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The President signed the “Tax Relief, Unemployment Insurance Re-authorization, and Job Creation Act of 2010” (The Act) on December 17, 2010. The effect of The Act was to roll-back the payroll tax paid by employees to 4.2% for one-year (2011) only – a reduction of 2%. The Congress and President agreed in the Lame Duck session of Congress during December 2010 that such a reduction might prove stimulative to the economy. I am going to propose you do something with that 2% that is not necessarily stimulative to the economy but it will benefit you in the long-run. I propose you take that 2% effective raise you just got (or even part of it) and increase your 401(K) savings (or IRA) by 2% per pay check.
According to one investment firm that sells 401(k) plans, the average worker needs to save about 15% of his or her paycheck annually in order to have enough money to retire. The average contribution rate, however, is 7.6%, according to T. Rowe Price. T. Rowe Price figures that retirees will give themselves an annual inflation adjustment, which is one reason the figure is so high. Nevertheless, most experts figure you can only start taking 4% to 6% of your savings each year to avoid running out of money. To get $50,000 a year, you’d need $833,000 to $1.25 million when you retire. And with overall life expectancies increasing over the past century, that number might just be higher. It is certainly higher if you expect to maintain a higher standard of living, as well.
Overall participation rates in 401(k) plans fell from 65% in 2009 to 60% in 2010, says Jack VanDerhei, EBRI’s research director. And, also according to T. Rowe Price, 57% of plan participants contribute 5% or less of their pay.
Coming off of the Great Recession and some significant stock market losses beginning in 2007, it is not surprising that 401(k) participation is down generally. Further, a number of young employees fail to participate in company retirement programs at all. I know at my current employer, most hourly staff opt-out of the program despite the 5.5% match provided by the company to participants.
As I learned of the passage of The Act, I immediately considered how I might benefit from the 2% “raise” that I effectively received thanks to Congress and the President. My first thought was to spend the money. After all, gasoline prices have been on the rise and some grocery costs are higher. In addition, with the winter months come higher heating costs and there are always holiday bills to pay. I could go and buy the purse I covet and spend some on my teenage daughter too.
I also considered what kind of raise I might receive in March when the annual assessments are released. My company first cut bonuses almost three years ago and then eliminated them in the past two years. Further, we have only received one raise in the past two review cycles. Nothing has been announced with regard to a possible raise this March. I could use the money, after all. But then cooler heads prevailed. I opted to increase my 401(k) contribution by the 2% (our contributions are pre-tax up to a limit and any Roth 401(k) contributions we make are after tax at my employer). My reasoning I believe is sound.
First, I am fortunate to have multiple investment options in my 401(k) program. I can choose to diversify my investments among 31 options, including a money-market fund (“stable value” option), international stocks, 3 bond options, and a short-term fund option. Second, I feel informed enough about the market and investing that I can make a reasonable selection among the choices and evaluate my options. Third, my employer offers periodic seminars with an investment advisor at work on the markets and on retirement investing. Finally, my employer has arranged for free one-on-one time, during work hours with the same investment advisor so that I can discuss my personal situation at any time during the year. I feel capable of making good investment decisions with the 2% contribution increase.
Finally, an employer providing a matching program of any type does offset at least some of the risk that money might be lost in some of the stock and bond investment options. It is like giving a guaranteed rate of return, before investment losses (as well as any tax-advantaged contributions, depending on the employee’s tax rate). I believe that the match does give a staff person the ability to make a few riskier selections within a diversified portfolio.
Ultimately, my decision to put all 2% into my 401(k) came down to the fact that I felt like I would not miss money that I had not already received. At this point, you might have received one or two paychecks and might have enjoyed your “raise”. Is the 2% something that you can live without for the next 11 months? Maybe split the difference and add 1% to your retirement contribution rate.
And if you have already hit a rate of 15% as suggested by T. Rowe Price, congratulations. Most of us have not.
More from this contributor:
New Year’s Resolutions for Your Small Business
Consumers Continue to Deleverage
The Importance of Managing Your Income at Year End