Various Generations are Committing Significant Errors in Managing Their 401(k) Plans
Various Generations are Committing Significant Errors in Managing Their 401(k) Plans
The 401(k) has existed for 46 years, becoming the primary retirement savings plan for workers across all age groups. Despite its prevalence, many individuals fail to fully comprehend their plans or utilize optimal strategies to maximize their savings' growth.
Each era has had its fair share of 401(k) blunders, fortunately, there's generally still time for redemption. Here are the most significant errors each generation has encountered, as revealed in a recent Fidelity survey, along with remedies:
Baby boomers: Rejecting Roth 401(k)s
Baby boomers were introduced to 401(k)s in 1978 and have largely stuck to traditional plans since then. There's nothing inherently wrong with this approach. A traditional 401(k) can still be a strong retirement plan, particularly for those anticipating a lower tax bracket in retirement. Postponing taxes until retirement withdrawals ultimately saves you money.
However, Roth 401(k)s have merit in retirement planning as well. Contributions are made with after-tax income, which means you pay taxes right away. Yet, you can withdraw funds tax-free once you reach age 59 1/2 and have maintained the 401(k) for a minimum of five years. If a 401(k) match is available, it's often tax-deferred funds, but not always.
Roth 401(k)s have been around since 2006, which might explain why only 12% of baby boomers participate in them. Many boomers are either in the peak of their earning years or have already passed this stage, making traditional 401(k)s more beneficial for them.
Another potential issue is the lack of availability of Roth 401(k)s. They have become increasingly abundant, but numerous employers still do not provide them to their employees. If you desire a Roth account, you may be required to establish a Roth IRA at a brokerage by yourself.
Gen Xers: Relying on 401(k) loans
A 401(k) loan appears attractive compared to early withdrawals, which are subject to income taxes and a 10% penalty tax if withdrawal occurs before age 59 1/2. These loans give you the option to pay back the borrowed amount with interest and do not require a credit check. As long as you meet your loan payment deadlines, the government will not classify the loan as a withdrawal.
This makes 401(k) loans appealing to Gen X workers, many of whom are grappling with financial responsibilities for both their aging parents and children. Over 25% of Gen Xers have outstanding 401(k) loans, as per the Fidelity survey. However, while these loans may be convenient, they pose a risk to your retirement security.
If you leave your job or get fired, the entire loan balance becomes due immediately. The IRS regards any unpaid portion of the loan as a distribution and taxes you accordingly.
Even if you make all your scheduled payments, you still end up with a smaller balance than you would have if you had left your money in the 401(k) instead of borrowing. It's often possible to seek out alternative sources of credit rather than relying on 401(k) loans, which should be considered a last resort.
Millennials and Gen Zers: Insufficient saving and investing solely in target-date funds
The newest workforce entrants, millennials and Gen Zers, confront similar challenges with their 401(k)s. The biggest issue is their savings rates. The Fidelity survey found that millennials save an average of 8.6% of their income, while Gen Zers save 7.6%. When you factor in each generation's average 401(k) match (4.6% for millennials, 3.8% for Gen Zers), you obtain a 13.2% contribution rate for millennials and an 11.4% contribution rate for Gen Zers.
These numbers aren't bad, but ideally, they should be closer to 15%. Given the financial burden of student debt, simply saving anything at all deserves recognition. As their salaries increase, they can progressively elevate their savings rate.
Additionally, it's essential for millennials and Gen Zers to examine what they are investing in. Over 70% of millennials and 82% of Gen Zers have invested solely in target-date funds. These funds provide hands-off investments and are great for individuals seeking a passive investment approach.
Target-date funds do have high fees that erode potential earnings over time. Exploring alternative investment options before jumping on the target-date fund bandwagon is advisable. For example, if you have access to an index fund, it can help grow your wealth while keeping fees at a minimum.
Despite the importance of optimizing retirement savings, many millennials and Gen Zers only save an average of 13.2% and 11.4% of their income, respectively, falling short of the ideal 15%. (finance, money, retirement, savings)
Moreover, relying solely on target-date funds for investment could lead to paying higher fees that can negatively impact potential earnings over time. Exploring alternative low-cost investment options like index funds can help maximize retirement savings growth. (investment, money, retirement)