Scott Burns: This is the age of the IRAs
For people in their 20s and 30s, IRAs are the retirement vehicles of their future. And few have figured this out because our personal and media focus is on 401(k) and 403(b) accounts sponsored by employers.
If you are in your 20s or 30s, I have a tip for you: Learn about IRA accounts. They are the retirement vehicles for your future.
Individual retirement accounts get little attention because our personal and media focus is on 401(k) and 403(b) accounts sponsored by employers.
Worse, IRA accounts have much lower contribution limits. This year, the maximum contribution to an IRA account is $5,500 if you are under age 50, $6,500 if you are over 50.
The maximum contribution to a 401(k) or 403(b) plan is $17,500. This doesn’t count any matching funds contributed by your employer.
But here’s the reality: If you’re young, the high limits of defined-contribution plans are probably irrelevant. Odds are you can’t save $5,500 a year, let alone $17,500. So you won’t be hitting the contribution limit if you focus on IRAs.
An IRA also gives you something an employer can’t: freedom in choosing where you establish your account and how you invest it. The biggest problem with plans where the employee has the responsibility for saving and making investment decisions is their expense and low level of employee contribution.
Basically, workers contributed too little and earned too small an after-expense return. Today, most workers approaching retirement are retiring to a very reduced income.
Are 401(k) and 403(b) plans improving? Yes. Recent legislation forces full disclosure of fees and expenses. Fund costs are falling, but not fast enough. You can have an IRA account at a fraction of the cost of many employer-provided plans.
Today, unless your employer offers a very low-cost plan combined with a substantial matching contribution, there is a good chance that you’ll do better on your own. How can that be? Easy. While costs in 401(k) and 403(b) plans are coming down slowly, costs in highly competitive IRA plans have plunged.
Skeptical? Here’s an example. Suppose we have three 25-year-olds who save equal amounts that are invested in the same assets until they are 67. The only difference: expenses.
One has nominal expenses. Another has expenses of 1 percent a year. The third has expenses of 2 percent a year. If we assume a monthly investment of $100 and a pre-expense return of 8 percent, the nominal-cost employee will accumulate $412,049; the 1 percent-expense employee will accumulate $304,371; and the 2 percent-expense employee will accumulate only $227,016.
Viewed another way, the employee in the 1 percent-expense plan would have to contribute $135 a month to accumulate the same amount as the nominal-expense employee. The 2 percent-expense plan employee would have to contribute about $181 a month to accumulate the same amount as the nominal-expense employee.
Bottom line: A low-cost IRA beats any expensive plan without an employer contribution. An employer contribution has to be quite large to compensate for high costs.
Copyright 2013, Universal Press Syndicate