Wouldn't it be great to start the New Year with a way to double your money? Especially if this technique is legal, quick and simple?
This idea is no secret: it's called a corporate matching contribution.
Let's say that your boss comes to your office and gives you two choices:
a. Your company pays you an annual salary of $100,000, OR
b. Your company pays you an annual salary of $97,000, but it also deposits $6,000 into your retirement plan.
Which choice would you make?
If money is tight (especially if your salary is much less than this), you might find it very difficult to accept the lower salary. There are many, many people who are living on the edge, one paycheck away from disaster.
However, if you can accept a slightly lower salary, then the second choice makes much more sense. Your salary drops by $3,000, but your net worth increases by $6,000. You've just doubled your money!
To make the deal even sweeter, our tax code encourages you to choose the second option. Remember that your $100,000 salary is immediately taxed; you take home significantly less after Washington and California get paid. By contrast, the $6,000 deposited into your retirement plan will not be taxed until you withdraw it in the future, hopefully during retirement. And because your salary now drops to $97,000, your current income taxes are a little lower as well. There are only three requirements to make this work:
1. Your employer has to offer a retirement plan (such as a 401(k), 403(b), or 457) to its employees. According to the Bureau of Labor Statistics (2010), about 60% of companies offer these plans.
2. Your employer has to offer matching contributions. About half do; the median match is 3%.
3. You have to contribute to your retirement plan. This is the hard part that trips many people up. You have to be willing to forego the $3,000 (as in our example above).
Here are three ways to make this hard part easier:
1. Do you have any savings? (Credit card availability and home equity lines of credit do NOT count. I'm referring to a real account at a bank, mutual fund, or brokerage.) If so, here's a trick. If your salary shrinks by $3,000 (as in the above example), that means your take-home pay drops by roughly $2,000 (because your company withholds for federal and state income taxes). Take $2,000 from your savings every year and use it to pay expenses. While your savings balance drops by $2,000, your retirement account balance increases by $6,000. Now you've tripled your money! (Tax caveat here: you will eventually be taxed on the $6,000 in your retirement account. But the key word here is "eventually.")
2. Will you receive a raise or bonus soon? If so, can you take this extra money and steer it all into your retirement plan? This way, your take-home pay remains unaffected.
3. Does your spouse or partner work for an employer with no retirement plan match? If so, (gently) suggest that it might be better for you to receive a corporate match instead. Hopefully, you will both benefit down the road!
There are very few free lunches in this world. Corporate matching contributions are one of them. Don't miss out on an easy way to double your money...legally!
Lou Dagen is a Certified Financial Planner in the San Francisco Bay Area. For 23 years, he has helped clients around the world retire in comfort, educate their children, and increase their net worth. If you have questions that you like answered in future blog posts, please comment below. Or call Lou directly at 925-997-8507.
1. You would need a sinking fund of about $1.4 million to generate $100K per year for 30 years, or about $2.1 million to generate $150K per year. These numbers are both pre-tax and not adjusted for inflation, and assume a flat 6% return. 2. You didn't ask me this, but assuming you started saving today for either of these retirement annuities, you'd need to save about $5,000 monthly for the former, or about $13,000 monthly for the latter. Same parameters as above. 3. I think the heart of your questions is: since stock market performance has been so poor over the last twelve years, are pension (annuity) projections feasible? The answer is no, and that's why (as Fred Eriger also discussed) so many public entities are having such problems. 4. May I respectfully suggest that you're making three common errors in your assumptions. (1) You're not including dividend in your stock market return calculations, which make a big difference over time; (2) the S&P 500 was very tech-heavy in 2000 because of the tech bubble, so I wouldn't (and didn't with clients) use the index blend you posted; and (3) long-term investing means we can't cherry-pick starting dates. Look at performance starting in earlier years, and you'll see a big difference in performance. Keep the good questions coming! --- Lou
May I ask you to see my comments from Chris Nicholson's post above? This is why I don't project any returns for clients, and instead, focus on what we can control. Rough job? It depends. I've been doing this a long time, and my compliance record is spotless -- I've never had a client complaint. I've guided clients through a lot of bad markets, and I know what works and what doesn't. While markets change, the basics never do. (Please see my response to Chris about what the basics cover.) --- Lou
