Free money, anyone?
Now that I have your attention, let’s talk 401(k) plans — the closest most of us are ever going to get to free money in our adult lives.
What is a 401(k) plan, you ask? A 401(k) is a workplace savings plan that allows employees to invest a pre-tax portion of their paycheck. The savings can grow tax-free until retirement, at which point withdrawals are taxed as ordinary income. A majority of employers will match an employee’s contribution — up to a point, with 2.7 percent of pay the average company contribution — thereby boosting the employee’s savings rate (this is the aforementioned “free money”).
No, the name does not guarantee that you’ll make $401,000, nor is it an attempt at luxury-car-esque naming, as in the BMW 740i. It takes its name, rather mundanely, from the section of the Internal Revenue Code which created it. There are other employee-sponsored retirement plans, such as the 403(b) and 457, but the 401(k) is the most common.
That’s what 401(k)s are and what they do. Now, if you are someone interested in free money (hint: you are) and could also use all the help you can get in planning for retirement (another hint: you do), then you need to get one if it’s available through your company.
Fortunately, about 80 percent of full-time workers in the U.S. have access to employer-sponsored retirement plans and of those workers that have access, about 80 percent participate, according to the American Benefits Council. Historically however, the youngest employees have been the least likely to participate.That trend could be changing, which is great news for millennials.
According to a new Bank of America Merrill Lynch analysis of the 2.5 million participants in the company’s own retirement plans, a whopping 64 percent more employees between the ages of 18 and 34 began contributing to 401(k) plans last year as compared to 2013.
There are a couple of reasons for that gigantic jump. One, the economy and the financial well-being of millennials have improved. Two, more companies are automatically enrolling new hires into plans, with a small number of companies even automatically upping the employee’s percentage contribution each year. A separate recent report from BMO Retirement Services found that participation rates among 25- to 34-year-olds jumped 22 percent when they were automatically enrolled; for those under 25, participation more than doubled from 29 percent in voluntary-enrollment plans to 68 percent in auto-enrollment plans. Employees can override these defaults, but typically don’t. It’s rarely the case in life that a person’s inertia works to his or her benefit, but in this case it does!
There’s probably a third and a fourth reason for a rise in retirement plan participation that’s also been true, although to a lesser degree, across the age gamut. Those are the concerns about Social Security’s future and rising healthcare costs.
Whatever the reason, we’ll take it — just like we’ll take free money!
No matter the driver behind increased 401(k) participation, the important thing is it’s increasing. As I explained in my last column, the sooner a person begins investing, the longer that person has to watch the incredible power of compounding interest work wonders on his or her money.
Millennials enrolled in 401(k) plans are saving a median (the midpoint of a distribution of values, meaning that half fall above and half fall below this figure) 6 percent of their income, according to a recent survey by T. Rowe Price. That’s compared to the median 7 percent for all enrollees and the median 8 percent for baby boomer enrollees.
Don’t let that bother you, millennials. More of us are participating, and that’s the first step in the 401(k) game.
The second step: choosing the right investment for your 401(k) account, which I’ll discuss in my next column. For in-depth, expert guidance, consider talking to a financial adviser.
Jennifer Pagliara is a financial adviser with CapWealth Advisors, LLC, and a proud member of the millennial generation. Her column, which appears every other Saturday in The Tennessean, speaks to her peers and anyone else that wants to get ahead financially.
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