Roth or Pre-Tax 401(k): 3 Questions to Ask Now

Eggs

More and more companies are offering their employees a choice of either pre-tax or post-tax (Roth) contributions within their 401(k) plans. According to a recent survey by Callan, the percent of retirement plans that offer a Roth option grew from 49% in 2010 to 71% in 2017.

But as with many aspects of investing, more choices can lead to confusion. If you’re faced with the choice between making a pre-tax or Roth 401(k) contribution, how do you know which one is right for you?

The question is especially timely now, when most of us are in the process of filing our taxes and many may be considering how to reduce their tax payments next year. And the recently passed Tax Cuts and Jobs Act makes the decision even more complicated, as tax rates will be changing from year to year as the new law is fully implemented.

Consider these three questions to help you decide:

1. Taxes – pay them now or pay them later?

Both Roth and pre-tax contributions offer the benefit of tax-sheltered growth while you’re working. When you contribute with pre-tax dollars, qualified withdrawals in retirement are taxed as ordinary income. By contrast, Roth contributions invest post-tax dollars, meaning qualified withdrawals come out tax free.

There are calculators that can help you determine the tradeoffs—check to see if your employer offers one on your plan’s website. But one of the most important variables is your estimated tax rate during retirement. If you think your tax rate will be lower in retirement than during your working years, it may make sense to go with a pre-tax contribution.

Alternatively, you might choose the Roth option if you expect your savings to generate a higher income in retirement than you currently take home. And remember, the total amount you withdraw in retirement will likely be greater than any amount you contributed, given the power of compounding returns.

2. Will your choice impact how much you save?

The choice between a Roth or pre-tax contribution will make a difference in your take home pay. All else being equal, when you make a Roth contribution, your take home pay will be lower than the same contribution made with pre-tax dollars. If a larger paycheck today will encourage you to save more than you would otherwise, you may be better off sticking with a pre-tax contribution.

recent study from the Harvard Business School, however, shows that most people contribute the same amount to a 401(k) regardless of which contribution type they make. This is likely because most of us invest based on a fixed percentage of our pay (such as 10%), rather than by trying to optimize both our take home pay and our retirement savings.

3. How important is future tax flexibility?

Perhaps the best choice you can make is to not pick one over the other, especially since future tax rates are hard to predict. If your employer offers both options, you can always divide your contributions between Roth and pre-tax. That can give you some tax benefit today while enabling you to diversify your potential sources of income—including how much is subject to tax—when you’re retired. Many financial planners refer to this as “tax diversification” and, like investment diversification, can pay dividends today and down the road.

Please note that regardless of which path you choose, any eligible employer match may be contributed pre-tax. Make sure to reach out your employer or recordkeeper for specific plan details.

Paul Mele is the Head of Participant Engagement for BlackRock’s U.S. & Canada Defined Contribution (USDC) Group and a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

 

 

Did your 401(k) win a Nobel Prize?

Money Tree

If you are like me, you may glance at the headlines when the Nobel Prizes are announced. You may even start to read an article about what the honoree did to win the prize. But for the most part, you probably don’t see a connection between these technical disciplines and your everyday life.

Last year was different. One of the prizes is for work that may touch your life frequently and may even help you live a secure retirement. It was the Nobel Prize for Economics given to Richard Thaler of the University of Chicago.

From theory to (retirement) reality

Professor Thaler recognized that, despite people’s best intentions, many (perhaps most) won’t save for retirement without a nudge in the right direction. More importantly, he recognized that once nudged into “doing the right thing,” inertia takes over and most people continue to save.

This innovation is the foundation of behavioral finance. It’s why if you’ve started a new job in the last few years, you were probably automatically enrolled into your 401(k), a development that has boosted the average retirement plan participation rate above 75%. It’s also why your 401(k) may have auto-escalation—which is like signing up today to save more tomorrow through annual increases of 1% or 2% in your retirement contributions.

Five steps to make your 401(k) award worthy

You don’t need to be a Nobel-winning economist to see the benefit of these ideas. But there is even more you can do to help bolster your chances of retirement success, especially if you:

  • Worked for companies that didn’t make enrollment automatic;
  • Were enrolled (and stayed) at a lower savings rate; or
  • Frequently changed jobs, so auto-escalation hasn’t really helped you.

Regardless of your situation, consider these five steps to get your retirement savings on track.

1. Start saving as early as you can

If you haven’t started, start now. When it comes to saving for retirement, time is your best friend. If your company has automatically enrolled you, congrats and keep up the good work. If not, take a few minutes a sign up today.

