No. 11
It might be challenging to think about retirement when you are just getting started with your career. However, there will come a time when you’ll want to throttle back and be able to enjoy the three phases of life after work – your go-go years, your slow-go years, and your no-go years.
Why Read: Learn the basics of how and why to save now for the retirement you want to have.
Compounding is the 8th Wonder of the World
More chestnuts squirreled away now make for good eatin’ later
Why you should take full advantage of employer contribution matching now
Why is everyone fed up with the Fed?
Growing up I thought that retirement meant that you lived out your life in a back room at one of your adult children’s homes telling them how to raise their children and waiting for the postman to deliver your measly social security check. If you were lucky and had worked for a large company in the public sector, you might also have a pension.
Given that not all companies had pension plans, in the 1970s laws were passed allowing for the creation of Individual Retirement Accounts (IRAs). And because most Americans can’t seem to forgo short-term pleasures to achieve long-term goals, a bill is going before the U.S. Senate (named “Secure 2.0.” Do you think Congress hires a consulting firm to help with these clever names?) that will mandate employers to automatically enroll employees in a 401k with a minimum contribution of 3% of their pre-tax income.
What are retirement plan options and how and when do I get started?
The What
Employer 401k – provided by your employer this account allows you to make pre-tax investments up to $20,500 annually if you are younger than 50 and $27,000 if you are over 50. The over 50 contribution is referred to as a “catch-up contribution” since they are closer to retirement. Your contributions are automatically deducted from your paycheck pre-tax which lowers your taxable income at tax time.
The coolest benefit to the 401k is when the employer offers a match to your contribution, up to a certain amount of your salary. For example, let’s say your employer offers to match 50% of your contributions, up to 5% of your total salary. So, if you make $100,000 annually and contribute the full $15,000 to your 401(k), your employer will kick in an extra $2,500 = ($100,000 x 5% = $5,000 x 50%). Remember that if your employer offers a match, you must contribute enough to get the additional 5% or $2500.
Any match your employer provides doesn't count toward your annual contribution limit. However, the IRS does limit the total contribution to a combined limit of $61,000, or $67,500 if you're 50 or older. ( Why? Because they wouldn’t want you to get so rich that you buy a social media platform and threaten total chaos :) )
403b – If you work in the public sector or a non-profit you likely have a 403b, which is like a 401k. The primary difference has been that the 403b has traditionally had higher fees, less regulation, and fewer investment options than the 401k. This too appears to be changing as the 403b begins to adopt some of the same features as the 401k.
More info can be found on 403b here.
Traditional IRA and Roth IRA – Similar to the 401k the IRA and Roth IRA are both retirement investment accounts, but with some differences. Contributions to either are made directly by the individual rather than the company on an after-tax basis. You must have a certain level of earned income to be eligible to contribute to an IRA. Contributions to traditional IRAs generally lower your taxable income in the contribution year and when you take distributions from your IRA in retirement, they are taxed at whatever your income tax rate is at that time.
If you withdraw money from an IRA before age 59 1/2, you’ll have to pay taxes and a 10% fee. And with a traditional IRA you must start taking required distributions at age 72 even if you don’t need the money!
One of the primary differences between a traditional IRA and a Roth IRA is that contributions to the Roth are not tax deductible in the contribution year. There are also some income-eligibility restrictions with a Roth that are dependent upon how much you make and whether you are married or single, because why should the IRS make anything simple.
However, contributions to a Roth can be withdrawn at any time, tax-free and penalty-free. Five years after your first contribution and age 59½, earnings withdrawals are tax-free, too. This also makes the Roth IRA a great vehicle for wealth transfer. If you die with an unspent Roth it goes to your beneficiaries tax free – morbid perhaps but they’ll love you even more for having such foresight.
You can have both a traditional IRA and a Roth IRA, but you must meet certain requirements. I’d tell you what they are, but they keep changing so speak with an advisor when you initiate either. Which one you choose is a bet on whether you think you’ll be in a higher or lower tax bracket when you retire – if higher later then a Roth now is a good bet.
The Why
You should really try to max out your 401k or IRA contributions as early as possible for one simple reason – more money invested sooner compounds longer resulting in even more money later.
Compounding is the 8th Wonder of the World!
