The Retirement Plan

Way back in the 1860's, pensions were created for some government workers. The first corporate pension came soon after in 1875. In 1958, the first 403(b) plan was created in the USA. The 401(k) came around in 1978 and the TSP was created in 1986, followed by the 457, which was finally created in 1996. These are the the big five retirement plans offered to people like you and me at the workplace in the USA.

So, why should we care about that stuff? How you handle one retirement plan over another could affect your life in some very big ways. Almost all employers who employ over 5,000 employees offer a retirement plan. On the other hand, most employers who have fewer than 5,000 employees do not offer a retirement plan. You might want to keep that in mind when making a decision on where you work.

Here is a bit more to know about the type of retirement plan offered to you. 401(k)s are mostly connected to for profit public and private corporations. 403(b)s are attached to non-profit organizations. 457s usually reside with state and city employers. The TSP belongs to federal government employees to include the military. As for pensions, the few remaining ones belong primarily to government agencies.

Before we move forward, we should also mention that 401(A)s, Simple IRAs, and SEP/IRAs are offered by some employers. Some "quasi" pensions are offered like an ESOP, Individual 401(k) are out there as well, and of course if you have earned income, a Traditional IRA or a Roth IRA is available based on your earned income amounts. That is a lot of retirement plans! Now let's simplify matters a bit.

For the most part, the employer funds pensions, which are called defined benefit plans, SEP/IRA and ESOPs or you fund most or all of the retirement plan yourself with maybe some matching money from the employer (defined contribution plan). This would include the 401k, 403b, 457, TSP,  and Simple IRAs for the most part. The key is to identify what is offered and what you can do.

When you get hired, you need to figure out what kind of plan(s) you have and how to make the most of them to include their vesting periods. They are all just a little bit different. The days of the employer taking care of you (pensions), are pretty much over. Now the responsibility lies with YOU and that means YOU need to get educated on YOUR plan and how to invest wisely. Why? Your future is riding on it!

(1) Get as much free money from your employer as you can. (2) Stay put to reach the vesting period so you get to keep all FREE money. (3) Always contribute up to the match, whether that is 100% or 50%. (4) Contribute more than the match (20% would be a goal). (5) Invest in stock index funds(select low fee managed funds if not available) when you are young (under 50). (6) Decide on Traditional or Roth.

If your employer offers an after tax Roth option, look at your gross income to decide on Roth vs. the default pre-tax Traditional option. One guideline you could use is gross income of $70,000 for individuals and $140,000 for couples. If you are well over those amounts consider 100% Traditional. If you are close to those amounts, do 100% Roth. If you are well under those amounts, definitely do 100% Roth.

Are there exceptions? Sure, if you have kids in the home and you are getting a large tax credit per child, that makes the case toward higher thresholds and more Roth money because you are staying in the 10% or 12% federal tax bracket. If you itemize your deductions, you also might raise the thresholds. If you live in a no income tax state or low income tax state, you might raise the thresholds as well.

Most employers are going to stick you in a lifecycle/target retirement fund that owns stocks and bonds and is based on you retiring at 65. You likely have better options in the plan and that means low fee total market stock index funds. The fees will be lower and the returns will be higher (likely) over time. If you are under 50, ditch the default fund and go with one or more stock index funds.

That advise is for the current money in the plan and the new contributions as well. It is important that you focus on getting this information right as soon as you can. Why? We could be looking at hundreds of thousands of dollars difference in your accounts over time based on someone who knows what they are doing vs. someone who is clueless and chooses not to learn. Educate yourself!

Increase your contribution rate over time when you get cost of living adjustments to your paycheck, pay raises, bonuses, etc. Try to increase it every year even if it is only 1 or 2%. Make it a goal and stick to it. Get to 20%! Why? You will reach financial freedom one hell of a lot faster than the other person who is aimlessly going along and not increasing their savings rate. Take control of YOUR life!

What do you do when you leave that employer? Rollover all traditional money (yours and the employers match) to a Traditional IRA and into stock and bond index funds at Vanguard. If you have Roth money, roll that over to a Roth IRA at Vanguard and into similar index funds (keeping 100% of your Roth money in stock index funds works well). Consolidate so you don't have money all over the place!

What about pensions? If you have one and you leave that job early (before the money gets turned into lifetime monthly payments), roll the money over to a Traditional IRA at Vanguard and into the same index funds. When might you keep the pension there? If you intend to go back to that workplace or another workplace that offers the same pension (IPERS for example), you might leave it there just in case.

Why move all of that retirement money to Vanguard IRAs over time? Consolidation, simplicity, low fees, higher returns, and you get to decide the tax withholding. If you withdraw money out of a pre-tax retirement fund at work, there is a mandatory 20% federal withholding rate. When you pull from a Traditional IRA, you get to decide the withdrawal rate, which for some of you might be 10% or less.

Here is another good reason to move money out of the retirement plan at work and into IRAs. The required minimum distribution (RMD) will be eliminated on Roth 401(k), TSP, 457, 403(b) money by moving it to a Roth IRA. The pre-tax RMD will be consolidated in one Traditional IRA instead of multiple accounts. That is a BIG deal. It will simplify your life and make the whole situation easier to manage as you age.

Let's be clear, once you move money over to the IRAs at Vanguard, you still need to invest wisely at that point and continue to contribute when possible to a Roth IRA (how much your earned income dictates your eligibility). That money is there for you to use later in life when you decide to leave the world of full time or part-time work. The time is NOW to take control of YOUR life!

Stuff the lawyer wants me to say: Investing outside a bank or a credit union is not FDIC insured. You may lose the value in the investments you select. All information provided here is for informational purposes only. It is not an offer to buy or sell any of the securities, insurance products, or other products named. Translated: I am not selling anything! Educate yourself, research the information that you learned and finally make the right decisions that will benefit you and your family going forward.

Powered by