The Finance Gourmet

Personal Financial Advice from a former Certified Financial Planner

Contribute a PERCENTAGE to Your 401k

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Sometimes, it’s easy to let the small (but BIG) stuff get lost among all of the other information and knowledge out there. I’m just as guilty as anyone else, and that’s why I’m ashamed that there are already hundreds of other articles on my personal finance advice blog before I got around to writing this one.

It comes from a friend who was “running some things by me” who showed me that his 401k contribution is $750.

“Why isn’t a percentage instead of fixed amount,” I said.

“What difference does it make,” he said.

Oh boy.

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 Set a Percentage to Save Into Your 401k

You’ve already heard it a million times before. There are fancy names for it, like “paying yourself first,” or whatever you like. But, in order to save, to really save you need to get money out of your hand, before it ever gets into your hands.

It’s just human nature. We spend what we make. That’s why, no matter how old you are, and no matter how many times you’ve said it before, it still seems like just another hundred, or thousand, dollars a month is all you would need to hit easy street. It’s why so many people fight tooth and nail to insist that paying off their mortgage is the smartest financial decision they can make.

“After all,” they argue, “I’d have so much more money if I didn’t have to pay $2,000 every month to the mortgage company.”

The irony is that it seldom works out that way. Your expenses creep up. Just a little bit at first. Then, a little bit more, and a little bit more, and pretty soon, that “extra” money isn’t extra anymore. It’s built into your lifestyle.

So, how do you avoid this trap?

If you set your 401k contribution to a percentage, you can save more without ever realizing it.

grow your money 401k contributions

The same logic that causes us to spend what we make, also causes works the other way. You earn way more money than you take home each week or month. Go look at your paystub and you’ll see hundreds, or thousands of dollars missing from your Gross Pay. There’s Social Security, Medicare, maybe your health insurance premiums, and of course, taxes. The government knows all about getting the money out of your hands, before it even gets into your hands.

By now, you are used to your take home pay as just “your pay.” Even though you make way more, that money isn’t real to you. You aren’t missing it.

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Your 401k contribution works the same way. Even better, if you set your contribution as a percentage, rather than a flat dollar amount, your contribution will increase every time you get a raise. If 7% is $500 now, it would be $550 after your next raise, and $600 after that, and so on and so on.

The best part is that when you get a new raise, you will automatically see the increase in your TAKE HOME PAY as your raise. After all, the taxes get a little higher too, so you won’t really blame your 401k for squeezing your new pay rate.

So, if your 401k contribution is currently set to a flat dollar amount like $800, call up your HR department now (or at least before your next raise) and get that switched to a percentage that equals out to $800ish. You’ll be way ahead for it in the future.

Check out the IRS rules on 401k contributions.

401k Fiduciary Rule

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Politics sometimes makes it hard to get straight information about important topics relating to your finances. In this case, a court has struck down an Obama era rule that essentially applied the fiduciary standard to certain 401k advisors. According to the Republicans, this is a giant victory for freedom, and business, and enterprise. According to Democrats, this is a giant blow to fairness, and an attack on all hard-working Americans.

As is so often the case when politicians get involved, the reality lies somewhere in between.

What Is Fiduciary Standard?

There is a HUGE amount of case law and statutes about what exactly makes up fiduciary standards, but for our purposes, the easiest way to understand is to compare to the other existing financial standard, suitability.

401k fees savings fiduciary

I spend several years as a financial advisor. During that time, I was under the suitability standard. This meant that investments I recommended had to be suitable for my clients. In other words, I wasn’t supposed to be recommending highly-volatile, high-risk, futures contracts to my widowed, orphaned, school teacher, clients. Practically speaking, this standard had a lot less to do with what I wanted to recommend, and a lot more to do with what my company allowed me to recommend. Basically, mutual funds, or nada.

The fiduciary standard is a higher standard. In this case, the advisor has to recommend investments that are not only suitable, but in the client’s best interest. The distinction on paper is super easy to see:

Investment A is suitable for Client A, but Investment B would be in the client’s best interest.

The suitability standard means the investor could recommend Investment A or Investment B. A good advisor would recommend B either way, but he would only be required to recommend Investment B under the fiduciary standard.

Check out the Zelle reviews.

Why Companies Opposed to Fiduciary Standard?

So, why would any company be against doing what is in the best interest of their clients?

If you want to imagine the worst, those companies want to bilk their clients out of their hard-earned money, and that’s why they are opposed to fiduciary rules: greed and evil, pure and simple.

The reality is that collecting 1% per year to manage someone’s money over a couple of decades is profitable enough, that selecting a sketchy investment here and there probably isn’t worth it to major financial companies.

So, what is the real problem?

Lawsuits.

You remember our paper example of Investment A being suitable, but Investment B being in the client’s best interest? What makes Investment B the better investment? Lower fees? Higher returns? Lower commission? Lower risk?

In the world of investing, there is no such thing as a low-risk, low-fee, high-return, high-liquidity investment. If there were, everyone would just put their money into that and leave it there.

The reality is that risk, return, fees, and so on, are typically levers that move against one another. Lower-risk almost always means lower returns, and vice versa. So, which investment is in the client’s best interest, the one that protects their principal, but may not earn enough return to achieve their goal, or the investment that might give the client what they need, but may have a higher risk? And, how do you sort this out without using hindsight?

