“You must contribute to your retirement account to avoid regretting later”
” You will be doomed if you do not start planning your retirement with your 401(k)”
“Millennials do not understand the concept of saving for retirement”
How many times have you heard or read such statements and wondered why a generation of millennials is being targeted for all the wrong reasons? It’s almost as if people think millennials are a group of young reckless and dumb individuals who have a hard time figuring out 2 + 2.
Among the many topics millennials are criticized for, retirement savings is one of them. While it may be true that the concept of saving for retirement requires harsh circumstances for some people to realize, but it’s certainly not under the unattainable category.
If you are an employee and your company offers retirement benefits, then you are certainly aware of the retirement plan 401(k). Most companies match the amount you wish to deduct from your paycheck, thereby giving you a “buy one get one” kind of scheme. For those who do not fully understand this here’s an example:
Say your monthly gross income is $5000 and you decide to contribute 3% of your income to your retirement plan. This means that you will contribute $150 each month to your retirement plan and your company will match this contribution amount and credit your retirement account with another $150 every month. This means you accumulate $300 each month in your retirement account. Sounds pretty sweet right?
It is certainly one of the safest and easiest ways to plan for retirement, but this plan has it’s terms and conditions.
- Loan: In order to use your own money from a retirement account, you can request a loan which can be paid back in monthly installments and the interest accumulated is also credited to the retirement savings.
- Investment: The choices of investment options available for this retirement account can be limited based on the wealth management company handling your account.
- Vested balance may not be 100% when you decide to change jobs.
- Withdrawal: The amount accumulated cannot be withdrawn until the age of 59.5 – If withdrawn, the amount is not only taxed, but a penalty of approximately 10% is also charged.
While the loan option might appear to be attractive considering all the interest will be accumulated in the same account, one must keep in mind that 401k loan interest will be lower than the investment portfolio return. Most retirement accounts are invested into diversified instruments such as equities, bonds, foreign stock and debt markets, where returns can be higher than the interest rate you will pay on your loan. Therefore, the compounded growth on your account will be diminished because of a loan.
Not every asset management company offers attractive choices for investing your retirement savings. Many stick to long term low risk funds that can sometimes show poor growth as opposed to large index funds that can be dynamic and provide higher returns.
Vesting means ownership. Companies can have different policies with regards to you attaining a 100% ownership of your retirement savings. For example, company A decides that an employee will be fully vested at the end of 5 years of employment. This means that if you decide to change your job after 3 years, you may only get 60% of your savings to be rolled over to your next job, thereby losing out on the magical retirement number you had in mind.
A withdrawal can be the biggest mistake for your account as you could stand to lose a hefty sum of money. Say you accumulated $30,000 and decided to withdraw this amount. After taxes and a penalty you will only receive $17,500!
Why this isn’t the best choice for a millennial?
- Lack of Flexibility: Millennials often tend to switch jobs, explore new opportunities at the prime age and this can lead to the vesting issue I described before.
- Lack of Control: While it would be great to see all the money in your retirement account at the age of 60, how comfortable are you to hand over control to an asset management firm for 30 years? Most asset management firms invest in low risk assets when the number of years to retirement is large(which is the case for millennials), while you overlook other investment choices and let the fund manager decide your future.
- The Unpredictable Factor: You may feel elated with your accumulated savings, but life is unpredictable and you must be cautious before putting away all your savings into one retirement account. A single medical emergency or family occasion or large purchase could force you to dig into your retirement savings for a loan thereby losing out on market returns
- NOT Risk Free: Your retirement account is not risk free. The 2008 financial crisis resulted in several people losing their life long savings.
To be concise, a 401(k) isn’t the worst option, but it is ONE of the options. While you may choose to invest a small amount, you need to educate yourself better to learn different areas of investing. This means you must have control over your savings and your wealth as opposed to leaving it to fate for an extended period of time.
What are the alternatives?
- Term Deposits
- Short term bond funds
- Fixed income funds
- Equity investments. If you are unaware of the workings of the stock market, start exploring various mutual funds as a starting point (I will cover this topic in another blog post)
While there may be several other investment options, the point is to take charge of your finances and plan your future.
Be Frugal, Be Smart, Be Rich!