I have mixed feelings about 401(k) plans. I love the idea of long-term savings, although these are the not ideal vehicles in which to save.
What don’t I like? They are voluntary, for one thing. Employers don’t have to offer them, nor do they have to contribute. You don’t have to participate.
While I don’t quibble with free choice, the voluntary nature leads to undersaving. It’s a big reason why millions of Americans aren’t saving enough for retirement. The lack of “universal coverage” – about half of employers don’t offer them – leads to some major retirement issues down the road.
“This lack of universal coverage means that many workers will move in and out of 401(k) plans over their careers and that their 401(k) accumulations will be much lower than projections based on the prospect of a steady lifetime of contributions,” notes a recent study from the Center for Retirement Research at Boston College (CRRC).
The lower savings rates is dramatic. Those who started contributing late save less than those starting in their 20s.
“For example, a 25-year-old median earner in 1981 who contributed regularly would have accumulated about $364,000 by age 60, but the typical 60-year-old with a 401(k) in 2016 had less than $100,000,” the study found.
Since there isn’t a robust public policy that will restore traditional pensions or compel employers to offer – and contribute to – 401(k)s, employees are on their own. The remedies, though, are relatively simple. They include:
- Contribute early and often. As the above example shows, the earlier you start in your work life, the more you can accumulate. It’s simple math aided by compound interest.
- Keep your money in the account. Employees are all to often tempted to treat their 401(k) plans like ATMs. Since you pay taxes and an early-withdrawal penalty (before age 59 1/2), the best strategy is to leave your balance alone for as long as possible. Forget about loans and withdrawals. It’s not worth it.
- Maximize returns with low-fee vehicles. Index mutual funds invest in gigantic baskets of stocks and bonds across the world. Don’t pay any more than 0.15% for annual fees.
This research highlights earlier findings about the simplicity of savings: Save as much as you can, don’t touch the balance until retirement and keep your fees low. It’s one of the most basic formulas for retirement success.