Helping protect your paycheck: A cautionary tale
According to the 2011 U.S. Census Bureau’s American Community Survey, economic security is out of reach for a growing number of working families in the United States, The number of low-income working families rose from 10.2 million in 2010 to 10.4 million in 2011, representing nearly one-third of all working families.
Here, we provide strategies for saving for retirement on a low-income.
Saving For Your Retirement From Every Paycheck
Start to save even a little with each paycheck. You can do this automatically by setting up a direct deposit to a 401(k), IRA, or other savings vehicle.
Michal Grinstein-Weiss, an associate professor of social work at Washington University in St. Louis, explains “automatic enrollment can be a powerful tool for increasing the number of Americans saving for retirement and other purposes. Defaulting to automation will ensure Americans, particularly low income Americans, have a simple pathway to boost retirement savings.”
Increase Your Savings Rate Over Time
If you start out by saving only a small amount, you will also need to increase your savings rate over time.
According to Alicia Munnell, director of the Center for Retirement Research at Boston College, “the default employee contribution rate should be set at a meaningful level and then increased until the combined employee contribution and employer match reach 12 percent of wages. The default investment option should be a target date fund made up of a portfolio of low-cost index funds.”
Some 401(k) plans offer a feature which automatically increase your savings rate over time, but if your 401(k) plan doesn’t offer this benefit, you’ll have to make an effort to save more yourself.
Exceed Your Employer’s Savings Rate
Many workers are automatically enrolled in their 401(k) plan, typically at 3 percent of pay, but you will likely need to save more than this amount to have a financially secure retirement.
Jean Chatzky, a financial editor for NBC Today, advises “increasing contributions each year by 1 to 2 percent until a participant maxes out can literally double the amount of money an employee has in retirement.”
Saving for Retirement with an IRA
If you don’t have access to a 401(k) at work or there’s a waiting period before you can start to contribute, you can open up an IRA to get valuable retirement saving tax breaks.
Senator Claire McCaskill explains “most economists will tell you it is far easier to get people to save money for retirement through a payroll deduction at work instead of requiring them to open up an IRA on their own. The problem is many low income workers face real structural barriers to saving: they work seasonal jobs, or are in and out of the workforce before they can vest, or they work for employers who have neither the time nor the resources to offer a retirement plan.”
The IRA contribution deadline is April 15, and if you contribute shortly before you file your taxes you can realize nearly immediate savings on your tax bill.
Make Smart Decisions When You Change Jobs
You will likely need to sign up for a 401(k) plan and set up new direct deposits each time you change jobs.
Make sure to choose appropriate retirement saving elections at this time and hold yourself to them.
Save Part of Your Tax Refund
Put part of your tax refund into a retirement account.
Grinstein-Weiss explains “for many low and moderate income households, the federal income tax refund is the largest lump sum payment received during the year. After a household receives its refund, it is possibly in its best balance sheet position for the entire year and perhaps more open to saving than at any other point.”
IRS Form 8888 allows you to directly deposit your tax refund into a combination of checking, savings, or individual retirement accounts or to purchase Series I savings bonds.
Build a Separate Emergency Fund
Only use your retirement savings for retirement. Maintain a savings account separate from your 401(k) or IRA which can be used for emergencies so you don’t need to withdraw from your retirement accounts early.
Don’t Make Early Withdrawals
Withdrawals from traditional 401(k)s and IRAs before age 59 ½ trigger a 10 percent early withdrawal penalty and income tax on the amount withdrawn. You can avoid the taxes and penalty when you change jobs if you leave the money in your old 401(k) plan, move it into the 401(k) plan at your new job, or roll it over to an IRA.
Avoid High-Cost Investments
Fees can vary significantly from investment to investment, and unnecessarily high costs can significantly reduce your retirement account balance. Pay close attention to the fees charged by each investment option and choose low-cost options where available.
By following these strategies you’ll be well on your way to saving for retirement even if you’re a low-income household.
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