Essentially, what this all comes down to is that it is much easier for a client to win a lawsuit against someone who had a fiduciary duty than it is for someone to win a lawsuit against someone with a suitability standard. That’s really it.

See my SoFi reviews.

Is My 401k Safe Now?

Despite a court ruling, your 401k is pretty much just as safe (or not) as it was before the court ruling. Many have fees that are too high, with investment options that also have high fees. Others have better managed investments, and this often a function of how savvy the HR person is that picks and implements the plan, and how big the plan is. It simple costs more per-person to run a small 401k plan than a larger one, so the fees and investment options tend to be better in bigger plans.

In the end, some 401(k)s are better than others, and you should always advocate for a better 401(k) plan when possible, but your 401k plan is the best option for saving for your retirement and you should be loading it up with as high of percentage as possible of your income.

Basic 401k Recipe – How To 401k

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When I was a financial advisor, it always surprised me how often people who didn’t know the first thing about money, investing, or 401(k) plans ended up being so successful at saving for retirement. For them, when they got their first “real” job all those years ago, they signed up for the 401k — because someone told them to — put in 6% of their salary — because that’s how you get the full match — and just chose a basic stock index fund as their investment choice — because that’s all you really need to do right now.

Then, 30 years later, after having contributed 6% into a basic stock index fund every paycheck, during every recession, during every boom, during every bust, they ended up with a pile of money thanks to dollar cost averaging and compound interest — all without ever knowing anything about it.

In contrast, I also met many people who knew “everything” about money. They quizzed me on minutia like where a company becomes a mid-cap stock versus a small-cap stock, or what month the Federal Reserve raised interest rates, but ended up with very little money in their 401k plans. As it turns out, they were “too smart” to leave their money in the market after the internet bubble burst — not realizing that got out too late, and got back in too late, and didn’t save any money during the four years in between.

Set It and Forget It Basic 401k Plan

Look, if you have more than 15 years to retirement, the markets will work out for you eventually. Even if they go down, if you keep your contributions going, the markets will come back over 15 years, and you will have bought low in the meantime.

Basic 401k Recipe

Ingredients:

  • 1 401(k) plan – you have to get this from your employer. There is no such thing as a private 401k plan. (There is a solo 401k plan, but that requires you to have business income.)
  • 401k paperwork or website login
  • List of 401k investment options

Instructions:

Login to your 401k account or fill out the paperwork. Set your withholding at 6%. (If you can’t do 6 percent to start, then set up 2% and increase it every year — or every time you get a raise — until it is 6%.

Choose to invest 100% of your contributions (and any employer match) in a broad market stock index fund. (A total market fund, or a SP 2000 type fund works best).

Let bake until 10 years before retirement.

Should I Use the Basic 401k Recipe?

There are a lot of things to look at, and a lot of options that might lead to better results, but you have to be willing to look into them, and figure them out. If that isn’t where you are right now, then start with the Basic 401k Plan Recipe. The good news is that you can modify the recipe later when you have the time to learn, but you won’t be missing out now, while you don’t have that time or dedication.

IRA Contribution Limits 2017

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Not all tax numbers stay the same over time. Many income limits and other tax numbers are adjusted each year, either for inflation, or by another statutory mandate. These tax numbers include the tax tables and tax brackets for each year, for example. The IRS announces the numbers each fall.

This year is a bit confusing because some of the retirement plan tax numbers were increased by cost of living adjustments. However, other numbers remain unchanged from the previous year because the amount of the change was below the amount legally required to change the figures.

2017 IRA Contribution Limits

irs tax numbers graphicThe 2017 IRA contribution limits were recently published by the IRS. Note that these limits are for contributions made during the 2017 tax year, for use when filing income taxes due by April 2018.

The maximum IRA contribution for 2017 is $5,500. This is the same as the maximum deduction for 2016. The 2017 IRA catch-up contribution amount remains unchanged at $1,000 as well. Only taxpayers over age 50 are permitted to make a catch-up contribution to an IRA account.

Therefore, taxpayers under age 50 may contribute up to $5,500 to their IRA during the 2016 tax year and those over age 50 may contribute up to $6,500. Remember, however, that IRA contributions may be made through April 15th of the following year. In other words, contributions made anytime between January 1, 2017 and April 15, 2018 may be claimed on the 2017 income taxes. This is provided, of course that none of the amount contributed between January and April 15th, was deducted on your 2016 taxes.

Maximum Income for Deductible IRA Contributions 2017

Traditional IRA contributions are tax deductible for taxpayers with incomes below certain thresholds. These income limits are also adjusted each year for inflation. If you, or your spouse, are covered by an eligible retirement plan at work, then for 2017, the maximum adjusted gross income (AGI) for a full IRA contribution deduction is $99,000 for joint filers, and $62,000 for single filers. Taxpayers with high incomes above these amounts will have to calculate the phase-out for their 2017 IRA contributions. Those with incomes higher than $119,000 for married filing jointly, or $72,000 for those filing single, cannot deduct any part of their contribution to a traditional IRA account.

Taxpayers who do not have an eligible retirement plan offered at work, and whose spouse is also not covered by a work retirement plan may take a full deduction for IRA contributions regardless of how much money they earn.

If a taxpayer is not covered by a retirement plan at work, but their spouse IS COVERED, then the income limit for a fully deductible contribution is $186,000 or less. Deductible IRA contributions are phased out in such cases for incomes between $186,000 and $196,000 during 2017.

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