Do you have a 401(k)?
I recently met a 48-year-old at a workshop who told me that she had saved just south of $400,000 in her employer-sponsored 401(k).
She was understandably proud of her hard work and discipline, and, seeing my enthusiasm, she didn’t hesitate to ask something that a lot of people ask me: “Do you think I’ve saved enough for retirement?”
I already had some idea of the answer, but first, I needed to ask her a few questions: Do you have a mortgage? Are there any other assets? Is there any debt? Is any of that money in a Roth 401(k)? Where do you hope to retire?
Her answers were “no” to each of the first four questions, and as for where she hoped to someday retire, she hadn’t settled on a location, yet.
In rapid succession, I gave her some things to consider.
First, I told her that she might have 10 or even 15 more years to save, so if she wanted to really improve her odds of maintaining her current standard of living throughout retirement, she should set a goal to double the amount she had already socked away.
Then I pointed out some not-so-fun facts. First, since 50% of people are forced to retire early, usually due to poor health, there’s no guarantee that she is going to be able to work long enough to achieve that end. (Though I strongly encouraged her to try).
Next, I explained to her that, due to inflation, her money was unfortunately worth tens of thousands of dollars less than only just one year ago.
Then we discussed the bear market’s impact on her asset allocation.
And the last point I made was to remind her that the money in her 401(k) had been deposited without being taxed. And, that once she begins tapping into it, federal taxes, as well as likely state taxes, were going to take a substantial portion of her savings.
Then I gave her my honest evaluation: That she had done some admirable work, but that I didn’t think she had anywhere near enough money saved for a possible 20-year-plus retirement.
All of these are reasons why, just about every chance I get, I explain to people that they are probably going to need to save much more than they realize to be able to afford the retirement lifestyle to which they aspire.
Because, frankly, most people don’t want to rein in their spending once they stop working full time. (At least for the first few years, they generally want to live it up and knock several items off their bucket lists.)
The celebration of a new way of life (retirement) often results in early-stage over-spending and, by extension, quickly having less money invested to draw interest and gains. (It’s a cycle. The more you spend of your nest egg, the less you have coming in from your investments, so the more you end up spending of your nest egg.)
Then, if the market hits a rough patch, like the one we are in now, any amount you have invested takes a hit.
Still, I can’t help but be appreciative of 401(k)s, which are easily America’s most popular retirement savings vehicle.1
And yet, a little backstory: It’s something of a miracle that 401(k)s even exist.
The venerable 401(k) that we all know and mostly love wasn’t created in a drafty mountaintop investment laboratory by a bunch of mad, number crunching scientists. The fact is, that its invention (or discovery) was really something of an accident.
Back in 1980, a benefits consultant named Ted Benna was looking for a way to save a client money, when he discovered something new about tax deferred savings in Section #401(k) of the IRS’s Internal Revenue Code. Apparently, Congress had altered the tax code just a couple of years earlier to correct a loophole that existed in the laws that governed profit-sharing plans.
The funny thing is, that Ted Benna’s client ignored his advice. But, undeterred, Benna’s own company jumped into action and began offering something akin to 401(k) plans to its employees even before the IRS had formally acknowledge their legitimacy.
A year later, the IRS did in fact issue guidelines, and within two years, nearly half of all large U.S. companies began to offer them. (This of course wasn’t all for the benefit of employees. 401(k)s were not only cheaper for employers to administer than pensions, but they also served to shift most of the burden for retirement preparation to the shoulders of their workers.)