Why maxing out the retirement is not what you think it is.
The most common Kroger cereal aisle conversation is someone proudly leaning in to tell me she is maxing out her retirement plan. I respond, “Wow, you are putting in $19,000 per year?!?” Then she will say, well, I am not putting that much in, but I put in the maximum we are allowed. “Hmmmm---wait, you mean, you are maxing out the match?” She looks confused and says “Yes, that’s it. I am doing the most I can do.”
Here is possibly the greatest misunderstanding on 401(k)s.
First, let’s cut through the jargon—yes more! Matches are great. That’s where the company gives people free money into their employees’ retirement accounts. FREE MONEY! They might give free money just cuz the company did well, and one time a year will put in a profit sharing contribution, or sometimes they give a fixed amount regularly.
But many companies like to use their money to motivate their employees to save, and they use their money to match their employees’ savings. A common one is the employer will put $1 for $1 up to an employees’ 3% of pay and then $0.50 on the dollar from 4%-5%. Wow, super super confusing. I am actually making things worse here. Let’s say I make $50,000 per year. If I put 3% of my pay ($50,000 x 3% = $1,500) per year, then the company will too. Then if I put an additional 2% ($50,000 x 2% = $1,000) then the company will put half that amount in, or $500.
So in a world of committed non-savers, the match is incredible. You get the employee to save $2,500, when she would have saved nothing. And on top of that, the employer puts in another $1,500! What a win. That’s maxing out the match.
But the problem is that while maxing out the match is lingo that makes us think we are saving enough, we are indeed usually undersaving.
The industry has been proud of us for saving anything at all, which is why many people are happy with employees just maxing the match. The 401(k) savings experiment was a total fail, as we see half of baby boomers who were the first to enjoy this amazing new savings tool just not use it. Half of baby boomers are retiring onto social security alone.
Now we can see why employers, advisors, friends, colleagues, etc. might get excited for an employee base to max out the match.
But the issue is that in the scenario above, that’s not going to let our friend retire. We know through lots of models and simulations that people need to be saving 10% if they get started in their 20s. And that is not 10% made up of the employee’s contribution plus the employer’s contribution. I wish it was. The reason the employee has to save 10% regardless of the match from the employer is that saving is accomplishing two things at once. It is adding money to the retirement account and reducing lifestyle. A lifestyle that is 90%, means that an employee retiring who is used to living on 90% of pay who has saved 10% her working career should have enough money to support the 90% lifestyle for a really long time in retirement.
I try not to be alarmist, but I am not giving people a goal and wink wink know that they can fall short of it. Actually, it’s quite the opposite. I am concerned that similar to the match I might be advising people to save too little. See, our models and simulations still assume three things:
Social security in it’s current form (anyone want to put money on that assumption?)
Taxes don’t go up when we go to retire (what’s our debt right now? Anyone expect taxes to actually stay the same?)
Healthcare costs and long-term care costs stay the same (again, what world do I live in???)
The plight of our under-saving has been covered up by record stock market returns over a long period of time, a lot of inheritance money passing from parents to baby boomers and the ability to rely on social security to cover a lot of retirement costs. But for many who didn’t have money in the stock market, who didn’t get an inheritance and who only live on social security their lives are bleak. And unlike our working career where banks, credit cards, student loans, etc. all want to help us enhance our lives beyond the salaries we actually make, they disappear when we stop making money in retirement. That leaves us with three options: live on very very limited means (many retirees can’t afford medications and basic food/other needs), live with kids or be supported by kids, or keep working. The latter option is the one people inevitably take as long as they stay healthy.
So, I hope you believe me. I am not trying to be a downer. I am not saying anything that isn’t mainstream thought. It’s just that I am personally asking you to do something different. Realize that the encouragement to save just the match is coming from a place of fear from people saving nothing. But you can’t use that to benchmark your own savings.
If you are in your 20s and maybe early 30s, save 10%. Well into 30s, make it about 15% if you are just getting a start on retirement. 40s, well, think about 20-25%, and 50s up you can still do it. You can still retire, but you need to be saving about 30%-40% of pay.
Don’t let another day go by without making this important decision. Your future self needs this money. Call up HR. Be bold. Max out your appropriate savings rate. The beautiful thing is that at most companies if you accidentally overcommitted, you can back it down by the next pay period. Just ask them to make sure!