Why Retirement Savings Falls Short
I was reading Matt Koppenheffer's article on retirement investing "4 Stocks and 1 Critical Rule for a Comfortable Retirement" and I wanted to shed some light on what I have observed regarding retirement savings and where I agree and disagree.
I agree the more you can defer the better off you are in retirement through the power of compounding. Participating in forced savings through your paycheck is a powerful ally since you don't "see" the cash in your net check amount or direct deposit.
I disagree with the statement: "Of course, there's no reason that you have to choose between making healthy contributions to your retirement account and choosing investments that will perform well over time."
Many retirement plans are saddled with funds that carry high fees which leads to consistent underperformance. The average investor in many cases would be better served holding index funds in an IRA to overcome this shortcoming, especially if they are not offered a company match. Teachers forced to choose an annuity with 3-5% annual fees in their 403(b) are better off in an IRA as well.
Secondarily, there are many reasons why people need to choose between a portfolio of individual stocks and a retirement plan. It is nice if someone can defer 15% of their salary AND hold stocks in an IRA/brokerage account outside of the plan. However, many people are underemployed and if they have a family, they have a hard enough time meeting bills let alone putting away 15% in an IRA or 401(k). The idea that most people can do BOTH is very unrealistic. I've seen data that suggests the average 401(k) balance at retirement age is somewhere between 30K and 50K.
You might say well what evidence do you have? Over the years I probably have prepared taxes for well over 2,000 clients of which about 75% have a 401(k) plan offered to them and only about 25% of these clients participate. The other 75% main reason for not participating? They are living check to check and couldn't afford it. Very few of these folks have IRAs either.
Each year at tax time, I suggest that people contribute atleast the percentage the company matches. Year after year, I look at the W-2's and only a few take this advice. Autoenrollment and autoincrease provisions may help in this regard, but much of the growth of one's account requires maintaining employment for somewhere between 3-7 years to be 100% vested in match/employer money. This reality can not be discounted. Leaving employment after a year or two KILLS individual retirement balances. All unvested money is forfeited back to the plan. Another pitfall, paying a 10% extra penalty in federal taxes for withdrawing the money before age 59 1/2 on top of the standard 20% withholding for federal taxes.
My advice: If you have a tendancy to bounce around from job to job, an IRA is your best friend. If you are a stock picker, the IRA is great too. If your company offers a match or profit sharing, see if you can put aside atleast the amount the company matches. If they have index or target retirement funds, you are in business. Low fees are your best friend. If you can do both IRA and 401(k), then you are a lucky person. If you can't, I'm sure you have plenty of good reasons.