Meet Chris and Amy. They are 42 years old, they have a house with a mortgage, 2 teenagers and together make $140,000/year at work. When their friends ask them how they save for retirement they excitedly respond ‘we participate in a 401K plan at work and we each put in 5% and get a 4% match! Although we started in our late 30’s we are well on our way!
They feel like they are well on their way, but are they?
This is a big problem, maybe the biggest problem that the ‘American worker’ faces in the future.
According to a study published on July 15, 2019, by the ‘Pension Rights Center’ 137 million Americans participate in a workplace retirement plan. But the majority of these plans - Pension Plans, 401K, and 403B plans are using participants’ PRE-TAX money.
In other words, the employee is making their contributions directly from the employer BEFORE taxes are withheld. Now you may be one of the lucky ones who have a Roth 401K option at work and if you are that is great!
A Roth 401(k) is a 401(k) plan where you put in after-tax money as the participant and any match goes to the traditional pre-tax 401(k) plan. While your employer contributions are still taxed when withdrawn. However, any money you put in - and growth - when withdrawn is tax-free.
But most companies do not have that option and continue to offer pre-tax retirement and pension plans, even companies that sell retirement plans!
Good Advice at the Wrong Time
I remember when I got my first job. My dad said, "Now that you are making money don’t get used to all of it. Start now putting away 5% into your 401K plan because you will never miss it AND you will NOT have to pay taxes on that money until you retire, and taxes will be lower."
Well part of that statement turned out to be true, the other part was not on anyone’s radar - well almost anyone’s. The ‘taxes will be lower (in the future) turned out to be one of the biggest problems for retirees who didn’t plan.
Let’s go back to Chris and Amy. Remember that house that they have and the 2 teenagers they are raising? That house they have comes with a mortgage and interest as well as property taxes. Those things along with their 2 kids add up to a significant amount of tax deductions - and they have benefited from them since they began saving in the tax-deferred 401K plans in their mid-thirties.
These and possibly other tax deductions put Chris and Amy in an extremely low effective tax bracket, in their case 11%. And it has been that way for a while and will continue that way for many more years.
If you have questions about your retirement plan, or are wondering if you’re on the right path to reach your retirement financial goals, contact us today. It’s never too late to make a better plan for your future.