2 Nov 2014
Yes, you heard me right, I said don’t count on your 401k. But Kim, everyone says that is the way to invest. The way to reduce taxes. The way to build a nest egg. That is correct, all I am saying is you should not count on your 401k as your sole source of retirement income.
Just as you should be diversifying your 401k or 403b investments you should also diversify how and where you save money.
Don’t count solely on your 401k, I know so many people and have clients that their 401k or 403b has decreased so much in value they don’t have enough to comfortably live on without getting a second source of income during their retirement. Let this be a great eye opener for all of us who are several years away from retirement. Now is the time to invest in different sources of savings.
First, the main goal is to insure you are not in debt by the time you retire. That means you should be living now well below your means, paying off all your debt. Your credit cards, cars, and of course your home. So many people tout the idea of having millions of dollars at retirement from savings. Well yes, that would be good to have but there is no guarantee of that, especially when you are relying on outside sources for that savings to build, such as the stock market (that is what 401k mutual funds are invested in) the market could all of a sudden shoot up to record highs, it could also be flat for years to come and who knows it could also decrease as well. No one can really predict it. That means you are relying on what the market does as well as what society is doing for your retirement income to hopefully grow.
Another thing to consider, 401k investments are pre-tax. Meaning you don’t pay tax on them until you begin to draw from it. Who is to say what the tax rate will be in 10, 15, 20 or more years. Where do you think all these government bail outs and stimulus dollars are coming from? They are coming from your tax dollars. The more the government spends the more taxes they need to fund that spending. So when you go to draw on your 401k or 403b there is no guarantee what the tax rate will be then, it may be 15%, 20%, what if it is 35% or more? Again, this is not something that can be predicted, but it is something that can be planned for now.
Now I am not saying stop investing in your 401k or 403b, what I am saying is be smart about it and diversify.
First, invest in a ROTH IRA before putting money into your 401K plan. ROTH IRAs are post tax dollars, meaning that what you are putting in is money you have already paid taxes on. So that means you know for sure what the tax rate on that money was, and it has already been paid. There is a down side in that depending on your age, you may only be able to invest up to $5,500 if you are under age 50 and $6,500 if you are over. There are also some limits as to the amount of income you currently make as to whether or not you are eligible to invest in a ROTH, basically if your modified adjusted gross income for those who are married is $178k or more your limits to investing in a ROTH begin to change so check with a CPA or a licensed financial adviser before making these investments.
With all that said, the ROTH is still an investment in the stock market, so even though you have eliminated one unknown, the tax rate at retirement, you haven’t eliminated the unknown of how the market will perform.
Where do you invest next? In simple things with very low returns, such as bonds, and savings accounts. Yes, the return rate is low, but you will know what you have at retirement. You will be investing post tax dollars, as well as paying a known tax rate on the growth each year. True your investment won’t grow fast, maybe 1 to 2%, true you will pay tax each and every year on that year’s growth (interest earned) however both of those factors are known factors and something tangible that you know you have as a savings for retirement.
Oh I hear some of you saying “next she will be telling us to put money under our mattress” no, I am not saying that although having a small amount of cash on hand is never a bad idea just in case of an emergency or disaster such as a hurricane or flood and you couldn’t get cash from ATMs for several days due to power outages, but again that would be a very small amount of cash, maybe a couple of thousand dollars and that isn’t money you would be saving for retirement. My point here is a couple of things:
1. If you have no debt at retirement you living expenses are very low, therefore need for income is low and reasonable
2. If you spread your savings and investments out, you are decreasing your overall risk so when retirement age comes you will have some form of savings you know will be there regardless of what the market does.
So take a look at your current portfolio’s, insure that you are well diversified not only in your investments but in the type of savings that you are putting your money in. Don’t put all your eggs in one basket, don’t count on your 401k, or Social Security. Put some money away in a low risk account that you know will be there when you retire, get your bills and debt paid off now, learn to live below your means. Once you retire, with no debt and a solid savings you will be amazed how well you can live on what you have.