8 Simple Steps to Avoid Debt

August 23, 2018

By your mid-thirties, you are far enough along in life to understand that staying out of debt is a key to your long-term financial health. But have you ever sat down and thought about what, specifically, you need to do to stay debt-free? Here are eight simple steps that will help you.

Sarah is 35 and single. She owns a home and lives alone. She is not an extravagant spender. She rarely takes vacations. She always buys a secondhand car. Yet she has trouble staying out of debt, and she has had no success with saving. What can she do to change the pattern?

 

Step 1: Set up a budget.

By definition, avoiding debt requires that you spend less than you take in. It is just common arithmetic. But while Sarah knows exactly what her income is—she can recite the amount of her biweekly take-home pay to the penny—she is only vaguely aware of her full range of expenses.

Voya’s Home Budget & Savings Calculator can help Sarah understand her monthly expenses by showing her exactly where her money is going. Visualizing her spending is the first step toward managing it.

As with her income, Sarah knows the amount of her monthly mortgage from memory. It’s around 25% of her pre-tax income. She also knows her monthly car payment by heart as well as the number of months before she pays it off (22).

However, Sarah does not have such a strong sense of her discretionary monthly expenses, such as the cost of dining out, or even her fixed monthly expenses. The simple act of plugging numbers into Voya’s Home Budget & Savings Calculator made her realize how little she thought about utilities, home maintenance and general expenses such as food and clothing. Even though her mortgage and car payment are her largest individual expenses, Sarah realized that when she added all her smaller monthly payments together, they exceeded the combined total of those two largest expenses.

So what can Sarah do to bring that number down?

 

Step 2: Use cash for everyday purchases.

Years ago when Sarah first got a credit card, she started carrying less cash. It seemed to make sense; if she didn’t have cash in her pocket, she wouldn’t spend it. So she used her card for every purchase she could. Soon she was charging almost all of her expenses: morning coffee, lunch, dinner out, movie tickets and so on.

Then she tried an experiment. For a month, she paid cash for all small everyday purchases, saving her receipts as if she was on a business trip. When the month was over, she added up the receipts and compared the total to her typical monthly credit card statements.

She was shocked by what she found. When she used a credit card, she spent far more. The difference was particularly noticeable when it came to food. A single $12 lunch, bought with a simple swipe of her credit card, seemed like a painless expense. But five $12 lunches a week is $60, and that’s $240 a month—more than the total of her car payment.

Once she started using cash and she saw the total amount of her cash dwindling as the week went on, it became easy to decide that she really didn’t need chips and a $2 bottle of water with her lunch. She even started bringing lunch from home a few times a month. At the end of the month, she had trimmed her lunch bill by $100. The conclusion was clear. Sarah knew what to do next.

 

Step 3: Watch monthly credit card debt more carefully.

For Sarah, this was a natural result of using cash more often and becoming more price-conscious at the point of purchase. She never fully grasped the psychology of it before: Just because she could buy something using a credit card that did not necessarily mean that she could afford it. She now assessed every potential purchase in the context of her monthly budget.

 

Step 4: Pay more toward credit card bills than the minimum amount due.

That small figure is so tempting. On one of her cards, Sarah has a balance of $1,000 with a minimum monthly payment of just $30. Under her current terms, it would take her 47 months to pay off that debt with a total interest charge of $396.74. If she increased her monthly payment by just $10, she would pay only $262.81 in total interest—a savings of $133.96—and pay off her debt in just 22 months.

 

Step 5: Pay off the credit card with the highest interest rate first.

If Sarah had a total card balance of just $1,000, she would be in pretty good shape. But she got a second card to collect airline miles, and the interest rate is higher by three percentage points. On the same $1,000 balance, with the same $30 minimum payment, it would require an extra four months to pay off the second card with a total interest charge of $513.97. Therefore, Sarah will save money in the long run if she pays off the card with the higher interest rate first.

 

Step 6: Pay off credit cards and short-term debt before paying off the home mortgage.

Two years ago Sarah received a small inheritance of $5,000. She used $2,000 to take a trip and used the remaining $3,000 to help pay down her mortgage. Unfortunately for Sarah, she would have been better off using that money to pay off the balance on her credit cards.

This might seem counterintuitive. A home mortgage is the largest debt most of us will incur in our lifetimes. Wouldn’t paying it off first be the wisest way to rein in debt? Not necessarily. Remember, avoiding debt involves effectively managing all of your financial assets. That includes tax deductions, and interest on short-term debt is not tax-deductible but interest on mortgages is.

 

Step 7: Resist the temptation to use home equity or assets in a 401(k) plan to pay off credit cards.

If Sarah follows steps 1 through 6, this ought to be a moot point. We’ve included it as a point of emphasis. Sarah needs to think of her home and her 401(k) plan assets as protection from risk, not as sources of funding for debt. If she ever reaches a point where she is even thinking of using them to pay off debts, that is a clear indicator that it is time for her to reevaluate her income/spending balance.

 

Step 8: Do not let credit card payments detract from personal and retirement savings.

Again, avoiding debt means staying within a budget. Thanks to Voya’s Home Budget & Savings Calculator, Sarah realized that trimming her credit card debt was the shortest route to staying within her monthly budget.

Now she has to get into the habit of funneling those savings into her retirement plan, which will also reduce her tax payments. As Sarah has learned, her financial well-being isn’t just a matter of what she makes—it’s about limiting what others take.

Sarah no longer panics about occasional short-term debt. Now that she has a more thorough understanding of her finances, including a viable plan for managing debt while continuing to save, she’s on track to a secure future.

Sarah should also consider whether her employer offers matching contribution on employee salary deferrals when she determines how much to contribute to her 401(k) plan.

 

Please read the Program Annual Disclosure Document (April 2018) carefully before investing. This Disclosure Document contains important information about the Program and investment options. For email inquiries, use: contactus@abaretirement.com.

Securities offered through Voya Financial Partners, LLC (member SIPC).

Voya Financial Partners is a member of the Voya family of companies (“Voya”). Voya and ABA Retirement Funds are separate, unaffiliated entities, and not responsible for one another’s products and services.

Managing your retirement savings through life’s transitions

As people grow through life, change is inevitable. And as we move through life’s stages we face change. Transitioning through these life stages can be challenging to manage, but can also bring great opportunities for growth when you make good choices. Focusing on things you can control during the changing stages of life is important. And one of the most important things you can control and maintain through life transitions is your retirement savings.

So how should we go about addressing retirement security through life transitions?

First and foremost we need to understand that life is not lived in a straight path. Retirement security is a journey that must adapt to the changing needs of each law professional through each of life’s stages. The various life stages include early working career, accumulation, pre-retirement, at retirement and in retirement.

Managing retirement savings through life transitions

Let’s discuss the transitions in between and during life’s stages that all of us must pass through. During these transitions, we may be landing our first job, changing jobs, starting our own firm, looking at diversifying our portfolio to plan better for retirement, or find ourselves making the leap into retirement. It is important to understand that throughout these transitions, we must keep a focus on our retirement savings.

There are a few different options for managing our retirement savings throughout life’s transitional periods:

  1. Leave your money behind in a former employer’s plan: Your money stays put where it is as long as you have over $5,000 in your plan. No paperwork is involved at this point, your money will stay tax-deferred and you can stay invested in the plan’s investment options.
  2. Roll your money over into your new employer’s plan: If you’ve moved to a new job and are eligible for the new employer sponsored retirement plan, you may be able to roll your old account into the new one. This option reduces the number of accounts you need to track and manage.
  3. Roll your money into an IRA: Roll the money you currently have in your employer plan into what’s called a “rollover IRA.” With this option your account will continue to grow tax-deferred and you can continue making contributions, up to IRS limits, each year.
  4. Take a lump-sum distribution: Taking your money out of your employer plan as a lump sum payment is an option, but it’s important to understand that you won’t get all of the money in your account because of tax withholding and possible early withdrawal penalties if you are under age 59½.

