How to Face 4 Ugly Truths About Retirement Planning

By Damian Davila on 7 April 2017 0 comments

Most working Americans still have a long way to go to ensure a comfortable, financially secure retirement. But, with consistency and dedication, retirement planning can be a feasible project. Let's review some of the ugly truths of retirement planning, and the strategies you can use to conquer them. (See also: 7 Things Financial Advisers Wish You Knew About Retirement)

1. Employer matches require work

While people often like to think of employer matches as free money, the truth is that you do need to do some "work" to earn those matches.

First, your employer may require a minimum period of employment or contribution to your retirement account before you become eligible for employer contributions. According to a Vanguard analysis of 1,900 401(k) plans with 3.6 million participants, 27 percent of employers require a year of service before providing any matching contributions. And that waiting period may be on top of the waiting period to be eligible for an employer-sponsored 401(k) in the first place.

Second, once you're eligible for the employer match, you may have to contribute a minimum percentage from each paycheck yourself to get it. According to Vanguard, 44 percent of employers required a 6 percent employee contribution to get the entire 401(k) match on offer.

Third, only 47 percent of surveyed employers provide immediate vesting of employer contributions. Since only moneys in your retirement account that are fully vested truly belong to you, you may have to wait up to six years to get to keep it all. If you part ways with your employer earlier than that, you may have to say goodbye to some or all of those employer contributions. (See also: 15 Retirement Terms Every New Investor Needs to Know)

How to handle it

Find out the applicable rules for employer contributions under your employer-sponsored retirement account. Ask about the waiting period for eligibility, how much you should contribute to get the full employer match, and what is the applicable vesting schedule for employer contributions. This way you'll know how to make the most (and keep the most!) of any employer contributions.

2. Full retirement age is higher than many of us think

According to the 2016 Retirement Confidence Survey from the Employee Benefit Research Institute (EBRI), one in every two American workers expected to retire no later than age 65.

The problem with that plan is that only those with born in 1937 or earlier have a full retirement age of 65. Your full retirement age is the age at which you first become entitled to full or unreduced retirement benefits from the Social Security Administration (SSA). Retiring earlier than your full retirement age decreases your retirement benefit from the SSA.

For those born 1960 or later, full retirement age is 67. If this were your case, retiring at age 62 or age 65 would decrease your monthly benefit by about 30 percent or 13.3 percent, respectively. (See also: 13 Crucial Social Security Terms Everyone Needs to Know)

How to handle it

If you're one of the 84 percent of American workers expecting Social Security to be a source of income in retirement, then you need to keep track of your retirement benefits. There are two ways do this.

First, since September 2014, the SSA mails Social Security statements to workers at ages 25, 30, 35, 40, 45, 50, 55, and 60 and over, who aren't yet receiving Social Security benefits and don't have an online "my Social Security" account. Here is a sample of what those letters look like. Second, you could sign up for a my Social Security account at www.ssa.gov/myaccount and have access to your Social Security statement on an ongoing basis.

Through either one of these two ways, you'll get an estimate of your retirement benefit if you were to stop working at age 62 (earliest age you're eligible to receive retirement benefits), full retirement age, and age 70 (latest age that you can continue delaying retirement to receive delayed retirement credits). That way you can plan ahead for when it would make the most sense to start taking your retirement credits.

3. Retirement accounts have fees

One of the most common myths about 401(k) plans is that they don't have any fees. The reality is that both you and your employer pay fees to plan providers offering and managing 401(k) plans. One study estimates that 71 percent of 401(k) plan holders aren't aware that they pay fees.

While an annual fee of 1 to 2 percent of your account balance may not sound like much, it can greatly reduce your nest egg. If you were to contribute $10,000 per year for 30 years in a plan with a 7 percent annual rate of return and an 0.5 percent annual expense ratio, you would end up with a balance of $920,000 at the end of the 30-year period. If the annual expense ratio were to increase to 1 percent or 2 percent, your final balance would be $840,000 or just under $700,000, respectively.

How to handle it

One way to start minimizing investment fees is to pay attention to the annual expense ratio of the funds that you select.

  • When deciding between two comparable funds, choose the one with the lower annual expense ratio. Research has shown that funds with a lower expense ratio tend to better performers, so you would be minimizing fees and increasing your chances of higher returns.
     
  • Explore index funds. For example, the Vanguard 500 Index Investor Shares fund [Nasdaq: VFINX] has an annual expense ratio of 0.14 percent, which is around 84 percent lower than the average expense ratio of funds with similar holdings. The Admiral version of this equity index fund has an even lower annual expense ratio of 0.05 percent.
     
  • Check the prospectus of your funds for a schedule of fees. From redemption fees to 12b-1 fees, there are plenty of potential charges. Review the fine print of any fund that you're considering investing in and understand the rules to avoid triggering fees. For example, you may need to hold a fund for at least 65 days to prevent triggering a redemption fee. (See also: Watch Out for These 5 Sneaky 401(k) Fees)

4. 401(k) loans are eating away nest eggs

According to the latest data from the EBRI, 23 percent of American workers took a loan from their retirement savings plans in 2016. On top of the applicable interest rate on your loan, you'll also be liable for an origination fee and an ongoing maintenance fee. Given that origination fees range from $25 to $100 and maintenance fees can go up to $75, 401(k) loans are one expensive form of financing. (See also: 5 Questions to Ask Before You Borrow From Your Retirement Account)

Additionally, when you separate from your employer, the full unpaid balance is due within 60 days from your departure. If you don't pay back in time, that balance becomes taxable income, triggering potential penalties at the federal, state, and local level. One penalty that always applies is the 10 percent early distribution tax for retirement savers under age 59-1/2.

How to handle it

Don't borrow from your retirement account. Studies have shown that 401(k) borrowers tend to come back for additional loans, increasing their chances of default. One study found that 25 percent of 401(k) borrowers came back for a third or fourth loan, and 20 percent of 401(k) borrowers came back for five or more loans. Borrowing from your retirement account should be a very last-resort option because there are few instances when it's worth it. (See also: This Is When You Should Borrow From Your Retirement Account)

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