In my experience, when clients are looking for income, they don't want to take any great risks. Therefore, the no-load mutual funds I invest in tend to be conservative. Looking at my client's portfolios, their funds are currently yielding between 2% and 6%. Some of this interest is tax-free, but still, they're not sexy yields. In this era of low interest rates, 7-9% interest is either (1) in low-quality bonds (2) leveraged (3) higher-risk real estate or (4) fraudulent. This is why I cautioned you about JTA. You'll notice that over the last two years, your quarterly distribution has stayed roughly the same, but 2/3 of the money from your original investment is being returned to you every time. Your true yield therefore isn't really 7.9%. Illegal? No. Misleading? Yes. In your example above, I'd ask the 80-year-old another question. Does he want to amortize (spend down principal) to maintain his quality of life, or does he want to leave as much as possible to heirs and/or charities? This one answer would tell me his true priorities, and what he really wants his assets to do. As a planner, that's more meaningful than shooting for the highest potential return. Hope this helps, and keep the good questions coming! --- Lou
As you know, the problem comes when officials, whether for good reasons (trying to help people retire) or bad (trying to buy votes, contributions, and influence), over-promise and under-deliver. I don't know how to solve this. For many years, I've told young-ish (under 50) clients who have higher ($150K+) incomes, to assume that Social Security will be means-tested, and therefore unavailable to them. I hope I'm wrong, but I don't know what else government can do. (Barring radical changes, like allowing unlimited immigration of working-age foreigners, drastically raising Social Security taxes, etc.) --- Lou
To answer your question, according to Fidelity, as of September 30, 2012: Average 401(k) balance: $75,900 (for ages 50-54, average is $110,600) Average annual contribution: $7,900 (which is 8% of pay) (ages 50-54: 9% of pay) Average annual corporate match: $3,420 Sorry I couldn't find anything specifically for 48-year-olds; ages 50-54 was the best I could do. Also, I couldn't find anything on the top 10%. Mike, may I respectfully suggest that the average balance may not be relevant for you? Take a look at the average contribution rate (9% of salary for workers a little older than you), and perhaps you could use that as a guide or target instead. I've always suggesting "tithing" 10% to oneself first, before all other expenses. There are so many other variables (cost of living, dependents, other assets, etc.) that I'm not convinced that average balances are that important. Doing the best you can, saving as much as you're able, keeping a positive spirit ... those are better measures of success than a number on a statement. Hope this helps, and thanks again! --- Lou
JTA closed today (Wednesday) at $11.15 per share. You're correct that its last quarterly distribution, on December 12th, was for $0.22. Multiply that by four quarters, get $0.88, divided by $11.15, equals an annual yield of 7.9%. So far, so good. However, here's what you're missing. Of that $0.22 quarterly distribution, $0.1344 was a return of principal. That's neither income nor yield. Therefore, your true yield is much lower. Via subtraction, your income distribution is $0.0856 per share. Multiply that by four quarters gets you $0.3424, divided by $11.15, gets you a true yield of 3.1%. I feel that it's not worth it. The Barclays U.S. Aggregate Bond Index is currently yielding 2.7%, and more importantly, it's not leveraged. I can buy this index via a no-load index fund. Since JTA has 2/3 of its holdings in stocks, I can buy an S&P 500 index fund (with a ~2.1% yield), and mimic JTA, but pay literally one-twentieth what you're paying Nuveen. By the way: look at JTA's history, and find its highest premium over its NAV; you may be surprised. To everyone else: as I said in previous responses, be VERY careful in this low-interest environment, when someone offers you something with a high yield. Sometimes, things are really too good to be true. --- Lou
Since this blog was about corporate matching, would you feel comfortable sharing the percentage, and the maximum amount, your company contributes to your 401(k)? (Don't mention the company or give your specific account balance, of course.) I'd like other readers to get a sense of how valuable this benefit can become. Thanks again for your good wishes, and keep the good questions coming this Friday! --- Lou
For all other readers: Mike's example is a great way to close this week's blog. Mike was smart and used his company's generosity to his full advantage. This is a great way to build your net worth over the long term. Thanks to everyone for your responses, and please look for Friday's blog about eliminating non-deductible debt. --- Lou
Also, The Barclays bond fund? Rates are going up soon, as they have nowhere else to go, and bond prices are INVERSE to rate rises. Get ready to get crushed there. Furthermore, I am not excited about a 2.7% yield. Munis do better than that and they are tax free.Therefore, I am concentrating more on a few select equity closed end funds for now (for equity allocations).