 

Guiding principles for saving regardless of life stage

Now that we’ve outlined the different life stages, and discussed the various pros and cons to the different methods of moving your money around during transitions, we will leave you with some guiding principles we like to follow when it comes to saving for retirement. Follow these simple steps and you will be on your way to a more secure retirement.

  1. Reframe your brain: Don’t think of saving in your retirement plan as a luxury or something you can start later. Consider it a requirement of moving into the legal profession.
  2. Find your balance: Paying off debt is likely your priority. Fine. But that doesn’t mean you can’t find a balance with saving as well. Much of the success you’ll have as a saver is behavioral. You just have to do it. Find a way to start early, even if it’s a small amount.
  3. Use your autopilot: If your retirement plan offers an automatic escalation feature, use it! Before you know it, you’ll be saving more than you thought possible.
  4. Find your match: If your employer offers a contribution match, try to maximize it. Don’t leave valuable money on the table.
  5. Give your savings a raise: Commit to allocating some percentage of your pay increases – should you be so lucky! – to your retirement savings. Say you’re getting $200 more per pay check – commit $50 of it to your retirement account.
  6. Don’t give up: Some unexpected thing is going to happen … it always does. It’s okay to reduce what you’ve committed to saving for retirement, but never stop. If you stop, inertia sets in and it becomes very difficult to start again.

 

Press inquiries:
Christine Hotwagner
Program Operations Director
ABA Retirement Funds
JoinUs@ABARetirement.com

Find out what makes savers tick

Generally speaking, it doesn’t require much convincing to have someone agree that saving for retirement is a smart thing to do. And yet, browse through any article about saving for retirement or listen in on discussions taking place in Washington, D.C., today and you’ll likely hear questions like these: Why do nearly 3 in 4 small companies choose not to sponsor a retirement plan? Why do nearly a quarter of people with access to voluntary retirement plans choose not to invest in them? Why do so many people seemingly ignore the potential benefits of time and compounding, and procrastinate when it comes to joining their plan?

Many of these answers reside in one of the three key elements of retirement readiness: Access, Ability, and Willingness. These elements account for much of what happens – or doesn’t happen – when it comes to saving for something that’s way off into the future like retirement.

Access with ease, please!

Access has to do with whether or not some type of savings vehicle is accessible to you, and with what ease. Industry studies have shown that when a 401(k) plan is available to employees, the majority take advantage of it and join the plan. But for those who work for companies that choose not to sponsor a retirement plan, most fail to establish one on their own. There are, after all, products such as individual retirement accounts (also known as IRAs), available to those who wish – on their own account – to save for retirement. Yet, few open and contribute regularly to an IRA.

Needless to say, access – through your employer – is one of the key elements of retirement readiness. But here’s the rub. Small companies, who employ an important share of the American workforce, tend to choose against sponsoring a retirement plan. As a matter of fact, based on Social Security Administration data,1 only 28% of companies with fewer than ten employees sponsor a retirement plan. The reasons are varied and range from the perception of high cost to administrative burden. Lack of access can be even more problematic in the legal community because 9 out of 10 lawyers are in firms with fewer than ten attorneys.2 Extrapolating the information from the market at large, this would indicate that the propensity for law firms to be small means there may be lack of access to retirement vehicles such as 401(k)s, for many lawyers.

Law firms of all sizes need to acknowledge that a retirement plan is a benefit valued by its employees. Industry data shows that 55 percent of employees working for small companies want a retirement plan. Giving employees what they want is an important way of retaining talent and attracting new ones.

Able Wallets

Ability pertains to an individual’s discretionary income and whether or not they have the ability to save in the first place. It is fair to recognize that some Americans simply do not have income left to save after meeting life’s necessities – rent, food, gas, debt repayment. But many do, or could with a little budgeting and planning. The nationwide median household income in the US is $56,516.3 When it comes to lawyers, the median income rises to $139,880.4 Certainly there’s a difference in frame of reference between these two groups but arguably neither is without the ability to save.

The choices we make, the things we spend money on, directly impact our ability to put money aside for the long-term. You may have heard of the $115,000 coffee habit, where a three-times-per-week $5 latte habit could have turned into more than $115,000 if invested over a 40-year period.5

Whether you’re a firm administrator, a paralegal, or a lawyer, there are opportunities to save money. One of the beauties of tax-deferred savings vehicles like 401(k)s is that they are deducted from payroll before the money gets in your hands. This helps tremendously to automate what you may lack in discipline. But you still have to take action, join the plan, and elect a deferral amount, which brings us to our last key element of retirement readiness.

The human willingness to believe precedes their ability to think

Even with access and the means available, many still don’t save for retirement. The final element of retirement readiness is willingness. Willingness is often tied to basic human behavior and is at the root cause of the lack of retirement preparedness for so many Americans. The investment community is realizing what advertisers have known since the dawn of advertising – that emotion drives action (and sometimes inaction). Understanding how emotions and psychology affect investment decisions lies in a relatively new field of study called behavioral finance, which combines psychology and finance economics. Here are a few examples:

One human predisposition is to perceive the “pain” of an immediate loss or sacrifice to be stronger than the perceived “benefits” of a conceptual, long-term gain. The perceived pain of giving up our $5 latte today is stronger that the potential benefits of saving that money over a 30 or 40 year career. This behavioral tendency is called hyperbolic discounting and is especially damaging for people struggling between the enjoyments of spending their money now on something they want versus potentially greater benefits later once they reach retirement.

In addition to discounting future gains for near term benefits, humans also have an aversion to loss. Studies show that the pain individuals feel when they lose cash is twice as strong as the joy they feel when they gain an item of equal value. This behavior is a leading cause to poor investment timing decisions – sell low to minimize losses and buy high to join in on the euphoria.

Fear or loss can magnify the effect of familiarity bias. What’s familiar can seem comfortable and safe. Our past experience is a powerful navigational system for our future actions. The net result can lead to inferior asset allocation, preferences for local stocks or industry and professional proximity – lawyer investing in legal services stocks for example.

A myriad of emotional biases and natural tendencies challenge our best efforts to be rational thinkers. This often leads to paralysis, inaction, or poor decision making when it comes to saving for retirement. The good news is that the more we know about these behaviors the more we can prevent them through product design, education, and choice architecture. Automatic enrollment, target date funds, negative election, and Gamification are just a few of the relatively recent developments that help offset poor behavioral tendencies and boost willingness.

As we all march toward a common goal – to reach a safe and secure retirement – we need to acknowledge those three key elements. Employers, irrespective of their size, need to recognize the value a qualified retirement plan can bring to its employees and provide better access. Workers, irrespective of their income, need to commit to saving early and maintain that commitment through thick and thin to the best of their abilities. And savers, irrespective of their biases and tendencies, need to leverage the tools available to them and follow through on their willingness to save for retirement. Leveraging these key elements – access, ability, and willingness – will likely help you improve your retirement readiness.

 

SOURCES

  1. Retirement Plan Coverage by Firm Size: An Update, by Irena Dushi, Howard M. Iams, and Jules Lichtenstein, Social Security Bulletin, Vol. 75, No. 2, 2015
  2. The Lawyer Statistical Report, American Bar Foundation, 2012 Edition
  3. S. Census Bureau, 2016 Current Population Survey Annual Social and Economic Supplements
  4. Bureau of Labor Statistics, 2016
  5. This hypothetical scenario is not intended to reflect the performance of any particular investment. It reflects the growth of an investment of $60 per month for 40 years, at 6% average annual return. If the investment were made in a tax-deferred vehicle such as an employer’s 401(k), 403(b), or 457 plan, taxes would be due upon withdrawal at the investor’s current rate.