2. Max out your savings rate

If you can’t save the max ($18,500 in 2018), save as much as you can—and certainly at least as much as your company is willing to match.

3. Increase your savings when you can

Commit to investing at least part of this year’s bonus or raise to your retirement savings plan. And let your company sign you up for a future increase to your savings rate (or, sign up for one yourself). Studies show it’s much easier for people to agree to save more in the future than getting them to save more today.

4. Check to see how you’re invested

No one knows what tomorrow’s markets will do, so be sure you’re well diversified and have an appropriate amount of growth-oriented investments for your age. You’re investing your retirement money for decades, so don’t overly focus on short-term fluctuations in the market.

5. Don’t have the time or interest to manage your own investments?

Consider a professionally managed, age-appropriate choice like a target date fund instead.

The key is to make your retirement investing as automatic as possible. That way, you can let time and the power of compounding work to your benefit. After all, it was another Nobel Prize winner, Albert Einstein, who said, “compound interest is the most powerful force in the universe.”

Paul Mele is the Head of Participant Engagement for BlackRock’s U.S. & Canada Defined Contribution (USDC) Group and a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of January 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Top 4 Retirement Saving Ideas

Mother rubber duck leading several rubber ducklings

It’s America Saves Week, an annual reminder for us all to put good savings habits into practice. Wondering where to start? We asked over 1,000 401(k) investors in our latest DC Pulse Survey. Here are their top retirement saving tips—and advice on how to make them your own.

1. Don’t wait until it’s raining to fix the roof.

Confidence in retirement savings is up 64% compared to last year’s survey, in part, because recent investment performance has been relatively strong. The trouble is, industry forecasts suggest that future returns may be lower than they’ve been previously.

If this comes as a shock, you’re not alone—65% of the investors we surveyed hadn’t heard of the forecast. However, almost 15% of our respondents have already started preparing for lower returns. Their best tip? Start saving more now. Time is your greatest asset to compound returns, helping you make up for the possibility of lower returns.

2. Use it or lose it: Take advantage of all available resources.

With age comes wisdom, and better retirement savings habits. We found that baby boomers are 43% more likely than gen x or millennials to take advantage of retirement planning tools, like income calculators. But, regardless of what generational bucket you fall into, you should use every tool at your disposal—especially given the prospect of lower returns.

3. Act your age.

Sixty may be the new forty, but acting your age is still valid when it comes to investment allocation. In fact, our survey found that, compared to those nearing retirement, younger investors are more comfortable with aggressive growth strategies, even if that means they could lose money when the market declines. Baby boomers, on the other hand, were more likely to prefer conservative growth, with smaller returns but less chance of losing money.

Target date funds seek to do just that. They remove some of the guesswork of investing by offering a diversified mix of stocks and bonds that rebalance over time.

4. Don’t just meet the match—beat it.

Most employers will match a portion of your retirement savings on a dollar-for-dollar basis, typically up to the first 3% to 5% of your contribution. If your plan offers this, odds are you’ve heard that you should contribute enough to get the full company match. It’s a rule of thumb that women seem to have latched onto: We found that women are 21% more likely than men to meet their company match.

It’s a big step toward retirement readiness. But for men and women alike, deferring even 5% of your pay is not likely to reach your retirement savings goal. If you can’t beat the match from day one, see if your plan offers auto-escalation, which will increase your contribution rate annually. Your future self will thank you.

For those already on the right track—keep up the good work. And for those of us who may be behind the curve, remember the race is far from over. There are simple steps you can take today to close the gap.

Anne Ackerley is the Head of BlackRock’s U.S. & Canada Defined Contribution (USDC) Group and a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of March 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

How to Prepare Your 401(k) for Rising Rates

Checklist

By now, even the most remote tribes of the Amazon must be aware that interest rates in the U.S. may rise as a result of Federal Reserve activity. They’re lucky, because Fed activity shouldn’t have much of an impact on their lives. But for you and me, the people saving mainly through our 401(k) accounts? Reading the press closer to home may have you convinced that the (bond) sky is falling.

If these headlines have you worried, here are some ideas to help you think about your retirement-investing strategy going forward:

Five Ways to Think About Your 401(k) 

1. First, don’t panic when you hear news of rates going up. Yes, you will read about some hedge fund manager making (or losing) millions from interest-rate speculation, but you are not a hedge fund manager. For most of us, the rational course of action is not to react. At least short term. Better to be slow and thoughtful than quick and possibly reckless.

