67 percent of Americans workers aged 21-64 with access to employer-sponsored 401(k)’s do not participate in the pre-tax retirement plan.
I was absolutely floored when I read this stat published by the Employee Benefit Research Institute. There had to be a typo in there somewhere. (I double checked; there wasn’t.) Virtually then, more than two thirds of the working population (with access), don’t do 401(k)’s?
While I often resist approaching this subject at the risk of “beating a dead horse”, it is now crystal clear; the horse is nowhere near the end of its days. Next question: Why isn’t the majority of the working population taking advantage of this benefit?
After much consideration, my ventured guess is this: employees opt out because there is a lack of true understanding for the machinations of 401(k) plans, benefits of participation, and costs. Of these, perceived cost may be the biggest stumbling block.
Deductions & Reductions
Deductions taken from your pay check will reduce your take home pay, but it will not reduce it in the dollar for dollar manner many assume. Because these employee contributions are made on a pretax basis, any amount contributed to the plan will reduce your taxable income. Therefore, every dollar contributed to a 401(k) will result in a reduction in take home pay of 72 cents for an employee in the 28% Federal Income Tax bracket: $1.00 – $ .28 = $ .72. Think about how that multiplies.
Many states will also compute their income taxes based on this adjusted figure. In Illinois, if you are in a 28% Federal Tax bracket and the 5% State Tax bracket, the true cost of your dollar contribution would be 67 cents. ($1.00 – $ .28 – $ .05 = $ .67.) Federal Tax Credits available to lower income people may reduce these relative costs even further.
I also believe many people opt out because they don’t understand the markets, how to invest, or much of anything having to do with finances. While that used to be a somewhat valid excuse, modern day benefit management methods are proving otherwise.
Investment programs have become much more automated than they used to be. Most plans now offer portfolio programs professionally managed to selected specifications. For example, the direction of your plan can be focused on the actual target date you have in mind to begin withdrawing funds when you retire.
Current benefit management systems take the task of portfolio construction out of your hands and into those of professionals who balance risk and reward within the elected set of demographics. The days of having to select individual market accounts and balancing them yourself are over.
In addition to paycheck reductions and managed assistance, another major benefit of 401(k) plans is tax deferrals.
All growth in these products is deferred until they are withdrawn from the account. Therefore, if you contribute $3000 per year for thirty years, a total contribution of $90,000 would have been made. If the account balance is $500,000 after this time, none of the additional $410,000 would have been taxed as it was growing.
Keep in mind these funds will become federally taxable as ordinary income in retirement. State treatment of retirement income varies; Illinois does not tax retirement income from 401(k)’s.
Because most people are in a higher tax bracket while working than they are in retirement, 401(k) participation is even more beneficial.
Contributions for participants who fall into this norm will: allow deductions from taxable income at a relatively higher tax rate and have receipt in retirement at a relatively lower tax rate. Ultimately, you’ll be paying less tax on the income you earned.
One Final Nay
Take advantage of employer match plans! (I.e. When employers offer matching contributions to your fund when you elect to participate.) Not taking advantage of this is literally passing up free money. Opt in now and cash in later!
Kurt Rusch CLU, ChFC