Seven Ways Employers Set Up Millennials to Fail at Retirement Saving
Your guide to extracting maximum value from workplace accounts
You’ve got a workplace retirement plan. Fabulous! But there’s plenty your employer likely isn’t telling you — or doing for you —that’s costing you money. Here’s how your employer might be letting you down:
We probably set you up to leave money on the table. Most workplace plans offer an employer-matching contribution, based on some sort of formula tied to what the employee contributes. A common setup is that an employer matches 50% of a worker’s contribution up to a limit. A common limit is 6% of salary; if the employee contributes at least 6% of salary, the employer will earn the maximum match of 3%.
But many employers set your default contribution rate too low to earn the maximum match. If the plan set you up to contribute 3% of your salary, your match would be just 1.5%. Callan, a benefits consulting firm, reports that just four in 10 plans chose a default contribution rate for employees that would ensure the maximum match. Lesson: Make sure you contribute at least enough to earn the maximum match. Not sure? Ping HR ASAP.
You’re not saving enough. We’re not exactly helping. A rule of thumb is that someone in their 20s and 30s needs to save at least 10% to 15% a year to have a good chance at ample savings come retirement. According to a Transamerica survey, 55% of millennials contribute less than 10%. Save more when you are young and the miracle of compounding will build a fabulous nest egg.
We might not offer a simple feature to help you save more. An elegant way to get employees to save more is auto-escalation: It raises a worker’s contribution rate on a set schedule, say one percentage point a year. Plans often require you to opt in to auto-escalation. That’s not very auto.
If your workplace lacks an escalation, step up and follow your own auto-escalation plan. Pick an annual date — birthday, hiring anniversary — and circle back to raise your contribution rate by at least one percentage point. Power move: Any time you get a raise, instantly siphon off at least half of it for retirement.
We might not tell you, but the Roth is the smart choice for you. Most workplace plans now offer a traditional 401(k) or a Roth 401(k). The sole difference is when you pay tax. With a traditional, your contribution this year reduces your taxable income (so you’re getting an upfront tax break) but you pay income tax on every dollar withdrawn in retirement. With a Roth, there’s no upfront tax break; your contribution this year comes from money you’ve already paid tax on. But in retirement there will be no tax due on withdrawals.
Younger adults should consider a Roth. You’ve likely yet to hit your peak earnings. So, your federal income tax bracket is lower. The value of the upfront tax break on a traditional account isn’t all that. The other issue is that right now tax rates are near historic lows, and the federal deficit sure isn’t. That suggests rates aren’t likely to stay low forever. Paying tax now on your retirement money — by saving in a Roth — is one way to insulate yourself from higher tax rates decades from now.
We offer actively managed funds, but index funds are the better option. According to Callan, seven in 10 plans offer a mix of actively-managed funds or trusts, as well as “passive” index funds that track an investment benchmark. Index funds are the better choice. Most active managers fail to beat the index and they charge higher fees.
We really should warn you against (over) investing in our company stock. Roughly one in three retirement plans surveyed by Callan offer company stock as an investment choice. Nearly six in 10 plans that offer company stock say they don’t set any cap on how much an employee can invest in company stock. The basic, irrefutable law of investment diversification is that a single stock is extremely risky. Let alone from a company you also rely on for employment. You can love your employer, be a true believer, but that doesn’t change the fact that having more than 5% to 10% allocated to company stock is irresponsibly risky.
We could do a better job encouraging you to not raid your retirement account. Many plans offer employees the right to loan themselves money from their retirement account. The problem: Money you’ve taken out can’t grow; if it takes you years to pay back the money (with interest), those are years lost to compounding. And typically, people with a loan outstanding aren’t continuing to contribute to their account. And if life gets messy and you can’t repay, the IRS considers it a withdrawal, and penalty and taxes can be levied.
The loan option should be considered only for true financial emergencies: making rent and putting food on the table. Not to finance “wants.” Yet Transamerica reports 25% of millennials who borrowed from their retirement account used the money to purchase a car.
Permanently withdrawing money years before retirement is an even costlier mistake. Once you leave a job, federal rules that cover 401(k)s allow you to cash out those savings. Tempting for younger workers with smaller balances. Tell yourself it’s “just $10,000,” and you could use the money right now. Some employers force cash-outs for balances below $5,000. Others insist that if you want to cash out, it’s an all-or-nothing deal.
What would truly help boost retirement security is for employers to allow partial cash-outs (many do) and most importantly, show the opportunity cost – forgoing years of compounding — of cashing out today.