2. Yes, rising interest rates mean that bond prices may fall, but that doesn’t mean the bond fund in your workplace savings plan is going to tank. As interest rates rise, prices of longer-term bonds can fall. But fixed income funds in 401(k) plans typically have a diversified mix of securities, so their sensitivity to interest rates can vary tremendously. That’s the beauty of diversification. Also, remember that interest rates’ rising may be good news in the long-term, as higher rates should eventually produce higher yields from diversified bond funds.

3. Speaking of diversification, it’s probably a good time to refresh your understanding of your investments. Check to see that your fixed income holdings are diversified and you are happy with their management style. You may prefer to basically follow an index, but if you have other options available in your plan, it’s worth considering diversifying with a fund that is actively managed, or has a series of underlying fund managers all within one fund. Knowing that your portfolio is diversified, along with a professional’s regular review of how the fund is performing, should allow you to sleep easier at night.

4. If all this talk of interest rates and bond prices has your head spinning, you may be pleased to hear that most workplace savings plans offer an easy alternative to monitoring the markets—and trying to zig and zag through market turbulence. Target date funds are professionally managed balanced funds where all the asset allocation decisions are made for you. Instead of having to decide what to do about interest rates, you could let the fund’s manager worry about that for you. Target date funds are based on the number of years left before you retire, so they will typically allocate less money to bonds when you’re younger, and more money to bonds as you approach retirement.

5. One other point: If you are retired and trying to maximize your income, rising interest rates may actually be good news. Take the time to visit with your financial advisor to make sure your portfolio is properly diversified, and that you are maximizing income for the years ahead.

Scott Dingwell is a Director in BlackRock’s Global Client Group where he serves on the U.S. and Canada Defined Contribution Team. He writes about retirement for The Blog.

 

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

©2015 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.

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How Much Should You Put Into Retirement Accounts?

Piggy Bank

Taxes can be one of the main drags on the growth of your portfolio. That’s why tax-advantaged accounts such as 401(k) and IRA accounts can be such a boon when you’re saving for retirement. But how much should you put into these accounts as opposed to regular taxable accounts? The answer is “as much as you can” in order to minimize your tax bill, though there are a couple key constraints on how much you “can” allocate to these accounts.

This first constraint is that there are usually large penalties if you withdraw money from tax-advantaged retirement accounts when you’re under the age of 59 ½. Therefore any money you think you’ll need to pay for expenses before that age shouldn’t be put in a tax-advantaged account. You should also make sure you have money set aside outside of retirement accounts to act as a buffer against unexpected expenses. Once you’re established this buffer, you should put as much money into tax-advantaged accounts as you can afford to.

The second constraint is legal: the government puts a cap on how much you can put into retirement accounts each year. The annual limit on how much you can contribute depends on the type of retirement account. In 2014 the contribution limit for 401(k) accounts is $17,500, for example, while the limit for IRA accounts is $5,500. These contribution limits are higher for people over the age of 50.

Putting as much money into tax-advantaged retirement accounts as you can, while avoiding the penalties you’d have to pay if you withdraw money early or exceed the annual contribution limits, can make it substantially easier to meet your retirement goal.

The Danger of Company Stock in 401(k) Accounts

Enron

When you’re thinking about how to select investments in your 401(k) account, there are often many options to choose from. Most of these are diversified mutual funds that each contain hundreds or thousands of stocks or bonds (or sometimes both). Many companies, however, also include a much less diversified investment option in their 401(k) plans: stock in the company itself. It’s an investment option that’s best avoided.

Lots of people (though certainly not everyone) like company they work for, so it may feel good to invest in your employer. This can be especially true when the company is doing well, since both the price of the stock and your income from your job are more likely to rise. But if the company starts doing poorly, the stock price and your income could decline at the same time, hurting both your paycheck and your portfolio. In other words, owning stock in the company you work for reduces the diversification of your wealth.

A classic example of this situation was Enron, the energy company that went bankrupt in 2001. Enron employees held nearly 60% of their retirement assets in company stock, which was wiped out as the company collapsed. Thousands of employees, many unaware of the risk they were taking, lost both their job and their retirement savings.

Enron is an extreme example: few companies will collapse in such spectacular fashion, and only having a small portion of your 401(k) in company stock isn’t likely to devastate your portfolio. Still, as a rule of thumb, it’s better to avoid such concentrated investments, especially when their performance may be connected to your income from your job.