Monday, September 3, 2012

Yay! You're Hired. Now Let's Talk About Retirement.

Congratulations! You’ve got a job offer. Before you accept, start thinking about retirement.

If you’re a 22-year-old with more than 40 years of your career ahead of you, retirement may be the last thing on your mind.  However, by taking advantage of the benefits your new employer may offer, a small investment today will pay big dividends when you’re 60+.

In the past month or so, I’ve had the money discussion with my kids and with other former students who have been out of school and in the workforce for anywhere from one month to five years.  The most important point I stress is to think long-term.  Delayed gratification is a foreign term to many 20-somethings.  They want to go out several nights a week, have a new car, go on vacations to the Caribbean or Europe, have an incredible apartment, and start paying off those college loans – all on a first job starting salary of $27,000.  While some may have the family means to be subsidized by parents to do all of the above, many more find out that living at home for awhile or rooming with friends in a less-than-desirable neighborhood is more realistic.

A first-time, post-college employee is usually interested in two things in a job offer:  salary and vacation days.  There is much more to consider before you accept an offer.  What health benefits (medical, dental, vision) are offered, how much do you contribute toward them, and how long do you have to wait before they start?  Is there a flex-spending account? (More on that in a future post.)  What about insurance coverage, tuition reimbursement, stock offerings, and affinity programs offering reduced prices on company products or other pricing discounts?  Then, there is the long-term item: is there a 401(k) or 403(b) and if so, is there a company match?

For too many people, Social Security is their only retirement plan.  Who knows what that program will look like five years from now, much less 50 years from now?  The days of private companies offering pensions are pretty much over.  It’s an expensive proposition for them, and of course, for the private sector, it’s all about the bottom line.  I only worked one job that offered both a pension and a 401(k), and I left that position almost 20 years ago.  Still, it’s nice to know that my five years and eight months there still qualified me to receive just over $300 a month for however many years I have in retirement.  Public employees on the municipal, county, state and federal levels still have pension plans, at least for the time being, though nearly all are now contributory, meaning you put in a little to help fund your own retirement.

That’s really what 401(k) and 403(b) plans are.  You contribute a portion of your salary either pre-tax or after-tax, and often the company matches a portion of that amount.  It’s more important for a 22-year-old to contribute even a small amount than it is for someone my age putting away the maximum allowed each year.  Why?  It’s all about compounding.

One of my former students, Andrew, remains a close friend.  We chatted the other day about finances and, as I knew he would, he has made some very wise decisions. Andrew is 23 and works for a major employer in Connecticut.  He participates in his company’s 401(k) and plans his expenses accordingly.  Because the deduction is taken out even before he gets his direct deposit, he doesn’t miss it.  His company offers a 401(k), match up to 6 percent of his contribution to the plan.  That’s “free money.”  Hopefully your employer also has some form of match.  It means your employer is giving you money toward your retirement.  The longer you are employed and do not participate in the 401(k) plan, the more “free money” you lose.  Some companies have a “vesting period,” meaning you need to work a certain amount of time (normally one to two years, but sometimes longer) before you actually own the company match.  Leave after six months and you don’t get the match.  Andrew is setting himself up now for a more comfortable and secure retirement.  That’s smart and pretty forward-thinking for a 23-year-old.

To illustrate the power of compounding, I will use an example provided by my employer.  Jennifer and Brian are the same age.  Suppose Jennifer started saving $2,000 a year (that’s just $38.46 per biweekly paycheck) from age 25 to 35, and then stopped saving. Her friend Brian started saving $2,000 a year at age 35, and continued until he was 65.  If both accounts earn 8 percent annually, at age 65, Jennifer will have $335,000 in her account, but she will have contributed only $22,000.  Brian, who started saving at age 35 and contributed $62,000, will only have $247,000.  Both cases do not include a corporate match but do include the reinvestment of dividends and capital gains and no current taxes paid on earnings in a retirement account.  The lesson is simple.  The longer you invest, the more you can earn trough compounding.

A 401k or 403(b) – in general, they are pretty much the same – is not the same thing as having a pension.  First, you, not your company, make your own investment decisions.  There is no guarantee of gains and, in fact, you may lose some of your principal (the amount you invest, plus your corporate match, not just any dividends you earned) sometime during the course of your career.  During the Great Recession that began in 2008, at worst I lost about 30 percent of my portfolio and for a brief time, those losses ate away at my principal – the amount I contributed.  With the gains in the stock market recently, my accounts have bounced back.  Fortunately, I have no plans to retire anytime soon and kept contributing to my 401(k), picking up some bargains thanks to lower stock prices.  Your tolerance of risk and the amount of time you have to invest will determine the type of investment you make.

I’m not a financial advisor and I won’t get into all the various possible investment scenarios to consider.  But, with a traditional 401(k) or 403(b), you invest with pre-tax income, which reduces your gross pay, meaning you pay less income now, with the thought that you may be in a lower tax bracket after you retire.  You will pay tax on the amount you withdraw and there are penalties for early withdrawals (before age 59½) except for some specific circumstances.  In a Roth 401(k), your salary deferrals are made on an after-tax basis and your earnings grow tax-free.  You will not have to pay taxes on the money when it’s withdrawn, provided you’ve held the account for at least five years and you have reached age 59½ or have become permanently disabled.

The average 401(k) balance in the United States is less than $75,000.  That’s not enough on which to retire.  Most financial advisors tell you to spend no more than 5 percent of your retirement fund balance each year.  Five percent of $75,000 is just $3,750 a year, or a little over $300 a month (like the pension I mentioned above). The average monthly Social Security payment is just under $15,000 a year, or about $1,200 a month.  Today, would you be able to get by on just $18,500 a year?  If you plan to live with your children and stay healthy – perhaps.  Don’t plan on it.

One less night out a week, invested over the course of at least 40 years, can help ensure you don’t have to work until the day you die.  What I cited in this post is for illustrative purposes only.  Talk to your HR reps, your parents, a financial advisor, and become a student of finance and the markets.  The payback will make it worth your while.  There are many retirement calculators online.  Try this one from CNN, and don't be shocked by the amount of money you need to put away to retire in a manner in which you will be comfortable.

One last thing…I will try my best to write more frequently and will follow up with a piece on other job benefits soon.