401(K) plans are complicated! Today, Paula and Jon are joined by 401(K) expert Tricia Bailey. We're going to cover what employees need to know about their plans.
One of the biggest things plan participants don't understand are the fees associated with the plan. How much do employers pick up vs. how much do employees themselves cover? Because this information is disclosed in a complicated form, listed in percentages, few employees read it. And even fewer understand it! That's why working with a financial planner can be so important. Is the plan a good fit, or should you be allocating more toward other retirement vehicles?
80% of the population uses "set it and forget it" style target date funds, based on their age. Well, everyone's financial situation is different, and one size certainly does not fit all. And two plans, with the same target date, might be managed completely differently by two different companies!
When it comes to fees, Paula mentions not all fees are bad. Sometimes, free means you get what you pay for. Understanding what fees you are paying and what services are available is key to planning your financial future
With the recently passed SECURE Act 2.0, there will be additional vehicles set up to help Americans save for retirement. This will be a welcome change, as the vast majority do not have nearly enough saved for their future. Paula shares the story of a rude awakening for a couple she just met.
For solo entrepreneurs, there are retirement vehicles such as a solo 401(K) and a SEP IRA. Tricia explains how they work. But if you are a very high earner, the contribution limits on these accounts will not allow you to have the same lifestyle in retirement that you have now. She breaks down the numbers and some ways to save a much larger nest egg for retirement.
If you have additional questions, you can reach Tricia Bailey at 248-520-6372. or find email Paula Christine at Paula@PaulaChristine.com. You can also learn more online at www.PaulaChristine.com.
Paula: Welcome to Beyond the Paycheck. I'm Paula Christine. Today we are joined by Tricia Bailey, who's a 401K expert. Welcome, Tricia.
Tricia: Thank you for having me, Paula. I appreciate you having me on.
Paula: Oh, thank you for joining us. I know that you work mostly with employers, but I just wanna talk briefly about some things that the employee needs to be aware of when they're looking at their 401k. And I think one of the biggest things that most employees don't understand is the fees associated with a 401k plan. Can you just briefly talk about that for a minute?
Tricia: Absolutely. So within every retirement plan, There is some sort of additional cost for managing the money for the funds themselves and just the basic maintenance of the website and being able to log in and that sort of thing.
And so these costs, sometimes employers are picking up a large piece of it. Sometimes the employees are paying the majority of it, and I think it's really important to note how much is coming out of your retirement account to cover the expenses of the retirement plan every year. Everybody will receive a document and nobody ever reads these documents, but..
Paula: That's because they don't make 'em reader friendly.
They write 'em in a language. Nobody understands.
Jon: I think that language is legalese or financial ease.
Paula: I know, correct.
Tricia: They make it so complicated and they're like, oh, it's very transparent and really isn't. At the end of the day, it really isn't that transparent, right? Because most people don't think in percentages and everything is listed as a percent.
I think what most people really need to do is sit down with a financial planner and have them look at the fee disclosures that come out on an annual basis, and that's gonna really help them determine, okay, what am I paying in fees? Is this a good plan for me? Should I invest more in an IRA? Should I do something outside of the plan?
You know, if I'm a husband, wife, maybe we do something different because it's very, very hard to pick through those fee disclosures and try to be able to understand them yourself.
Paula: That is great advice because I think that everybody should have multiple different buckets of money. 401k, your Roth IRA, and then non-qualified funds, which I call the brokerage account.
That makes sense because in a brokerage account you can control your fees quite a bit.
Tricia: Yes, you can.
Paula: Where you can't inside your employer's plan. So that's excellent advice.
Tricia: Within the employer plan, you're subject to whatever the business owner has decided to implement. But as an employee, it really is on you to have that conversation with a good financial planner that's gonna be able to say, okay, let's invest this way with this amount of money, or, it will help you pivot, right? Cause everybody's situation is so different.
Paula: When you look at a 401K plan, and I know there's sometimes there's, 10 investments, sometime there's 50. If you were to sit down with an employee, do most people invest in the lifestyle funds or, what's the other one? Target date funds?
Tricia: The target date funds, yeah. I personally cannot give advice onto which direction to go, but I can tell you based on the data that I have, the directions that employees are investing their money is about 80% of the population, their investments are slowly going into target date funds.
What's ironic with these different target date funds? Say you'll have the same vintage, and what I mean by vintage is, it'll say the year 2025 or the year 2035 or year 2045. So say for example, I have two funds from two different fund companies that are the year 2040. They may be investing very differently.
One might be considered, what's a "to philosophy," so meaning to retirement. So it becomes most conservative when somebody hits the age of 65. And some might be considered a through retirement, meaning they don't start becoming most conservative until well past age 65. So the education just isn't there surrounding it.
There's so much complexity to it now. They're saying it's simple. It's a target date fund. It's based on your age. It's wonderful, it's easy, but that's the only demographic that we know about these individuals, right? That is all we know, is their date of birth. And so we're saying, all right, everybody should be lumped into this particular fund based on their age.
Now, if I was an employee that maybe I was a single mom, maybe it took me a while to be able to save something for myself. Maybe it took some time before I even started investing in a plan. I should not be as conservative necessarily as some of my colleagues that might have started saving when they got right outta school.
So somebody that has a larger amount, and this is really, this is where a financial advisor is gonna be able to help somebody determine how much should I save, where should I put it? What should I be putting it into? Yes, the target date is an easy solution for the ones that aren't having that conversation, but is it necessarily the right solution?
And that's where the struggle and the education comes in.
Paula: There truly is not enough education when it comes to investing inside of a 401k because even the advisors are handcuffed sometimes with what they can say and do.
