In my financial practice, I am often questioned about what clients should do with their workplace retirement plans. For many, these savings are their largest investable asset over time, so it is no surprise that the topic comes up. Given the high level of interest from my clients and with workplace benefits enrollment season underway, I thought I'd focus this month's posting on three common questions I often get about workplace retirement plans.
#1. How much of my paycheck should I contribute?
As a benchmark, I encourage clients to put 10 to 15 percent of their salary into an employer-sponsored retirement plan. I tell them that putting aside 10 percent is very good, while 15 percent is even better. Since contributions are most often taken out at the paycheck level -- before you even see the money or have it in your hands -- the savings process is easier psychologically. You learn to live without that money and saving for retirement becomes an easy habit to set and keep.
If saving 10 to 15 percent of your salary is just not feasible for you right now, contribute at least some amount and enough to get any employer match. You can slowly increase your contribution level each year -- from 6 to 8 to 10 percent and higher -- so the shock to your budget is not as great and you get yourself up to a point where your retirement savings are growing at a healthy clip.
#2. When should I start contributing and how do I balance other financial demands, particularly debt?
Start contributing as soon as you start employment. Without a doubt, contribute at least enough to take advantage of the employer match. Don't walk away from free money.
Many people struggle with credit card debt, which can certainly impact your ability to save for retirement. I encourage clients to continue saving for retirement -- even at a small amount -- to start building your nest egg and establishing a savings habit. If you have credit card debt, put together a plan of attack that reins in spending, adjusts your lifestyle and gets you to a better financial situation, so retirement savings can become the top priority. When you are debt-free, bump up your retirement savings.
#3. What's a Roth and should I put some retirement savings in this savings bucket?
Around 34 percent of 401(k) plans include Roth 401(k) accounts, according to the 2011 "Hot Topics in Retirement" Aon Hewitt study, but employers are increasingly adding the Roth option to their plans. So, if your workplace plan does not yet offer a Roth, it may be coming soon.
Roths are certainly worth exploring, as they allow you to save for retirement with after-tax dollars that have the potential to grow tax-free. Putting some portion of your retirement savings into a Roth helps diversify the tax treatment of your money. To help explain the benefits of the Roth to my clients, I use my "Farmer Joe" analogy to help them understand the concept. Since I live in Arizona with a large cotton farming presence, let's say that Farmer Joe spends $50,000 on cotton seed. After harvesting the cotton and selling it, he has earned $150,000 as a result of that initial investment in cotton seed. Now I ask Farmer Joe: "would you rather pay taxes on the seed or the harvest?" Clearly, Farmer Joe would want to pay taxes on the seed. For younger investors, the Roth presents a great opportunity to take advantage of years of potential tax-free income growth. The longer you have until retirement, the more benefit you are likely to see from a Roth.
The Roth does not always make sense, depending on your time horizon and tax situation. Those who are close to or in retirement don't have as many years to reap the rewards of the Roth, so it may not be as beneficial. In addition, you may want the tax deduction today, so the traditional retirement savings option that taps pre-tax dollars is more appealing.
Good news, help is on the way
Financial concerns can be a big workplace distraction. An ING U.S. 2012 Redefining Retirement Readiness study found that one-third of workers spend five or more hours each week, at work, preoccupied with personal finances. That is a lot of time lost each week due to personal financial concerns.
Many people don't have access to a financial planner or think they can't afford it, but everyone still needs help and guidance with their retirement savings. More employers are creating financial planning experiences for employees that are holistic -- looking at employees' complete financial picture from retirement savings and budgeting, to college savings and insurance protection.