The 401(k) turbocharged many people’s retirement savings during the coronavirus pandemic. For those people with access to one and who have the discipline, wealth and job stability to afford one, 401(k) assets rose, to $6.7 trillion overall.
But in recent years, some critics beat down the 401(k), claiming the tool is for the upper classes and leaves many Americans behind. Even now, many people don’t have access to 401(k)s. Or they have access to a 401(k) but don’t know how to invest in it or don’t have the means or fortitude to stick with it.
“When 401(k)s were started some 40 years ago, they were seen as supplemental retirement tools,” said Bonnie Orlowski, vice president of financial intermediary relationships at Ariel Investments. “Social Security was expected to make up a substantial component of retirement. Between that and defined benefits, that would be enough for retirement.”
Retirement Savings: 401(k)s Aren’t Gaining New Participants
And yet, many investors still rely on 401(k)s. “Over time, Social Security has become more challenged. And pensions have declined dramatically. Only the 401(k) is left. And that is not sufficient,” said Orlowski. “It is a very paternalistic investing tool and too dependent on the individual.”
When asked where they save for retirement, only 37% of Americans surveyed said they save in qualified retirement accounts such as 401(k)s and IRAs, according to an IBD/TIPP poll in April. Among other choices, people said they hold retirement savings in cash-value life insurance (cited by 14% of survey respondents), annuities (14%), real estate (13%), taxable or private investments (13%) and other investments (23%), including savings accounts and money markets.
According to an August 2020 report by the U.S. census, only 57% of the population have retirement accounts and only one-third of Americans put money in 401(k)s.
The good news is that the invested money in 401(k)s increased to $6.7 trillion at the end of 2020, from $6.2 trillion a year earlier, according to the Investment Company Institute. The bad news is that the number of active participants, about 60 million Americans, hasn’t increased since 2017.
Retirement Savings For The Rest Of America?
For the other 63% of Americans, many don’t have access to a 401(k) at work. Emotion or dire circumstances also lead to 401(k) mistakes. People might move jobs frequently and cash out of their 401(k)s, or treat their 401(k) like a checking account, paying taxes and penalties when they make withdrawals.
The disparity in income, education level, minorities, race, ethnicity and gender among 401(k) participants is also a concern. For example, the Ariel-Schwab Black Investor Survey 2020 revealed that Black Americans are not benefiting from stock market growth at the same rate as white Americans at similar income levels. White 401(k) participants invest 26% more per month than Black 401(k) participants. Twelve percent of Blacks dipped into their 401(k)s for loans, compared to 5% of whites.
The U.S. government seeks ways to counter human behavior and encourage lower-income and middle-class Americans to take advantage of tax-advantaged accounts. The past three presidents tried to pass retirement legislation, but failed in each case.
Retirement Savings Need A New Tool
“The existing 401(k) is too expensive, too top-heavy and too ineffective,” said Teresa Ghilarducci, a professor of economics at the New School in New York and director of the Schwartz Center for Economic Policy Analysis. “We would need the government’s assistance to alter 401(k)s or to create alternatives.”
President Joe Biden has pledged to do so through proposed 401(k) changes, tax incentives and automatic IRAs. Time will tell if he is able to pass that.
Until then, you might look for ways to supplement or replace your 401(k). But before you start, if you have access to a 401(k), consider contributing up to your company’s match. If your employer offers a 401(k) and matches at least 50% of your contributions, put in at least enough to maximize the match.
As Orlowski said, “It’s free money.” Even if you don’t plan on staying at the company long, you can always transfer money to an IRA without paying income taxes and penalties, although you should read the fine print on transferring money, as portability has been an issue.
Replace or Supplement Your 401(k)
Option 1: If you can’t contribute to a 401(k), open a Roth IRA for retirement savings if you can. With a Roth IRA you pay income taxes upfront. But you can take out earnings and contributions tax-free as long as you hold onto the Roth for at least five years and take them out after age 59-1/2.
You can even withdraw the funds income-free and penalty-free if you meet certain qualifications. What’s more, you may trade securities within a Roth IRA and invest in real estate or other private securities, says Ghilarducci.
Start A Muni Bond Ladder
Option 2: Start a municipal bond ladder. A ladder is a portfolio of bonds that mature at regular intervals, often every year, across a range of maturities. In today’s rising interest rate and rising inflation environment, a bond ladder makes sense for retirement savings.
In a municipal bond ladder, maturing bonds and coupon payments are reinvested in bonds at the ladder’s longest rung, which usually offers higher yields. Municipal bonds are typically free of federal taxes. If you can’t afford to shell out the minimum investment of $5,000 for a muni bond, you can invest in bond ladders through any number of ETFs. Invesco’s BulletShares or BlackRock’s iBonds are examples.
Use Taxable Assets For Retirement Savings
Option 3: Earmark taxable assets for retirement. These assets aren’t tax-advantaged, but at least they don’t carry penalties and can be good investments for those without access to a 401(k).
Through a taxable brokerage account, set aside a portion of your assets just for retirement. Don’t touch it for other expenses. Fill the account with index funds such as some of IBD’s best mutual funds like Vanguard Growth Index (VIGRX), TIAA-CREF Large Growth Index (TILIX) or Calvert US Large Cap Core (CISIX).
Or, you could invest it in passive ETFs, such as Vanguard Total Stock Market Index, SPDR S&P 500 (SPY) or Invesco QQQ (QQQ), all of which are on among IBD’s best performing ETFs of 2021. Use IBD’s strategies on how to use ETFs for market timing.
If you want to add a potential lift to your retirement portfolio, you can add a few actively managed mutual funds, such as these best growth mutual funds: Baron Partners Retail (BPTRX) and Morgan Stanley Insight I (CPODX) or this best sector fund, T. Rowe Price Global Technology (PRGTX).
Consider Life Insurance, Other Vehicles
Option 4: Just get started. If investing scares you, start by putting your cash into a savings account. And then add CDs or even money market funds or short-duration funds. The yields on all of these options don’t compare to the stock market or mutual funds, but it’s a start. “Anyone can open a simple savings account. At least you know you have cash,” said Orlowski.
Option 5: Open a cash-value life insurance policy, such as whole or universal life. “The problem with insurance is the high fees and adverse selection,” Ghilarducci said. Adverse selection refers to the fact that insurers can pick and choose who to insure and at what rates.
But that can work to your advantage, especially when you’re young and healthy. Whole life was never designed for retirement. Nonetheless, whole life not only covers your family when you die in the form of a death benefit, it also allows you to build up a substantial amount of cash. You can use that cash value to pay health care bills, or retirement expenses or to purchase annuities or mutual funds. What’s more, you can hold onto whole life policies until you die.
Use Annuities Or Your House For Retirement Savings
Option 6: Consider annuities. Annuities have gotten a bad rap. Most of that bad reputation is well deserved. Misleading sales practices, fees and confusion about how they are structured taint annuities. However, annuities, when they’re set up correctly, can be smart retirement vehicles. Whether the annuities are fixed or variable, deferred or immediate, they can offer either a fixed income stream or be used as vehicles for investing in the stock market. And they can pay out for life or for a specified period of time.
Option 7: See your house as an investment. Owning a house is probably one of the best retirement savings vehicles around. Most people would sell their house last, after they exhausted their 401(k), their brokerage account and other savings. And you can tap into the equity on your home in the form of home equity loans or refinancing.
Option 8: Pay off debt. Last but not least, nothing can drag down retirement savings like having debt that you have to pay off first. Trim your debt to a minimum that is comfortable for you, especially in the years before you retire.
Follow Michael Molinski on Twitter @IMmolinski
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