Zoe, 30, lives in Queens and is a graphic designer at a marketing firm in Manhattan. She’s almost finished paying off her student loans, and doesn’t have any savings to speak of. However, she contributes 8 percent of every paycheck to her 401(k) plan, and she’s pretty sure she did so at her previous two jobs, too. The problem is, she doesn’t know how to roll over those old 401(k)s — in fact, she’s doesn’t even know how to track them down, or how much money is in them. She’d like to set up an IRA that she could use for a down payment on a house someday, but she has no idea where to start. She tried calling Fidelity for advice, but the guy on the phone basically spoke gibberish and she never followed up on next steps. What should she do?
There’s nothing that makes me want to staple my eyes shut quite like 401(k)s. What kind of person names his brilliant idea after a tax code? The guy who invented the 401(k) plan, apparently. “The term literally brings up a block in my brain,” a friend told me recently. “It’s like when you can’t remember a password to an account, and the reset function won’t work. Just: full stop.”
The man responsible is Ted Benna, and he’s currently in his 70s and semi-retired on a horse farm in Pennsylvania. In 1978, he realized that a newly passed tax code — yes, section 401(k) — left a loophole for retirement savings that we’ve been exploiting ever since. Then, in 2011, he started telling reporters that he’d accidentally created “a monster”: a giant finance vehicle fueled by hidden fees that Americans are blithely packing their hard-earned money into, unaware that their savings are just spinning wheels in the mud. It’s all become too complicated and confusing, Benna said. People can’t understand their own retirement plans anymore.
And on that point, he and I completely agree.
But first of all, Zoe, you’re in decent shape. By steadily contributing to your 401(k) from an early age, you’re leaps and bounds ahead of most people. More good news: When you contribute over a certain percentage of your salary to your 401(k) — usually around 7 percent — many employers (and hopefully yours) will “match” your contributions. It’s a misleading term, because they often won’t match you dollar for dollar, but they will sprinkle a little something extra on top, and that’s “free” money. Look into your current company’s matching program; if one exists, make sure you contribute enough to qualify for it.
And don’t feel bad about losing track of your old 401(k)s. The most important thing is that they exist at all, and you haven’t spent them. Allowing them to float around somewhere in the money universe, untouched, is very far from the worst you could do.
However, it’s time you wrestled these funds into a place where they’ll serve you best, and pronto. A few years ago, Sallie Krawcheck — a former Wall Street CEO and the founder of Ellevest, a new online investing platform for women — made this scary observation: “The retirement savings crisis in this country is a women’s crisis. Eighty percent of the people in retirement homes are women.”
What’s more, studies have shown that women over 65 are much more likely to be living in poverty than men of the same age. One major reason for this depressing fact is that we’re much less likely than men to invest our savings (you’ve probably heard about the gender investment gap — you can read more about it here). Thankfully, Zoe, you are not part of that statistic. Keep it that way.
Manisha Thakor, the director of wealth strategies for women at the BAM Alliance, likens retirement investment strategy to “taking your money to the gym.” The market makes your dollars limber and strong enough to carry you into a healthy old age, whereas letting them laze around in cash will make them atrophy and shrivel with inflation over time. Even if you don’t go to the gym, your money definitely should. It’s better to be a frail old lady with a killer bank account than the other way around.
See, the entire the purpose of 401(k)s, 403(b)s, IRAs, and any other horrendously titled, brain-block-inducing retirement savings programs is to squirrel away nibbles of your income and invest them, so that they grow with the gradual swell of the market. Ideally, when you’re ready to retire, those nibbles will have turned into a nicely stocked pantry that will keep you well-fed throughout your old age. All you need to do is:
(1) Generally know where they are.
(2) Don’t mess with unnecessary fees.
(3) Not touch them before the weirdly specific age of 59½, because if you do, the IRS will tax the bejesus out of you (roughly 30 percent of whatever you withdraw).
Do not let your brain block these three things, particularly No. 2, which often rears its head in mind-numbing asterisks and fine print. We shall prevail.
A Quick Note on Taxes
In terms of boring topics, taxes are up there with golf and people talking about golf, but bear with me: The function of retirement plans is to dodge taxes in a way that makes you more money over time. Which taxes you dodge depends on the individual plans. For example, whatever you put into your 401(k) is “pre-tax” — i.e., the IRS hasn’t touched it yet. That means it has more oomph in the market, where more money has a snowball effect. Also, unlike a normal investment account, you don’t have to pay taxes on your 401(k)’s growth every year.
Of course, you will get taxed on those dollars at some point — namely, when you take them out of your 401(k) after you retire. If you wait until the magical age of 59½ to do so, as you should, then it will just get taxed like normal income — nothing out of the ordinary. This is why 401(k) money is known as “tax-deferred” (not “tax-free,” sadly). However, you’ll be getting a bigger bang for your tax dollar because, after years of growth in the market, there will be lots more money in your account overall.
Step 1: Open an IRA
So, Zoe, what to do with those crusty old 401(k)s? In some cases, your current employer will let you move your old 401(k) into your current 401(k), which is a fine option. However, if you want to be able to use part of that money for a house at some point, you want to set up a Roth IRA instead. A Roth IRA is different from a 401(k) and a traditional IRA because it allows you to take part of your money out after a holding period of five years — long before you reach 59½ — without taxing it to smithereens. What all three retirement plans have in common is that you won’t get taxed on their growth in the market each year — which adds up in your favor.