Very respectfully, please let me caution you one last time: leverage magnifies performance, whether up or down. And return of principal does not equal yield. I completely agree with your points about low yields and tax efficiency. I have many millions of client money in municipals (and have a couple hundred thousand of my own there as well). I really hope Congress doesn't start tinkering with their tax treatment over the next couple of months. Finally, I enjoyed our discussion, and agree with you about perspective. My investing style is not the only one out there, and I've found many financial planners invest completely differently for their clients. If your method is working for you, then more power to you, and don't let me tell you differently. Anyway, thanks again for your intelligent responses, and hope you keep reading and adding your comments to my blogs! --- Lou
CalPERS is now assuming a 7.5% rate of return (net of fees) going forward, yet for their last fiscal year (July 2011 to June 2012), they made a whopping 1%. Granted, it wasn't a great time for the markets either (the S&P 500 made about 5.5%), but still, I don't see how the numbers will work either. I read an actuarial study showing that CalSTRS contributions will have to be increased by 12.2% of pay, in order to close their deficiency over the next thirty years. This is yet another reason why corporate matching contributions are so valuable for you. While we could agree that public pensions need to be reformed, focus on your own retirement first, save as much as you're able, and take legal advantage of whatever extra resources (like a corporate match) are available. --- Lou
http://database.californiapensionreform.com/
However, municipal pensions in California are paid through a combination of employee and employer contributions. Since all of our tax money (including those from the municipal workers themselves) is funneled through a municipality, we all chip in, not just private sector employees. Have a great weekend! --- Lou
" Here's the market's performance (represented by the S&P 500) over the last eleven years, starting with a really bad year: 2002: (22.1%) 2003: 28.7% 2004: 10.9% 2005: 4.9% 2006: 15.8% 2007: 5.5% 2008: (37.0%) 2009: 26.5% 2010: 15.1% 2011: 2.1% 2012: 16.0%"
The Standard and Poor's 500 is an index (a sample) of 500 large U.S. public companies. S&P uses these companies as a broad proxy of the U.S. economy. Investors can buy shares of stock in these companies (such as Coca-Cola, IBM, Wal-Mart, etc.), either individually or via an index mutual fund. You're right that an individual investor's performance may radically differ from that of a stock market index. But wouldn't that apply to any investment: real estate, commodities, bonds, even certificates of deposit or savings accounts? The real question is which investments are most suited for you, based on your goals and needs. My point to Camaro was that he was getting incorrect information, and I didn't want those inaccuracies to negatively affect his future. I hope this answers your question. Please write back here if you have a follow-up. --- Lou
Thanks for pointing that out! --- Lou
You did not mention that with a Defined Benefit retirement plan for public employees, such as the State of California or the city of Burlingame those employees are guaranteed their pension regardless of the investment's success. Additionally we the private sector have no control over those public employee investments but have to pay them if their investments go sour. Sounds awesome...they can gamble their retirement money and if they lose we in the private sector have to pay. Only in America!
I have not read through all the comments on here thoroughly, however I don't think anyone has yet to point out the biggest flaw to your original post: A 401(k) is not a great investment. Although, if an employer matches funds it essentially is "free" money that is not the whole story. The whole story goes something like this: free for now only to be taxed at a later date at a rate that is completely undetermined currently on an amount that is completely speculative (who knows if the amount you need/want will be there when you need it if it is tied to the stock market, which most 401(k)'s are) and oh yeah, you don't control the money or have free access to it. It is as close to a government retirement plan as there possibly could be. Stated another way: you are a farmer, you have the land and some seed. You have a few choices...you could get taxed on the seed at a particular rate, or you could get taxed on your harvest on a rate that you don't know. Which is the better deal?