The pandemic seems to have changed just about everything about employment in America — where we work, if we work. Does this change the savings strategy of young people entering the workplace?
The Leaven asked Nancy Mellard, of CBIZ Benefits & Insurance Services.
Q. Young workers watching their 401(k)s rise and fall over this pandemic year are asking if there is another — more reliable — way to save for retirement. How have Americans traditionally saved for retirement in the past, and why do 401(k)s play a significant role in retirement savings today?
A. Historically, many workers were covered by pension plans whereby the employer/plan sponsor was responsible for saving for retirement, not the employee. This pension, coupled with Social Security, funded most retirements.
Over time, pension benefits were reduced and plans were terminated. Instead, employees were given the opportunity to save for retirement using a 401(k) plan. With the 401(k), or the 403(b) in the case of nonprofits, the employee is responsible for deciding how much to contribute from their paycheck and how to invest the money. Some financial consultants counsel clients on how to use contribution plans as an important part of retirement funding.
Q. Should a young person just starting out open a 401(k)?
A. Absolutely! You cannot control the market, but years of saving with a 401(k) can make a big difference. As young employees determine how much to save from their paychecks, they should keep in mind that 401(k) contributions can reduce their tax bill. They should also increase their 401(k) savings as their income increases annually. Some plans make annual increases easy and efficient with as little as 1% per year. For example, if a young person budgets a 5% deferral now, they can choose an auto escalation feature to increase that amount to 6% the following year. This is a great way to build your nest egg.
Q. People often delay starting a 401(k) because they’ll have to answer questions they don’t know the answers to. So, let’s start with an easy one. Should they start with an employer plan if available?
A. Yes, they should contact their company’s HR department and ask how to start. Most employers/plan sponsors make this easy for employees.
Q. What if they don’t plan to stay at that job long? Is that still your advice?
A. They should begin saving regardless of whether they think the job will be over a short or long term. Remember, saving with a 401(k) is typically better over longer periods. Additionally, some employees stay at companies longer than expected, so putting it off would not benefit them in the long run. Employees can transfer their 401(k) balance to the next employer or to an IRA rollover account if they decide to move on in their career to another employer.
Q. What if their employer doesn’t offer one?
A. Have a discussion with HR to see if any plans might be offered in the future. The employee can also contribute to individual IRAs to begin building that retirement nest egg.
Q. Would you recommend a tax-deferred option or a Roth? What is the difference?
A. Every situation is different. In general, a regular contribution to a retirement plan is before tax. Simply stated, if you put $1,000 into a plan, your taxable income on your W-2 will be $1,000 less. This means you will not pay tax on the money you put into a plan. Employees must pay the tax when they withdraw funds from a retirement account. An employee that withdraws funds before age 59 and a half could be subject to a 10% penalty and tax on the withdrawal. Most retirement investors wait until after that age to withdraw funds.
With a Roth, contributions are made after tax. If your plan has a Roth feature and you contribute $1,000, your W-2 income will not be reduced by $1,000. However, when you take the funds out at retirement (at least five years after contributing), the funds withdrawn are tax free. If you expect to be in a lower tax bracket, a Roth account may make sense. Some retirement investors strive to have both Roth and non-Roth retirement accounts to provide flexibility for income tax planning in retirement.
Q. How will they know which stocks to choose?
A. When starting out, most retirement plans offer mutual funds as investment options. These funds offer diverse investments and are professionally managed by the employer/plan sponsor. Individual stocks may be risky, as they can produce concentrated stock portfolios. A diversified approach is common for most investors.
Q. What then? Should they follow the stock market and check their balance frequently?
A. If you set up a diversified portfolio based upon your projected retirement age and risk tolerance, some financial consultants recommend reviewing retirement account statements quarterly. That does not mean you should not check balances if you are curious. However, the most successful investors review it annually.
For those retirement plan investors that do not want to do a lot of homework, most plans offer target date funds. Target date funds are professionally managed portfolios that have a glide path. This feature readjusts the portfolio to become more conservative as retirement nears.
Q. What is the most important thing a young investor should consider when investing in turbulent times?
A. You cannot control or time the market. Time is on your side, so setting a strategy and sticking to it typically pays the most dividends. The market fluctuates frequently, so avoid impulse buying and selling. A financial consultant can help guide you over time. Long-term, diversified portfolios that stay invested typically win in the long run.
Q. How can I align my investments with my Catholic values?
A. Most 401(k)s and 403(b)s do not provide participants with the ability to invest in accordance with the U.S. Conference of Catholic Bishops standards. Socially responsible investing is growing, but still is uncommon. If you invest in the S&P 500 index fund, you will own some companies that do not reflect Catholic values, including our value for life. There are some mutual funds that screen for Catholic values. One example is the Ave Maria Fund family.
Nancy Mellard is executive vice president and general counsel for the Benefits & Insurance Division of CBIZ, Inc. She and her husband Ken have been chairpersons for Snowball and she is currently serving on the finance council for the archdiocese. In a later installment of Dollars & Sense, Mellard will offer some basic investing advice to older savers and those nearing retirement.