Writing this column reminded me that I, too, have a 401(k) gathering dust at the large media corporation where I used to work. I emailed my HR contact about it and got an out-of-office message because she was on vacation. (I was relieved — a legitimate reason to put off something you’ve been procrastinating for months, phew.) Then she got back to me with a link to T. Rowe Price’s website (thanks?), but my login information wouldn’t work, despite being entirely correct (I’m definitely sure about my own Social Security number and birthday). I finally called T. Rowe Price, spoke to a very helpful woman named Monica, and got the transfer forms. Moral of the story: Tracking down your 401(k) may take persistence. Nothing herculean, but get ready to type in your Social Security number about 19 times. The upside is that you’ll feel awesome once it’s done.
Luckily for everyone, opening an IRA no longer involves going to a bank and talking to one of those guys with too much hair gel in a creepy little office — you can do it all online, while drinking wine, in about 15 minutes. (Trust me, I just did.) Once you do so, you can shuffle your 401(k) money over quite easily. This is known as “rolling over” your 401(k), although it’s more like awkwardly dumping one sock of coins into another.
One important note: Any money that goes into a Roth IRA gets taxed during the rollover process at the same rate as your normal income. (In other words, these dollars you’re saving won’t be pre-tax anymore. Some people prefer this, because they’d rather get those taxes paid and out of the way now instead of later.) So, be prepared to see it in your taxes this year.
My friend Ella, who works for a tax attorney and is a genius with this kind of thing, recently rolled over one of her old 401(k)s and made the astute point that you should watch your tax bracket. “I’m in a lower bracket right now, so the tax I’ll pay on the $10,000 I rolled over barely makes a dent, but if I were on the cusp of two tax brackets and the rollover would bump me up, I might have waited,” she explained.
On a positive note, as long as you wait the obligatory five-year period before you touch your Roth IRA, those dollars won’t be taxed when you take them back out — but only up to the amount you’ve contributed. For example, if you put in $10,000 and, over that five years, it grows to $12,000, you still should only take out $10,000. If you do take out the full $12,000 before your 59½th birthday, you’ll have to pay income taxes on that earned $2,000, as well as a hefty 10 percent tax, which negates the whole purpose of saving and investing in the first place. (Also, bear in mind that the more you take out, the less it will grow in the future. I hate math.)
Step 2: “Do It For Me” Investing
Now comes the business part: You have to invest your money without falling victim to weird fees that run rampant through the market. “The fundamental thing I didn’t understand when I was younger was that putting the money in the IRA isn’t where the process ends,” said Ella. “A few years ago, when I opened an Etrade account and put $1,750 in it, I didn’t know that it wasn’t enough to invest in most of their funds, because the average minimum for investment in a single fund is $3,000. So that money just sat there, not invested.”
She wound up transferring it to Vanguard, an investment-management company that comes highly recommended by many financial experts (as well as Warren Buffett, The Economist, and John Oliver — whose segment on retirement plans is very much worth watching, too). I strongly suggest that you do the same; Vanguard has very low fees, a $1,000 minimum for many reliable retirement funds, and a history of steady return rates.
If you do decide to go with another firm (or a bank), check that their fees do not add up to more than one percent, as a rule. Someone in a suit might try to tell you that a higher fee will result in better money management (usually more “active” management, meaning it’s moved around more aggressively), and maybe it will, but plenty of research shows it won’t. These tricky fees are what Ted Benna was bemoaning, and they can be so high as to quash your money’s growth. Generally, it’s not worth it to try and get fancy with your retirement savings. Park it someplace cheap and boring where you know it’ll chug along in the right direction.
Christine Benz, the director of personal finance at Morningstar, essentially studies this stuff for a living and makes investing very simple: “Either a pure index fund or a target date fund is a fine idea; you can’t go wrong with those,” she says. The beauty of both of these options is that they’re low-fee and low-maintenance — and you can pick them out on a confusing drop-down menu of investment, which is saying a lot.
A target date fund is particularly great for people who want to stay hands-off, because the account is managed based on your age and life stage, so the balance of investments shifts automatically as you get older. (When you get closer to retirement, your investments should be very low-risk, but when you’re younger, you can afford to try riskier stocks that’ll hopefully get bigger results — to return to the gym metaphor, you can try trapeze gymnastics when you’re 29, but at 58 you’re be better off with Pilates.) As Christine put it, “A target date fund is the ultimate in do-it-for-me investing. Once you’re participating, inertia is your friend.” Music to my ears.
Finally, there’s one other investment option for your IRA, and it’s a new and exciting one. Sallie Krawcheck, whom I mentioned earlier, founded Ellevest with the specific goal of closing the aforementioned investing gender gap; the company aims to serve women’s needs better than any other existing system by using an algorithm tailored specifically to women’s incomes and life cycles. (Yes, no one else has thought to do this before, and yes, Ellevest’s fees amount to .5 percent of what they manage, so they fall well beneath the 1 percent rule.)
A major selling point, for me: Rather than sending nonsensical charts and columns of numbers, Ellevest asks you to plug in your goals (a house, retirement age, etc.) and then sends you updates based on whether you’re on target to meet them.
“If you fall off-track, because the market cracked more than we thought it would, or because you didn’t make your $1,000 deposit, we’ll reach out to you and say, ‘Okay, to get back on track, you need to deposit $1,200.’ That way it’s meaningful,” said Sallie. “That’s what our research tells us women want to know — ‘Am I good?’”
Zoe, you’re already good. But you can be great. Best of luck with the 401(k) hunt, and enjoy your house.