 

Press inquiries: Christine Hotwagner
Director, Program Operations
ABA Retirement Funds
JoinUs@ABARetirement.com

The Value of Financial Advice

You’ve probably heard the phrase “hope is not a strategy.” The definition of hope is “to want something to happen or to think that it could happen” (Merriam-Webster). When it comes to saving for a financially secure retirement, many statistics would suggest that we rely more on hope than we do on strategy. We hope Social Security will be around. We hope we won’t lose our jobs. We hope we’ll be able to pay off our debts. We hope we’ll stay healthy forever. We often get consumed by the things we need to pay for today – instead of focusing on ways we can save for our longer term future. While we may hope that things will take care of themselves when it comes to money matters, the reality is that there is simply no substitute for long-term planning. Sadly, only 31% of financial decision-makers in families say they have created a comprehensive financial plan.1 This statistic suggests that more than two in three Americans will be left with nothing but hope to provide for a safe and secure retirement. If you’re one of them, know that when it comes to creating your retirement plan, hiring a financial advisor may be the first step you need to take in order to turn hope into strategy.

A Voya study shows that working with an advisor significantly increases the likelihood that an individual will have more saved for retirement within and outside of employer-sponsored retirement plans. Those who use an advisor have, on average, saved 56% more money for retirement than those who do not work with an advisor.2

All charts from Voya Retirement Research Institute (2015). Advisor Value

 

Retirement Unplanned

Retirement planning is not all about putting a certain percentage of your paycheck into your Company’s 401(k), while making sure you put in the amount your Company will match. That is a start – a good and necessary start – but it just isn’t enough. There are many other financial uncertainties that come up along the way, and you need to be prepared for the unexpected. According to a 2012 Retirement Confidence Survey by the Employee Benefit Research Institute, “half of current retirees surveyed say they left the workforce unexpectedly due to health problems, disability, or changes at their employer, such as downsizing or closure.”3 Also, older consumers are carrying more debt, including mortgage, credit card, and even student loan debt, into their retirement years than in previous decades. With a sound financial plan in place, unexpected issues beyond your control don’t have to cause sleepless nights.

 

Less Health, More Care

Estimating the future cost of healthcare is a common oversight when planning for retirement. A Society of Actuaries survey in 2012 showed that only about half of all people who retire do so by choice. Thirty-one percent retire due to health issues, either their own or that of a loved one.5 It is important that you properly estimate the potential financial need for increased health care as you age – a task you may find much easier completed with the help of a knowledgeable advisor.

 

The Cost of Living…In Debt

Many people are buying homes later in life, or taking out home equity loans in order to maintain quality of life. A Census Bureau survey shows that fewer older homeowners own their home outright compared to a decade ago, and the mortgages they hold have less home equity than a decade ago.6 Consumer debt is still high as well. The Employee Benefit Research Institute has stated that one in two families headed by a person 55-64 had a credit card debt in 2007, compared with about one in three in 1992.7 Debt, especially as you near and enter retirement, can eat away at your savings or, worse, hinder your ability to save altogether. The balancing act of meeting your borrowing needs while growing your nest egg is one best performed with the help of a financial advisor who can help set a sensible budget and align financial priorities for you.

 

The Benefits of Financial Advice

Few people would dispute that seeking advice from a medical professional could pave the way to good long-term health. Seeking advice from a financial professional – much like seeking advice from your doctor – can put you on a path to better financial health. Life expectancy tables tell us the good news is that we are living longer. The bad news is that most of us haven’t saved nearly enough to fund a longer retirement. It is estimated that more than half (52%) of Americans have less than $10,000 saved for retirement while life expectancy is 78.5 years – more than 10 years into retirement.8 Professional financial advice could provide the planning necessary to help safeguard against outliving your savings. People who work with financial advisors tend to save more for retirement, and generally have more confidence in their financial well-being.2 The bottom line is – picking up your financial prescription may lead to better retirement outcomes.

 

Increased Confidence in the Future

The study by Voya shows that use of an advisor can increase feelings of control and confidence in understanding how to pursue one’s retirement goals.2 It seems logical after all. Imagine you’ve spent time with an expert, discussing your goals, listening to him or her explain options in an easy-to-understand way. That advice has made you more knowledgeable and given you greater confidence about achieving your goals. It eliminates the guesswork and speculation, leaving you less worried than if you had to do it all on your own. People who don’t use an advisor are more likely to be risk-averse, which increases the risk that they will fail to capture market growth in their early savings years. The Voya study found that 39% of people who choose to invest without the guidance of an advisor characterize themselves as “conservative” investors, vs. only 19% of advisor-assisted individuals.2 This means you are more likely to stay with investments you deem as safe, while missing out on potential market growth that could help you achieve your financial goals.

 

A Better Understanding of Needs

Most people who plan for retirement only plan for their ideal scenario – retiring healthy, purchasing a second home, planned vacations and travel to see the grandkids. But the reality is sometimes quite different from the dream. A financial advisor can help you map out your needs, no matter which retirement scenario unfolds. An advisor can also inject a dose of reality when it may be needed and quickly correct your savings path so you can more adequately meet future needs. Understanding your expected and unforeseen needs is at the heart of a good financial plan. An advisor can build and maintain that blueprint for you as life’s unexpected events take shape. People who use an advisor are also much more likely to have a formal retirement investment plan in place. Fifty-two percent of the people surveyed for the Voya study who use a financial advisor have a formal retirement investment plan in place, versus only 20% of those who go it alone.2

 

Increased Savings

People who seek out help from a financial advisor have better savings habits, which may include multiple savings accounts or an emergency fund more appropriate to their specific needs. According to the Voya study, people who work with an advisor are significantly more likely to have an emergency fund, and to have more saved in it than those who don’t work with an advisor. Almost half of the people who seek out a financial advisor have an emergency fund equal to six months or more of their salary, while only 28% of those without the use of an advisor had the same.2 People who work with an advisor are also twice as likely to have a workplace retirement account balance of $200,000 or more.2

 

Better Diversification and More Balanced Allocation

Personal experience is a powerful navigational system for future actions, whether or not that experience is logical. This preference for the familiar, referred to as familiarity bias,9 leads us to the faulty assumption that just because we’re familiar with something, it must be safe. When we allocate investments based on this familiarity bias, it can lead to poor diversification – an integral element of a balanced financial plan. A financial advisor can bring experience, knowledge, and a better understanding of investing, that can help you to a better diversified portfolio that fits your unique situation.

A Better View of the Future

Your vision for retirement is just that – yours. A financial advisor can help make that vision a reality. We all go through life relying on the advice of experts. That’s the beauty of living in a society where specialization can lead to improved standards of living. So why won’t more Americans work with a financial advisor to help improve their retirement picture? Today, advice and guidance are available in many shapes and forms, often in conjunction with a workplace retirement plan. These services can range from professionally managed accounts via Target Date Funds to holistic Managed Account guidance, and full-service on-line, phone-based, or in- person financial planning. There is likely a “flavor” of advice for nearly everyone. The challenge is getting more people to the table to have a taste.

Financial planning is a complex field where decisions are fraught with behavioral pitfalls. An advisor can use proven methods and expertise to develop a personalized retirement plan based on your needs, wants and wishes. When it comes to long-term planning, hope is not a strategy – but a sound financial plan developed with the help of an advisor should certainly give us hope for a secure and comfortable retirement.

 

SOURCES

  1. Princeton Survey Research Associates International (July 23, 2012). 2012 Household Financial Planning Survey
  2. Voya Retirement Research Institute (2015). Advisor Value, A Voya Retirement Research Institute® Study quantifies the benefits of working with a financial advisor.
  3. Employee Benefit Research Institute (EBRI) (2012a). The 2012 Retirement confidence Survey, by Ruth Helman, Mathew Greenwald & Associates; and Craig Copeland and Jack VanDerhei, EBRI. No. 369
  4. Federal Reserve Board (2010). 2010 Survey of Consumer Finances.
  5. Society of Actuaries (2012). 2011 Risks and Process of Retirement Survey Report of Findings, by Mathew Greenwald & Associates, Inc. and EBRI.
  6. Census Bureau, (2011). Complete Set of Tables: Table C-14A-OO Mortgage Characteristics – Owner Occupied Units.
  7. Employee Benefit Research Institute (EBRI) (2009). Debt of the Elderly and Near Elderly, 1992-2007. EBRI 20 (10) 24pp.
  8. Employee Benefit Research Institute (EBRI) (2014). The 2014 Retirement Confidence Survey, by Ruth Helman, Matthew Greenwald & Associates; and Nevin Adams, Craig Copeland and Jack VanDerhei, EBRI. No. 397
  9. The New York Times (November 22, 2010). “Avoid the Investing Trap of Familiarity,” by Carl Richards, CFP.

 

Press inquiries: Christine Hotwagner
Director, Program Operations
ABA Retirement Funds
JoinUs@ABARetirement.com

Your generation’s retirement: Unique challenges, common concerns

Hip hop or classic rock? Apps or newsprint?

In a whole host of ways, each generation tends to look at life a little differently. In much the same way, when it comes to retirement planning, different stages of life present very different viewpoints and challenges.

Generally speaking, there are about 6 generations living in America today. Of these, about 3 or 4 are active in the workplace starting with the Millennial Generation (ages 14-34). Generation X (ages 35-49) is next and the influential Baby Boom generation (50-64) is at the tail end pondering what will be its next steps in life.

When it comes to saving for retirement, the older generation is likely striving to maximize their savings during those remaining working years. But if you’re a younger worker, in today’s economy, your challenge may be finding the extra cash – and the discipline – to begin investing for a future need that’s still a long way off. But for younger workers, building your own savings is more crucial than ever. According to Voya Retirement Research Institute’s report called “Retirement Across the Ages,” nearly half of workers over age 50 today can count on pension savings of some kind. However, only about 27% of younger workers expect to do so. The availability of a traditional pension certainly impacts a worker’s perception of retirement security and whether or not they choose to save in a voluntary retirement account like a 401(k).

While each generation faces distinct challenges, they also share some troubling similarities. Namely, the Voya Retirement Research Institute report notes that most workers “regardless of age, feel that at least something gets in the way of their ability to save for retirement.”

What Gets in the Way of Saving?

Voya Retirement Research Institute® Report (2015). Retirement across the ages

From too little income to too much debt, these obstacles affect all the generations to varying degrees – and most workers are simply not saving enough to ensure a secure retirement. This is why, regardless of your age or which generational cohort you belong to, there are simple steps you can begin to take today to help your chances of reaching a comfortable and secure retirement.

Here are some tips to help you prepare for retirement depending what generation you’re part of.

Generation Y (Roughly to age 34)

  • If your employer offers a retirement plan and you’re eligible to participate, sign up. Signing up is the hardest part.
  • Begin saving as early as possible, to put time and the power of compounding on your side.
  • Develop good financial habits – and make saving part of your monthly budget, just like housing or food. There’s a way to balance paying off school debt and beginning to save for the long term. It’s all about committing to it. Start now, even if it’s small, but start.

Generation X (About ages 35-49)

  • As you get better footing in your career and your income increases, so should the amount you save every year. Commit a portion of your pay raise to saving. Say your raise means you’re getting an additional $2,000 per year. Save $250 or $500 of it by adjusting your 401(k) contributions so the money goes directly into your retirement savings account.
  • Stay focused; don’t let major expenses such as home buying and college costs distract you from your long-term goals. Save for these other things separate from your retirement savings. If you can’t pay for major expenses without making sacrifices elsewhere, then temporarily reduce what you’re saving for retirement but don’t stop completely. It’s like running. If you stop completely it’s much harder to start again. Simply slow down until you’re ready to pick it up again. Maybe look to use an automatic deferral increase feature if it’s available in your plan.

Baby Boomers (About ages 50-64)

  • As your children leave the nest and your mortgage is paid down, put that extra money toward your retirement. At this point in life, there’s probably no better place for it!
  • Consider taking advantage of catch-up contributions to ramp up your savings even more. The closer you get to retirement, the better idea you’ll have about how ready you are financially. And for most of us, there’s usually some catch-up involved at that point. Take advantage of what the tax code allows you to do and put more tax-deferred dollars toward your retirement.

Even though the year you were born says a lot about what your retirement saving challenges are, what the next best steps might be for you, or how you feel about saving and retirement in general, one thing doesn’t change. The sooner you take action, begin to save, and keep up with your plan the better you will likely be when you reach retirement. While savers from different generations may not agree on musical styles or how to keep up with the news, there’s one thing we can all agree on – that is our desire to achieve a safe and secure retirement.

 

Press inquiries: Christine Hotwagner
Director, Program Operations
ABA Retirement Funds
JoinUs@ABARetirement.com

Three-step approach to reducing your tax bill and saving more for retirement

We’ve all heard that old adage that the only certain things in life are death and taxes. Gallows humor aside, paying more than you have to in income taxes is not entirely inevitable. We discuss three common ways to help temper your annual tax burden so that you can save more for your retirement.

1. Contribute to a 401(k) Plan

If you participate in a 401(k) plan, one of the advantages is that your payroll contributions may lower your taxable income, either now or in the future. As you may already know, there are a few methods by which to contribute to your retirement plan: on a pre-tax basis, an after-tax basis, or a combination of both.

In a traditional 401(k) plan arrangement, your contributions are taken out of your salary on a pre-tax basis—that is, you contribute to your retirement savings before state and federal governments take their share of the rest. Your contributions then grow tax-deferred, which means you don’t pay taxes on them until you withdraw money from your account, typically in retirement.

The tax benefit of making a traditional pre-tax contribution is the reduction of your taxable income today. This may be advantageous to a saver that is currently in his peak earnings or highest tax bracket years. At retirement, you may be earning less money, and therefore be taxed at a lower rate than  you would be today. The challenge is that salaries and tax codes are not set in stone, and there’s no way to predict what these will be for you—or how your investments will perform until you retire.

Another tax-advantaged option to funding a 401(k) plan is by electing an after-tax choice, such as Roth. Roth 401(k) contributions allow a participant to defer his tax payments to retirement. While you will get no deduction up front, your money can be saved year over year in a tax deferred account and when you reach retirement you can withdraw your contributions and earnings tax-free. There are a few conditions to this, however: withdrawals generally must be made after you’ve reached age 59½ and you must have had your Roth 401(k) account for at least five years.

Choosing Roth 401(k) may be advantageous to a saver at the beginning of his career, for those making a relatively modest salary, or for those expected to make significantly more in the future. These savers may benefit from having a lower tax bracket today paying taxes now. In addition your plan investments may grow over the course of your working years which would also be tax free at retirement. While this may seem like an attractive option to many, it’s important to consider the Roth rules. If you want to withdraw your savings before the five-year holding period, or before you attain age 59½, you may be taxed and penalized. Additionally, future investment performance, salary levels and tax brackets are not predictable.

Combining pre-tax and after-tax contributions is a potential third option that could maximize the benefits of each choice for certain periods of time. If you have a pre-tax rollover 401(k) where you’ve consolidated traditional accounts from previous employers, you may choose to utilize a Roth contribution going forward to diversify your tax position. Again, it is always recommended that you seek the advice of a tax professional to determine the savings method that is best for your personal situation.

2. Use Tax Deductions and Credits

Tax deductions and credits can be used together to lower your overall tax burden. They are used differently.

First, tax deductions lower your taxable income, thereby reducing the amount of money you’re taxed by the government. You may be able to deduct from your taxable income:

  • Medical expenses, to the extent they exceed 7.5% of your income;
  • Homeowner deductions for mortgage interest and property tax bills;
  • Business or personal expenses such as the costs involved in running a side or home business; or
  • Charitable donations.

In general, the following items may be used as a tax credit. The amount of the tax credit is applied to your tax bill to lower it:

  • Child tax credits for children under 17, if you do not exceed adjusted gross income limits;
  • Education credits for your children or yourself if you meet “qualified student” guidelines and do not exceed adjusted gross income limits;
  • Child and Dependent Care Credit for children or adult dependents if you do not exceed adjusted gross income limits; and
  • Energy-saving credit for efficient furnaces, water heaters, air conditioners and solar panels in your principal residence.

As the rules and credit amounts change from year to year, you should discuss these issues with a tax attorney or accountant.

3. Choose the Proper Withholding

Getting a significant refund back on your taxes may mean you’re having too much withheld from each paycheck, essentially giving the government a free loan on your money. Sure, it’s nice to have no tax liability, but this is also money you could have used to invest in your future. Decreasing your tax withholding is an easy way to increase your contribution to your 401(k) plan by a percentage or two. It’s money you’re already not using or spending. In fact, you may be surprised how saving just 1% more could positively impact your retirement savings over a long period of time.

While this three-step approach may prove beneficial to most, you should always consider your specific situation and seek personalized guidance on this complex topic by consulting with your tax professional.

 

Press inquiries: Christine Hotwagner
Director, Program Operations
ABA Retirement Funds
JoinUs@ABARetirement.com

Should You Crack Your Nest Egg?

Most people agree that cracking your nest egg before you reach retirement age should be considered an option of last resort. But when life throws something unexpected at you—the loss of a job, an illness, or another need to pay for a large expense—you may find yourself looking at borrowing from your retirement savings to meet that need.

You will first need to confirm what options are available to you in your retirement plan. Some options may include early retirement withdrawals, hardship withdrawals and loans. If you have a withdrawal option available in your plan and you understand the potential tax consequences of taking the withdrawal, that might be the right option for you. For those who just need some short term help, a loan might be a more desirable option.

While there are benefits to borrowing from your retirement savings, there are some drawbacks, too. Because there are numerous implications to consider with a retirement plan loan, you should discuss this option with your tax advisor before you consider borrowing from your account.

Beware of the IRS Tax Impact

In regard to retirement savings, the IRS draws a clear line between “borrowing” and “withdrawing.” So a loan from your plan account may involve significant tax consequences if it is not paid back in full by its due date.

If you fail to meet the loan repayment requirements, the IRS will consider the loan a withdrawal, which will be subject to income tax. In addition, you may be assessed a 10% premature distribution penalty tax if you are younger than age 59½.

 

Weigh Your Options Carefully

Borrowing from your plan account may provide you with lower interest rates and loan fees than you could get from a lender, depending on your credit score. Plus, the interest you pay on your loan goes back into your account, so you’re essentially paying yourself. However, these advantages may not be enough to offset the lost opportunity of long-term growth your nest egg might enjoy if it were left untouched. Also, many plan participants either stop contributing to their 401(k) or reduce their contribution for the duration of their loan, so they also miss out on the employer match.

Interest and Taxes

PROS

• Interest rates are Prime Rate + 1%.
• The interest you pay goes back into your account.

CONS

• Those with a solid credit rating might get a better interest rate on other types of loans besides the 401(k).
• You’re repaying the loan with after-tax dollars, and those dollars will be taxed again when you withdraw them.

Repayment

• You usually must pay back the loan within five years, although an exception is made if a loan is used to purchase a primary home.

• If you leave your job for any reason, the balance of the loan will become due within 60 days. If you can’t repay it, the IRS will consider the unpaid amount a withdrawal, subject to penalties and taxes.
• Repayments are taken from your net pay (after-tax earnings), so your take-home earnings will be lower.

Borrowing Limits

• The maximum loan balance can be up to 50% of your vested balance but not more than $50,000 (this limit is inclusive of all qualified retirement plans in which you participate).

• Minimum loan amount is usually $1,000.

What Borrowing Could Cost You

This hypothetical example* illustrates how taking a loan from your retirement savings may negatively affect your account balance in the long run even when you continue making contributions and especially if you suspend making contributions:

No Loan

Loan Taken and Contributions Continued

Loan Taken and Contributions Suspended

Account Balance After 30-year Period

$394,652

$393,693

$276,483

Impact on Account Balance

None

($959)

($118,169)

* This illustration is hypothetical and for illustrative purposes only. It assumes a $40,000 salary (with a 3% annual salary increase), an ongoing savings plan contribution rate of 10%, 5% annual investment return in the savings plan and the impact of a ten-year loan of $10,000 (with a 4% interest rate) taken after 15 years of saving. The account will be taxable upon distribution in retirement.

The biggest pitfall is if the loan isn't repaid according to the loan terms. If the loan isn't repaid, it's considered a "deemed distribution" of the unpaid loan balance. That means that you now have additional taxable income in the year that the loan was unpaid, although you might have taken the actual cash months or years earlier.

If you're under age 59½, that deemed distribution will be considered "early" and will also be subject to the 10% premature distribution penalty tax. Since you've likely already spent the money sometime in the past when you took the loan, you may not have the funds to pay the taxes.

While the loan feature can be a convenient benefit at certain times in your life, you may want to make sure you have a complete understanding of the full impact of taking a loan from your account.

 

Press inquiries: Christine Hotwagner
Director, Program Operations
ABA Retirement Funds
JoinUs@ABARetirement.com

411 for your 401(k)

As consumers around the country prepare for the end of summer, many are getting organized for back to school season. This is also an opportune time to make a checklist to clean up your financial house and conduct an annual review of your 401(k) plan so that you are taking advantage of all the benefits it can offer.

If you are like most working Americans, your 401(k) plan is the cornerstone of your retirement savings. Following the below tips can help you be ready to retire with the dignity and financial security you expect and deserve.

Tip #1: Establish a Retirement Plan for Your Firm

If you’re a small firm owner or partners, and don’t sponsor a retirement plan for yourself and your employees, you should strongly consider it. Nine out of 10 lawyers (90%) work for firms that have fewer than 10 attorneys. The preponderance of small firms is a distinct characteristic of the legal community. Unfortunately, this also means that an employee’s access to a retirement savings vehicle such as a 401(k) may be limited. A 2011 survey conducted by the Employee Benefit Research Institute estimates that access to an employer-sponsored retirement plan is lower with smaller employers. As a matter of fact, only 17.3% of companies with fewer than 10 employees sponsor a retirement plan. The first step to meeting your retirement needs is having access to a plan. It’s also a great way to attract and retain talented employees. If you’re not sponsoring a plan today, think about establishing one.

Tip #2: Enroll in your Plan

If you haven’t yet enrolled in your 401(k) plan, make it a point to do so now. People are living longer now than ever before. According to a 2011 report by the U.S. Census Bureau, the U.S. is projected to have nine million people above the age of 90 by 2050—this is up from 1.9 million in 2010 … and 720,000 in 1980. This means our nation's 90-and-older population has nearly tripled over the past three decades … and is projected to quadruple over the next four decades. These longer life spans, coupled with spiraling healthcare costs, the uncertain future of Social Security and the decline of public pensions mean individuals are increasingly responsible for funding their own retirement. Contributing to a 401(k) plan can put you on the right track to be able to fund your retirement years. The money you contribute is tax-deferred from both federal and state income taxes, which means you don’t pay taxes on the contributions until you withdraw the funds, typically at retirement age. For example, if you are in the 28% tax bracket and you invest $5,000 a year, that’s $5,000 of your salary on which you are not paying taxes. This reduces your annual tax bill on that $5,000 by nearly one-third—$1,400 ($5,000 x .28). Furthermore, contributions to the plan are deducted automatically from your paycheck, making the process seamless for you. By contributing even a small amount on a regular basis, you can build substantial wealth over the long-term. Even just one or two percent can make a big difference.

If you’re unsure about how much you should contribute, take advantage of the many helpful online tools and resources available to you, such as Voya’s MyOrangeMoney (Voya.com). These tools offer an easy way for you to determine how much you need to save to reach your retirement income goal, and how different contribution rates will impact your retirement savings.

Tip #3: Leverage Both Pre-tax and Post-tax Contributions

If your plan allows for both traditional pre-tax and after-tax (Roth) contributions, evaluate which is a better option with your individual situation. You also have the option to split the deferral types. While pre-tax contributions allow you to contribute to the plan on a pre-tax basis, Roth contributions allow you the opportunity to grow these contributions tax-free. This is a valuable feature if you believe your taxes will be higher when you retire, since you will pay taxes on the contributions now based on a lower tax bracket and pay no taxes on the earnings when you retire.

Tip #4: Take Advantage of Matching Contributions

If your employer offers a company match, take advantage of it! This is a valuable benefit where your employer will match your contributions—typically capped at a percentage of your pay. For example, a company may offer a dollar-for-dollar match up to 3% of pay, or a 50% match up to 6% of pay. Find out what your employer will match and, at the very least, contribute enough to take advantage of the match.

Tip #5: Make Catch-up Contributions

If you are age 50 or older (or will be by the end of the calendar year) and your plan allows, take advantage of the “catch-up” provision. Legislation has made it easier for you to save more for your retirement with the permanence of the “catch-up” provision outlined in the Pension Protection Act of 2006. In addition to the general deferral limit of $18,000 for 2017, you can contribute an additional $6,000 for a total of $24,000. This means if you are 50 years old this year and haven’t started saving for retirement, you can contribute as much as $225,000 over the next ten years—tax-deferred—to your 401(k) plan. When you consider the potential of compound earnings, this can add up to significant savings.

Tip #6: Keep your Savings Working for You  

Even if the plan allows you to borrow from your plan, think twice before doing so. While it may sound appealing, borrowing from your 401(k) reduces the benefit of tax-free compounding that is the key to building up savings. Although sometimes unavoidable, before you make the decision to take a loan, there a few considerations to take into account:

  • You will pay interest on the loan with after-tax dollars, thereby losing the tax advantage.
  • You will pay taxes a second time when you eventually withdraw the money in retirement.
  • Interest on the loan is not tax-deductible, even if funds are used for a home purchase.
  • Most loans must be paid back within five years, but if you leave your job, the loan must be paid back in full immediately or the amount becomes a taxable withdrawal.

Tip #7: Invest for the Long Term 

Once you set your investment allocations, be patient. Predicting the market is not like predicting the weather. There are no high-tech gadgets or radar systems to predict the highs and lows that may lie ahead. It’s critical to remember that what is important is time in the market, not timing the market. Discipline yourself to maintain your allocation through down markets as well as up markets. Having a properly diversified portfolio will help make any market swing easier to digest. Conduct an annual review of your plan to confirm your allocations still align with your life stage and economic circumstances.

Tip #8: Consider Spending Time with a Financial Professional. 

Research1 suggests that those who spend time with a financial professional are saving more than their peers who do not, with greater investment knowledge and confidence in their ability to enjoy retirement. If you have never received help from a financial professional before, this is something to consider pursuing.

Information is power. Knowing how to take advantage of these simple—but important—tips can positively impact your ability to live comfortably in retirement.

 

1 Advisor Value, A Voya Retirement Research Institute® Study, 2015, www.VoyaRetirementResearchInstitute.com

------------------------------------------ 

Press inquiries: Christine Hotwagner

Program Operations Director ABA Retirement Funds JoinUs@ABARetirement.com

Retirement Planning for Lawyers

Here’s a big word for you from the world of behavioral finance – hyperbolic discounting. Hyperbolic discounting is a time-inconsistent model of discounting. Ok, that didn’t help much. Think of it this way – humans have a tendency to value short-term rewards over longer-term rewards, even when mathematically the rewards are worth the same. The farther away the reward, the more we tend to discount it.

How does it work? Assume someone has the choice between $20 now or $100 tomorrow. Most will wait a day and collect the $100 reward. But what if I were to offer you $20 now, or $100 a year from now? Turns out many people will opt for the $20 now, discounting the value of a larger reward because it is so far into the future. So expressed another way, hyperbolic discounting is a person’s desire for an immediate reward rather than a higher-value reward, at some point later.

Ok, let’s test your newly acquired knowledge. You have $650 left in your pockets and the new iPhone just came out. What do you value more, the new phone now, or the thousands of dollars your pocket money might grow to become by the time you retire 30 years from now?

Turns out you don’t have to be a lawyer to understand this concept, because it affects everyone the same. And that’s why law professionals, just like the rest of us living in today’s society, struggle to plan ahead and save adequately for retirement. So what can you do today to help ensure you’ll have what you need tomorrow?

So, first things first, if you are a firm owner, sole proprietor, or administrator in your practice, let’s talk about establishing a plan for your firm. Statistics have shown that people are much more likely to save for retirement if a 401(k) plan is available to them through the workplace. However, access to such plans has been a challenge when it comes to smaller employers, who typically choose not to sponsor a plan. Of all small employers – those with 10 or fewer workers – only 16.5% sponsor a retirement plan, according to an Employee Benefit Research Institute estimate. This is especially noteworthy in light of the fact that, according to the latest Statistical Report by the American Bar Foundation, 9 in 10 lawyers work for firms that have fewer than 10 attorneys. The propensity for law firms to be small means that having access to a workplace retirement plan is still a challenge today.

If you’re not already sponsoring a 401(k) plan and don’t know what to do, think about your key objectives. Do you want to minimize cost to your firm? Are you looking to attract and retain valuable employees? Or do you simply want to maximize tax advantaged benefits? Based on your key objectives, there may be several different retirement plan options that fit your needs. For example, if you are looking to minimize cost, a 401(k) or profit sharing plan might be the right fit. A safe harbor 401(k) or a cash balance plan can help to attract and retain employees. And if you are looking to maximize your tax benefits, you may want to look into a cross-tested plan or personal pension plan where the opportunity to save on a tax-deferred basis is much greater.

These are not necessarily easy questions to answer. If you find yourself struggling through the process, don’t worry. While there may not be an app for that, there are knowledgeable financial professionals who specialize in retirement plans. A qualified advisor or consultant can help you determine what’s best for you and your firm, explain how various retirement plans can deliver on those objectives you’re looking for, and even assist you in finding and evaluating suitable providers. You can even find online tools that can help orient your decision making when it comes to selecting the right retirement plan that fits your needs and the needs of your firm. Now that we’ve established a plan, let’s get back to the behavioral side of this equation. If you’ve read this far, you’re probably like most working Americans, and see your 401(k) plan as the cornerstone to your retirement savings. But if you’re not, and you believe you’ll never retire from practicing law, consider this: One in five retirees do not retire on the planned-for date due to illness or health issues. One of life’s realities is that with old age comes a variety of health concerns that may impact your ability and willingness to practice law. Law professionals are often forced into retirement due to ailments or health conditions.

The uncertainty about what your health has in store for you down the road is cause for planning. So whether you plan to retire or not, consider just a few simple tips that can help you be ready to retire with the dignity and financial security you expect and deserve.

 

Tip #1: Participate in your Plan

If you haven’t yet enrolled in your 401(k) plan, make it a point to do so now. People are living longer now than ever before. According to a report by the U.S. Census Bureau, the U.S. is projected to have 9 million people above the age of 90 by 2050 – this is up from 1.9 million in 2010 … and 720,000 in 1980. This means our nation’s 90-and-older population has nearly tripled over the past three decades … and is projected to quadruple over the next four decades. These longer life spans, coupled with spiraling healthcare costs, the uncertain future of Social Security, and the decline of public pensions, mean individuals are increasingly responsible for funding their own retirement.

Contributing to a 401(k) plan can put you on the right track to be able to fund your retirement years. The money you contribute is tax-deferred from both federal and state income taxes, which means you don’t pay taxes on the contributions until you withdraw the funds, typically at retirement age. Furthermore, contributions to the plan are deducted automatically from your paycheck, making the process seamless for you.

For law professionals this tip is especially important. The law profession is characterized by busy, time- consuming schedules with little time for planning outside of work. As a result, law professionals compulsively push off the decision to start saving. As inertia sets in, many people are left feeling as if their bank account was a ticking clock and too few years remain until retirement.

If you’re unsure about how to get started, take advantage of the many helpful online tools and resources available to you, such as Voya’s MyOrangeMoney (voya.com). These tools offer an easy way for you to determine how much you need to save to reach your retirement goals, and how different contribution rates will impact your retirement savings.

 

Tip #2: Take advantage of matching contributions

If your plan offers a company match, take advantage of it! This is a valuable benefit where your employer will match your contributions – typically capped at a percentage of your pay. For example, a company may offer a dollar-for-dollar match up to 3% of pay, or a 50% match up to 6% of pay. Find out what your employer will match and, at the very least, contribute enough to take advantage of the match.

Many law firms will offer generous matches and sometimes profit sharing plans where the employer has discretion to determine when and how much the company pays into the plan. The amount allocated to each individual account is usually based on the salary level of the employee.

 

Tip #3: Make catch-up contributions

If you are age 50 or older (or will be by the end of the calendar year) and your plan allows, take advantage of the “catch-up” provision. Legislation has made it easier for you to save more for your retirement with the permanence of the “catch-up” provision outlined in the Pension Protection Act of 2006. In addition to the general deferral limit of $18,000 for 2017, you can contribute an additional $6,000 for a total of $24,000. This means if you are 50 years old this year and haven’t started saving for retirement, you can contribute nearly as much as $250,000 over the next 10 years – tax-deferred – to your 401(k) plan. When you consider the potential of compound earnings, this can add up to significant savings.

 

Tip #4: Keep your savings working for you

Even if the plan allows you to borrow from your plan, think twice before doing so. While it may sound appealing, borrowing from your 401(k) reduces the benefit of tax-free compounding that is the key to building up savings. Although sometimes unavoidable, before you make the decision to take a loan, there a few considerations to take into account:

  • You will pay interest on the loan with after-tax dollars, thereby losing the tax advantage.
  • You will pay taxes a second time when you eventually withdraw the money in retirement.
  • Interest on the loan is not tax-deductible, even if funds are used for a home purchase.
  • Most loans must be paid back within five years, but if you leave your job, the loan must be paid back in full immediately or the amount becomes a taxable withdrawal.

 

Tip #5: Invest for the long term 

Once you set your investment allocations, be patient. Predicting the market is not like predicting the weather. There are no high-tech gadgets or radar systems to predict the highs and lows that may lie ahead. It’s critical to remember that what is important is time in the market, not timing the market. Discipline yourself to maintain your allocation through down markets as well as up markets. Having a properly diversified portfolio will help make any market swing easier to digest. Conduct an annual review of your plan to confirm your allocations still align with your life stage and economic circumstances.

 

Tip #6: Consider spending time with a financial professional 

According to Voya research,1 those who spend time with a financial professional are saving more than their peers who do not, with greater investment knowledge and confidence in their ability to enjoy retirement. If you have never received help from a financial professional before, this is something to consider pursuing.

Many things require planning – purchasing a new car, choosing a vacation destination, studying for the bar exam. So should retirement. As a law professional, time can be of the essence. And while the short-term benefit of working on billable hours now may seem greater than the longer-term benefits of saving for retirement, remember what you learned. The effort you put into planning your retirement today can positively impact your ability to live comfortably in retirement … even though your hyperbolic-discounting-mind is telling you otherwise.

 

1 Advisor Value, A Voya Retirement Research Institute® Study, 2015, www.VoyaRetirementResearchInstitute.com

 

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Press inquiries: Christine Hotwagner
Program Operations Director ABA Retirement Funds
joinus@abaretirement.com

Life is a zero-sum game – have you solved your save-spend balance?

A zero-sum game is a situation in which one person’s gain is equivalent to another’s loss, so the net change in wealth or benefit is zero. For example, let’s look at your typical Poker game. The first round of Poker begins with each player placing a specific amount of money into the center of the table (“the pot”) based on how competitive they think their hand is compared with the other players. The game continues around the table until all players have either placed money into the center or folded. Once all money is placed, the players’ hands are revealed and the player with the winning hand takes the pot. That player’s gain is therefore equivalent to all other contributing players’ losses and the net gain for the group is zero.

Unlike the name would suggest, zero-sum games are actually very real. As human beings, there are limitations on our time, money and energy. We do not get an endless supply of these things every day. And so when deciding how much of something – your time, your money, your energy – to use or give out, you are making the decision to take from one area of your life and give to another. You are continually evaluating how compromises may play out, hoping the ultimate outcome will strike a balance that gives you comfort and reward.

So when we think about the term “work-life balance” aren’t we basically talking about a zero-sum game? Every day we have to make the decision between how much time and energy we put toward our work and our careers and how much time and energy we dedicate to our “life” – whether that be our health, our families, our homes, our pets or our sports and hobbies. And when we make that decision in favor of our career, we are essentially taking away from our personal life. And vice-versa. It’s a delicate balance and one that is different for everyone, depending on careers, ambitions, expectations, characters, stages of life, etc.

This search for balance is no different for lawyers and legal professionals, and in fact some may argue that achieving this balance is even more difficult for these professionals. Traditionally, legal professionals tend to be very committed to their careers. They spend long hours in the office during the week and often work nights and weekends as well. Since they can essentially do their work anywhere and at any time, traditional office hours don’t apply. The essence of the zero-sum game for lawyers likely manifests itself in the number and complexity of work and life obligations while bound by the irrevocable fact that there are only 24 hours in each day. Since the speed of the earth’s rotation on its axis isn’t likely to change anytime soon, the work and life trade-off becomes more difficult to manage when there is more work to get done and just as many personal matters to attend to.

We can draw many parallels between achieving work-life balance and achieving financial balance, where saving and spending are at odds. In each case, there is a finite amount available – time in the case of work-life balance and money in the case of save-spend balance. In effect, saving for retirement is also a zero-sum game. Every dollar we choose to save now is a dollar we choose not to spend on the latest cell phone, or a new outfit, or a night out on the town. The save-spend balance is further complicated by the fact that the rewards are not necessarily delivered under the same time table. Typically, spending comes with instant gratification. In the case of saving, however, the reward is typically delivered at some point later. And when saving for retirement, the reward may not come for several decades. It’s no secret that we humans have a tendency to value short-term rewards over longer-term rewards, even when mathematically they are worth the same. The farther away the reward, the more we tend to discount it. This is the concept of hyperbolic discounting.

How does it work? Assume someone has the choice between $20 now and $100 tomorrow. Most will wait a day and collect the $100 reward. But what if I were to offer you $20 now or $100 a year from now? Turns out many people will opt for the $20 now, discounting the value of a larger reward because it is so far into the future. So expressed another way, hyperbolic discounting is a person’s desire for an immediate reward rather than a higher-value reward at some point later.

And you don’t have to be a lawyer to understand this concept, because it affects everyone the same. And that’s why legal professionals, just like the rest of us living in today’s society, struggle to plan ahead and save adequately for retirement.

And the “spend now or save now” decision is not the only challenge we face when it comes to planning and saving for retirement.

One of the biggest challenges is whether or not we have access to a retirement savings plan to begin with. Statistics have shown that people are much more likely to save for retirement if a 401(k) plan is available to them through the workplace. However, access to such plans has been a difficult hurdle to overcome when it comes to smaller employers, who typically choose not to sponsor a plan. Of all small employers—those with 10 or fewer workers—only 16.5 percent sponsor a retirement plan, according to an Employee Benefit Research Institute estimate. This is especially noteworthy in light of the fact that, according to the latest Statistical Report by the American Bar Foundation, nine in 10 lawyers work for firms that have fewer than 10 attorneys. The propensity for law firms to be small means that most law professionals do not have access to a workplace retirement plan.

So what can you do now to help ensure you’ll have what you need tomorrow? The short answer is – take action today!

Consider establishing a retirement plan. As a solo practitioner or small firm owner, you need to understand your responsibilities as the Plan Sponsor if you establish a retirement plan for your firm. If you have employees, you’ll need to factor them into the equation as well as saving for your own retirement.

If you’re like most working Americans you see your 401(k) plan as the cornerstone to your retirement savings. But if you’re not, and you believe you’ll never retire from practicing law, consider this: One in five retirees do not retire on the planned-for date because of illness or health issues. One of life’s realities is that with old age comes a variety of health concerns that may impact your ability and willingness to practice law. Often law professionals are forced into retirement owing to ailments or health conditions. The uncertainty about what your health has in store for you down the road is cause for planning. So whether you plan to retire or not, consider just a few simple tips that can help you be ready to retire with the dignity and financial security you expect and deserve.

Tip #1: Participate in your retirement plan. If you haven’t yet enrolled in your 401(k) plan, make it a point to do so now. People are living longer now than ever before. According to a report by the U.S. Census Bureau, the United States is projected to have 9 million people above the age of 90 by 2050—up from 1.9 million in 2010 and only 720,000 in 1980. These statistics illustrate that our nation’s 90-and-older population has nearly tripled over the past three decades . . . and is projected to quadruple over the next four decades. These longer life spans, coupled with rocketing health care costs, the uncertain future of Social Security, and the decline of public pensions, means individuals are increasingly responsible for finding their own path to retirement income adequacy.

Contributing to a 401(k) plan can put you on the right track to be able to fund your retirement years. The money you contribute is tax-deferred from both federal and state income taxes, which means you don’t pay taxes on the contributions until you withdraw the funds, typically at retirement age. Furthermore, contributions to the plan are deducted automatically from your paycheck, making the process seamless for you.

For law professionals this tip is especially important. The law profession is characterized by busy, time-consuming schedules with little time for planning outside of work. As a result, law professionals compulsively push off the decision to start saving. As inertia sets in, many people are left feeling as if their bank account is a ticking clock and too few years remain until retirement.

If you’re unsure about how to get started, take advantage of the many helpful online interactive experiences and resources available to you, such as Voya’s myOrangeMoney retirement calculator (voya.com). These tools offer an easy way for you to determine how much you need to save to reach your retirement goals, how different contribution rates may impact your retirement savings and when you can afford to retire.

Tip #2: Take advantage of matching contributions. If your retirement plan offers a company match, take advantage of it! This valuable benefit requires  your employer to match your contributions—typically capped at a percentage of your pay. For example, a company may offer a dollar-for-dollar match up to 3 percent of pay or a 50 percent match up to 6 percent of pay. Find out what your employer will match and, at the very least, contribute enough to take advantage of the match.

Many law firms will offer generous matches and sometimes profit sharing plans where the employer has discretion to determine when and how much the company pays into the plan. The amount allocated to each individual account is usually based on the salary level of the employee.

Tip #3: Make catch-up contributions. If you are age 50 or older (or will be by the end of the calendar year) and your retirement plan allows, take advantage of the “catch-up” provision. Legislation has made it easier for you to save more for your retirement with the “catch-up” provision outlined in the Pension Protection Act of 2006. In addition to the general deferral limit of $18,000 for 2017, you can contribute an additional $6,000 for a total of $24,000. This means if you are 50 years old this year and haven’t started saving for retirement, you can contribute nearly as much as $250,000 over the next ten years—tax-deferred—to your 401(k) plan. When you consider the potential of compound earnings, this can add up to significant savings.

Tip #4: Keep your savings working for you. Even if the plan allows you to borrow from your plan, think twice before doing so. Although it may sound appealing, borrowing from your 401(k) reduces the benefit of tax-free compounding that is the key to building up savings. Before you make the decision to take a loan, there are a few considerations to take into account:

  • You will pay interest on the loan with after-tax dollars, thereby losing the tax advantage.
  • You will pay taxes a second time when you eventually withdraw the money in retirement.
  • Interest on the loan is not tax-deductible, even if funds are used for a home purchase.
  • Most loans must be paid back within five years, but if you leave your job, the loan must be paid back in full immediately or the amount becomes a taxable withdrawal.

Tip #5: Invest for the long term. Once you set your investment allocations, be patient. Predicting the market is not like predicting the weather. There are no high-tech gadgets or radar systems to predict the highs and lows that may lie ahead. It’s critical to remember that what is important is time in the market, not timing the market. Discipline yourself to maintain your allocation through down markets as well as up markets. Having a properly diversified portfolio will help make any market swing easier to digest. Conduct an annual review of your plan to confirm your allocations still align with your life stage and economic circumstances.

Tip #6: Consider spending time with a financial professional. According to Voya research,1 those who spend time with a financial professional save more than their peers and have greater investment knowledge and confidence in their ability to enjoy retirement. If you have never received help from a financial professional before, this assistance is something to consider pursuing.

So we’ve discussed two of life’s zero sum games - work-life balance and save-spend balance. Both are similar in that they require you to make compromises. To what degree you are willing to compromise is up to you. When it comes to saving for retirement it’s important to understand how spending today may negatively impact your ability to retire comfortably in the future. You don’t have to put away half of your income every month, but you do have to make sure that what you are putting away will adequately cover your needs once you reach retirement age. Do you want to live in financial security in retirement? Travel? Live in the home you want? Have enough to pay for health expenses? If so, then you need to value your save-spend balance as much as you do your work-life balance.

1 Advisor Value, A Voya Retirement Research Institute® Study, 2015, www.VoyaRetirementResearchInstitute.com

 

Press inquiries: Christine Hotwagner
Program Operations Director ABA Retirement Funds
JoinUs@ABARetirement.com

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