After this article, you’ll be convinced: you should max out your retirement accounts as early and often as you can. Having money in tax protected accounts will give you piece of mind now, and a cushion in case of unplanned issues and bumps down the road.
The Failure to Contribute Is Costly
We came across a piece in Bloomberg claiming the 401(k) “crisis” is getting worse. To wit:
Tim Egan has been working since he was 14. He’s now 56 and has spent most of his career as a restaurant manager. He has virtually nothing saved for retirement and, until last month, never had a 401(k) account.
In the article, we learn Mr. Egan also did not open an IRA until his 40s, only to chase stock returns in 2008 and (apparently) leave his investment in cash in the subsequent recovery, missing the gains. As the IRA is now worth around $20,000 and we know he’s been investing since at least 2008, that means he hasn’t maximized his contributions for the last 7 years: $5,000 in 2008 as a 49 year old, then $6,000 for 2009-2012 as a 50+ year old (using ‘catchup contributions’ – see below) then $6,500 for 2013 through today.
Even if only in cash, that would be a $48,500 minimum still in the account, waiting to be deployed into something with a bit higher expected return than cash.
Mr. Egan’s story looks to have a happy ending – he recently landed a job with a 6% 401(k) match, so he will likely have a reasonably decent nest egg on top of his social security. But, as always, let’s try to direct this story to you, readers:
- You should max out your retirement accounts as early and as often as you can
- Even if you don’t have access to a 401(k) (or 403(b)/similar), you should take advantage of IRAs
Of course, after that you can save outside your tax-advantaged accounts.
But Can’t I Make It Up Later?
Readers will recognize this line of questioning from the article we recently skewered in our piece, You Need to Have Savings In Your 20s. While what we wrote is undoubtedly true, the importance of savings in these tax-advantaged accounts is exponentially more important in your 20s! Here’s the thing (for our American readers):
Once you miss a year, you will never be able to go back and catch up.
That’s right – if you suddenly find yourself with a windfall, you will be unable to go back and make the contributions you ‘missed’. That window is broken, and you’ve got no way to fix it… there’s no way to max out your retirement accounts for past years.
As it stands today, our tax code in the United States works under the principal of use it or lose it. If you made a $500 IRA contribution in 2013, you don’t have the chance to go back today and make it up – it’s over. For that reason alone, you should take advantage of it today.
Of course, there is another way that you may be blocked from contributing: you may eventually make too much money to qualify! Although there has been some talk of retroactively limiting the maximum total amount in an retirement account, as of today your earlier contributions are completely safe under the tax laws of your younger self – and, if you follow our advice, you’ll have a lot of money in there (great if you can’t contribute more!).
What About Catch Up Contributions?
Catch-up contributions are a provision in the tax code that allows folks 50 years old and older to make larger than normal contributions to their 401(k)s and IRAs and other similar accounts. For 2015, this means a 50 year old worker can make a $18,000 contribution to their 401(k) or 403(b), and an additional $5,500 in catch up contributions. For IRAs, it works out to a $5,500 contribution plus an additional $1,000 catch-up.
Although catch-up might sound like you can contribute to past year accounts, it doesn’t work that way – and as it is based on age, everyone qualifies for all of the cap space (you know, assuming eligibility otherwise).
Although the catch-up provision is an excellent feature of retirement accounts, it doesn’t substitute for earlier years of compound growth and cap space, especially since you will likely make more money in your 50s than your 20s-40s, potentially having more money that could go into your tax-advantaged accounts.
What if I Save Too Much? (And What If I Need Money?)
Although I have heard this ultimate-first-world-problem discussed as a real reason why people will hold money out of retirement accounts, this shouldn’t be your largest concern. First, there is a way to tap money from your IRA known as the 72(t) Substantially Equal Periodic Payment Distribution. By crafting your withdrawals in this way, you can get money out even before “full retirement age”.
That isn’t the only thing: first, Roth IRAs allow withdrawal of the contributions (but not any appreciation!) at any time. Of course, you won’t be able to put that money back (after a year), but in a hardship it is an option. There are also explicitly called out hardship withdrawal options which have no associated penalty. From the non-hardship side, some accounts (such as IRAs) allow withdrawals for specific categories like first-time home-buying and education.
401(k)s, depending on the setup, may also allow loans – it’s not a suggested method of tapping your funds in most situations, but 26% of all 401(k) holders have one outstanding.
Finally, you can of course tap your accounts with penalties. But with the number of exceptions above odds are you don’t have to. So, please, just max out your retirement accounts!
The Conclusion: Max Out Your Retirement Accounts Early and Often.
Even if you can’t max your contribution every year, you should put as much into the account as you can – in every year that it is available to you. There are always ways to get money out if you need it – whether using an exception or taking a penalty – but there is zero way in the United States to go back and get more money in.