If you invest $10,000 today at 8% interest in 20 years you’ll have $46,609, in 30 years $100,626, and in 40 years $217,246. Now imagine that you invest the same $10,000 today at 8% and each year you contribute another $5,000. In 20 years, you’ll have $275,419, 30 years $667,042, and in 40 years $1,512,527. Ka-ching!
The How
If you work for a company that offers a 401k plan sit down with your HR representative and review it carefully. Do the calculation to see how much you can contribute now and if there is an employer match, determine how to get the full benefit. Stretch if you must because the sooner you start saving for retirement, the sooner your money starts compounding, and you’ll have more to enjoy during the go-go years through the no-go years. Best of all you won’t have to live in a small back room with your adult kids.
For you job hoppers out there remember to take your 401k with you when you leave your job. According to Bankrate.com more than 25 million 401k plans worth about $1.35 trillion were forgotten by employees at the end of 2021.
So, be sure to track down any money that you left at a former employer and execute a rollover either into your new employer’s plan, or an IRA that you already have.
Fed Up
What is the Fed? What does it do? Why? What is going on?
Several people have inquired lately about the Federal Reserve Bank and its role in the economy. Let’s start with what the Fed is and why it exists?
In 1913 then President Woodrow Wilson – an academic who left higher education because it was too political – signed the Federal Reserve Act which gave the 12 regional Federal Reserve banks the ability to print money to ensure economic stability. This system of banks has the dual mandate to maximize employment and keep inflation low. They attempt to achieve this through a few monetary policy tools:
The Fed Funds Rate - the interest rate at which banks lend money to one another overnight. These funds are maintained at the Federal Reserve and are intended to ensure that the largest banking institutions do not find themselves short on cash
The Discount Rate - is the interest rate charged to banks and other financial institutions for short-term loans they take from the Federal Reserve
Purchase and Sale of U.S Treasuries – these are bonds, notes, and bills created by the U.S. Government’s printing press, a.k.a. the U.S. Treasury. These financial instruments have maturities that are both short-term and long-term (up to 30 years) in nature and are purchased by governments, companies, and individuals worldwide. They are backed by the “full faith and credit” of the U.S. Government, which is another way of saying that unlike your mortgage, which is backed by an asset (your house), the government backs these loans with just a promise to pay them back.
Using these tools, the Fed attempts to keep the economy chugging along smoothly by controlling the amount of money in the markets (money supply) and interest rates. Faith in the banking system and lower rates are supposed to encourage businesses and individuals to borrow and invest to keep the economy growing at a reasonable pace without creating boom and bust cycles. As with Goldilocks and the Three Bears, the Fed is chartered with keeping the economy “just right.”
Why does everyone appear to be Fed Up with the Fed?
The short answer is that boom and bust cycles seem to be commonplace affecting housing, equity markets, and other assets. Can the Fed do its job or not? The answer is complicated and somewhat rooted in the fact that that Fed uses linear models that try to predict behavior and most often human behavior is non-linear.
Whaaaaat?
Put simply, the Fed cut rates and bought Treasuries during the pandemic to keep the economy cooking along and it did to a point. The assumption was that liquidity and lower rates would increase investments by companies and that would keep people employed and spending. Investment and consumption in America act like a laxative to keep the economy moving.
However, too much of a good thing isn’t always a good thing and when the Fed kept printing money and reducing rates to near zero it had the opposite effect. Businesses used their profit to purchase back stock and people used cheap capital to purchase houses, cars, and speculate in the market driving up prices. While businesses had huge profits, that fueled higher stock prices, there hasn’t really been any productivity growth in the last decade. Essentially, they “pulled forward real growth from the future and pulled away from current economic risk-taking.”
Meanwhile, individuals who owned equities saw their investments rise to new levels. Some borrowed against their newfound wealth and took advantage of low interest rates to purchase bigger houses, faster cars, boats, etc. Throw in the war in Ukraine and supply chain issues in China and you have inflation rising to levels not seen since the 1970s.
By expanding its balance sheet through purchasing Treasuries and cutting rates to near zero, the Fed had hoped to give us stable prices and 2% inflation with productivity growth. What we got instead was a decade of terrible productivity growth along with bubbles in asset prices (e.g., housing, equities, even used cars!). Too much laxative has resulted in the shit show that you now see unfolding in the markets.
The Fed is now faced with trying to reverse course without causing a recession, but many economists aren’t buying it. The odds of a recession appear to be quite high. When it happens and how long it lasts is anyone’s guess.
Sources for these posts: