The information that HR provides to employees about their defined contribution savings plan typically focuses on basic plan facts. That leaves unanswered questions about how to use the plan. Below are some of the answers employees need to begin using their 401(k) to have the financial future they want (in Jeopardy style, followed by the questions).
$333 at age 65.
“At age 65, about how much can employees who have $100,000 in their 401(k) account expect each month for as long as they live?”
Repeat aloud: $100,000 at 65 assures around $333 a month. That’s what many experts say. That's an annual withdrawal rate of 4 percent of the account, divided by 12 months. A few experts say it’s closer to $167 a month (using a 2 percent annual withdrawal rate). Some say as much as a whopping $417 (at 5 percent per year).
Isn’t it better for employees to know this today rather than to find it out when they’re ready to end their full-time career?
Employees should ask the plan’s representatives about the withdrawal rate they recommend. Also, employees should ask about withdrawal techniques and annuities that could provide somewhat more. Of course, employees need to understand the advantages and disadvantages of their financial choices.
Not their house.
“What’s the most expensive purchase employees will ever make?”
The total cost of employees’ income following their full-time work will likely be much more than the cost of their house.
Let’s say they want $40,000 annual income starting at age 65 and lasting to 90—that’s 25 years. Simple math: $40,000 times 25 equals $1 million. Yes, $1 million. Did their house cost this much? If they want more income, or want it for a longer time, or if inflation outpaces their investments, the price will be higher—maybe a lot higher.
Here’s good news. Along with their 401(k), their income from Social Security, any defined benefit pensions, personal savings and part-time work will help employees pay for this "purchase." Working full-time longer also reduces the cost.
The number won’t be exact.
“Can an expert or software program tell your employees exactly how much money or "the number" they’ll need for their future?”
Here’s why it won’t be precise. A key part of estimating the number is entirely up to individual employees—the future they want. If today was the last day of their full-time working career, would they want a continued lifestyle that’s half as much as they spend now, twice as much, or the same as they spend today? It’s their future, their life, their decision.
How long they’ll need the income is another key element. To highlight the impact, here’s an exaggerated example. If an employee's life ends when he or she is run over by the party bus when celebrating their last day of full-time work, that employee will need $0 future income.
At the other extreme, an employee who stops working at age 60 and lives to 105 will need 45 years of income. That’s longer than he or she worked, and probably more money for that income than was earned in a lifetime of work.
Although the number can’t be exact, employees should talk to experts and use computer programs to get a good estimate of the likely range of the cost. (As a first step, a simple one-page estimator can help nudge them to consider how large a nest egg they would need to buy the future lifestyle they want.)
“How many things can employees do with their 401(k) to help assure an adequate income when their full-time career ends?”
1. Define the future lifestyle the individual wants. Even though it cannot be determined precisely, all employees need to set a personal dollar goal for their 401(k) account.
2. Contribute. Starting today, employees should put into their account an amount from each paycheck that’s targeted to reach their goal—with some help from their investments as well as contributions from their employer. In most cases, employees will have more income to save later in their careers.
3. Invest wisely. Have a mix of investments and a long-term strategy. It’s money the employees might not be spending for 20 to 40 years.
4. Receive income. Take money out of the 401(k) account only after the employee’s full-time career ends, and in a manner that assures a lifetime income.
Employees need a dollar goal that’s relevant to them. Otherwise, there is little chance that they will succeed. Naturally, they might change their goal over time. Their plans and aspirations might change. Inflation and a host of other things could change. But they cannot focus on hitting a target if they don’t have one.
Investing is important. But during the first several years that employees have an account, investing is not as important as contributing. If employees don’t contribute, there’s nothing in their account to invest, nothing to grow.
Every day they wait to start contributing is a day they’ll miss any contributions from their employer and the opportunity for compound earnings. The larger the account gets, the more compound earnings matter. That’s money earned on the contributions plus—here’s the kicker—it’s money earned on the money they’ve already earned.
The dangerous part of not contributing today is that if employees wait they might never be able to afford the future they want.
Consider this. Will employees be able to build up a 401(k) account in their last 10 to 20 years of work to support their desired lifestyle for 20 or 30 years when they no longer want to work—or are unable to work? At that time, if they don’t have much in their 401(k), they might need to get by on whatever Social Security pays. They might need to turn to their children, their community or the government for more. Again, it’s their future, their lives, their decision. Good or bad, that’s the system for millions of Americans.
Of course, if employees pocket their 401(k) money when they change jobs, none of this matters. The money they take out during their working career is money they won’t have when their working career ends.
Employees are getting what they pay for.
“Whose money is paying the organizations that run your 401(k) and manage the investments?”
In most cases, it’s the employees’ money. The fees are taken out whether their accounts go up or down in value.
For every $1,000 employees have in their accounts, they could be paying around $5 to $15 each year, or even much more. The fees pay for the management of the investments, plan administration, printed materials, web sites, statements, phone representations and most other aspects of the 401(k).
The 401(k) representatives should be able to tell employees how much they are paying.
Employees might be receiving good value for these fees. But if they are not satisfied with a service, employees should tell the plan administrator—they’re paying for it.
Different investment options usually have different fees. Certainly, some good investments have high fees. And perhaps some equally good ones are lower priced. As in making any important purchase, employees need to be smart shoppers. They should know what they want, what they’re buying, what the cost is and what outcomes they should expect. Then, over time, they should make sure they’re getting what they’re paying for.
If they could see the future, they’d be picking the winning lotto numbers.
“Why won’t investment professionals tell employees which investment will turn out the best.”
Many employees have unrealistic expectations. Investment advice from even the smartest investment experts is a guess; probably a very sophisticated, intelligent guess, but not a guarantee.
At a minimum, a good investment advisor can help employees plan better and avoid obvious mistakes. Most advisors can help employees do much more.
To some extent, investment advice is based on what certain investments have done and what the experts think the investments will do. But what worked in the past might not work in the future. And what experts predict might not happen.
That’s why most advisors encourage employees to have a well thought-out, diversified mixture of different types of investments. Advisors can help employees decide what mix they want, choosing from among investments that are expected to do well when the market goes up and the ones that are likely to remain generally stable when the market goes the other way.
Employees are purchasing their future lifestyle. They should know the basics of investing. They should know enough about any advisor they use to judge if he or she is working in their best interest. Even if employees are using a balanced investment fund or a target-date fund—or a computer program that’s providing advice—the employees should be confident that the approach is aligned with their needs, objectives and emotions.
With these answers, employees could begin to make better use of their 401(k) to achieve the future financial lifestyle they want. They’d know:
• Roughly how much money they’ll need to help pay for the largest purchase they’ll ever make—their future—even though the price is impossible to calculate precisely.
• The four things they can do with a 401(k).
• That they are paying for the plan, the investments and services.
• That no one knows for certain which investments will be the best, but that good advice is a good investment.
Perhaps most of all, employees would know they’re in charge of their future financial lifestyle. And if they get good advice and make wise use of their 401(k)s now, they will be better able to define, pursue and achieve it.
For 20 years, Dennis Ackley has been an advocate for clarity and accountability in 401(k) education, helping workers gain the basic knowledge needed to begin achieving the financial future they want. His award-winning communication programs on retirement and employee benefits have reached three million employees at hundreds of employers.
SHRM Online Benefits Discipline