the company match.

Odds are your employer matches your contributions to your retirement savings account up to a certain level, say 5% of 6% of your pay. Whatever that level is, if you do not contribute up to that point, you are letting “free” money slip through your fingers.

___ Resolve to increase your savings rate in your workplace retirement savings plan by at least 1%.

If you are already saving, are you saving enough? Have you ever made an attempt—with some kind of planning tool or the assistance of a financial adviser—to figure out how much you will need? Even if you have, it is remarkably easy to increase your current rate of savings by as little 1%--and you might be surprised just how much difference that will make!

___ Resolve to consider rebalancing investments at least once this year.

Your retirement savings account is being rebalanced all the time—by the investment markets. You can start out the year with half of your account balance in stocks and the rest in bonds, and a month later find that 70% is now in stocks and just 30% in bonds, or the reverse. How much and how fast depends on how your balance is allocated, and what is happening in the market. The bottom line: Once you have taken the time to put together a thoughtful allocation, you need to keep an eye on things. Once a month is good, once a quarter is probably enough, and once a year—well, that’s a minimum. Try picking a day that you won’t forget—your birthday, an anniversary…. Or any three-day weekend.

___ Resolve to use target-date investments properly.

Target-date funds are a pre-mixed investment solution—and most are designed in such a way that they assume that you are investing all of your retirement savings in that one investment. If you mix and match that with other funds on your retirement savings menu—or split your savings between two (or more) target-date funds—you will probably wind up with a mess. Just pick one. It’s the basket you SHOULD put all your eggs into.

What would YOU add to this list?

- Nevin E. Adams, JD