Tricia: There's so much to it, right? And there's only so much bandwidth a lot of advisors have that they can only spend so much time having these conversations.
So there are managed accounts and things like that people can utilize. But then again, you're paying an additional fee for those. So trying to determine what the right solution is. It's always best to sit with somebody, your own planner.
Paula: Sometimes paying fees has an advantage because if you're paying someone to actually manage something for you. You're expecting to do a little bit better than if you were managing it yourself.
Fees aren't a bad thing, it's just that you should just understand what that fee entails and what it is, and are there other options out there that might be better for you, with lower fees.
Tricia: Yeah. Free is not always bad. You get what you pay for. But you wanna know what you're paying for when you're paying it. I guess is what it comes down to.
Paula: Yeah. And here's the thing, just doing anything, even if your fees are a little bit higher than normal. If you're just doing the savings in your retirement plan, you're gonna be better off in the long run anyway.
Tricia: I couldn't agree with you more. For a lot of Americans, this is all they have is the retirement account.
That's why I'm really passionate about every company having a plan so that every American gets an opportunity to save. You cannot out-invest not saving, right? So you have to save something for yourself and if this is the way to do it, because it's easy, you don't see it, so you can't spend it. That philosophy, I'm really on board with it. And secure 2.0 even is coming out with additional pieces where you can tie emergency savings accounts to the retirement plans and things like that. So that's helping to bridge the gap for those Americans that don't even have, $400 in their account to cover an expense like a tire, blowout or something like that.
Paula: You know what, we should have you back to do a conversation on the SECURE 2.0 Act because there are so many changes. But let's talk about, myself and Jon, we're both independent contractors, independent small business owners. We don't typically have that normal 401k. I know that we have options to do like a SEP IRA or
Jon: Yup, I got one of those.
Paula: Or a solo 401k. So talk a bit about, what options are available for someone like John and myself.
Tricia: Unfortunately, a lot of people aren't talking about this, and I just gave a presentation to the Michigan CPA Association about this. You as an entrepreneur, you as a solo business owner, if you make too much.
That SEP or that solo 401k where you're only putting in maybe $22,500, or you're putting in $66,000 and you're making significantly more. Then that's not gonna get you to retirement. It's great, it's helpful, but it's not gonna get you to retirement. Maybe you're making too much that you can't even get the tax deduction on an IRA or not even be able to contribute to a Roth IRA, right?
If you make too much money. So there's things that are being kept from you as a solo owner and that earns money. Somebody that makes a lot of money. These are challenges that you have and you're like, I'm paying so much in taxes. How do I help mitigate this? So that, one, I'm gonna have enough in retirement.
That I'm able to pay my taxes down the road and give myself a bit of a tax shelter. Today, you would have to start with a solo K, and then you tack on an additional layer to that solo K where you're able to save even more for yourself as you get older. Now, it is based on your age and how much you make, and if you're an S-Corp, you have to have W2 wages. But if you're an LLC or partnership, it's still just pass through income. And when I say you can save more for yourself, I'm saying significantly more.
Jon: You've got my attention.
Paula: You've got mine too. But let's go back. Describe what a solo 401k is.
Tricia: So solo sounds like it is just one person, but you definitely can put your spouse into the plan.
So even if you have to own the business as a hundred percent owner. Maybe your spouse does something for you, or you can have them do some type of a job for you where you pay them a payroll, pay them some W2 wages, and now you can take that and you can throw that into the retirement account for themselves as well.
So a Solo K work plan works very similarly to say your traditional retirement plans. However, it is just meant for either one person or that person and their spouse. We wanna make sure that the plan is designed in such a way that if you do hire somebody that you're not negatively impacted and have to get them into the plan right away.
So we make sure to design the plan so that oh yeah, we added this employee. I'm like, oh, great. Now you have to give 'em 20 grand based on your plan design, right? No, we have to make sure, put some stop gaps in place so that you don't have any kind of surprises.
Paula: Yeah, I always wondered how that happened if you decided to hire an employee.
Tricia: So if you decide to hire an employee and you've been running a solo K plan, it's truly just a plan amendment that now we have employees and it switches over to a traditional 401k plan and/or a safe harbor plan. And let me talk about what a safe harbor is versus traditional. Just real briefly, if you have employees, you are limited on what you can put into your retirement plan. You can only put in 2% greater than the average of your employee unless you say, all right, I choose to be a safe harbor plan. So that means I'm gonna give my employees something so I can put in the maximum allowance. So the maximum that anybody can put in, if you're a solo entrepreneur, or anybody really in a401k plan for 2023, you're looking at $22,500.
If you're over the age of 50, you can do up to $30,000. But if I made $500,000 to $700,000, is $30,000 enough to get me to retire? It's not really So the next step up from there is called a profit sharing. So you can do an additional profit sharing. If you're 60 years of age, you can get up to $73,500.
Okay, that's closer. But what if I said it 50 years of age, you can save an additional $309,000 for yourself. Plus the $73,500 possibly, right? Depends on your demographic.
Jon: Tricia, I'm 42, so now you're giving me a goal in eight years.
Tricia: All right. And 42. What if I told you could save an additional $126,000 for yourself?
Jon: I gotta sell some more podcasts.
Tricia: But you can get a tax break of $86,400 if you're in the highest tax bracket. It's truly for people that are looking for how do I move money from my left pockets to my right pocket. How do I not pay so much in taxes from year to year? It's a commitment. It's not a marriage per se, it's a long-term relationship.
The IRS is looking for a three-year commitment from you.
Paula: That's longer than most marriages, huh? Nope, I'm sorry.
Tricia: But yeah, so the IRS is looking for a three-year commitment to say, if you're 60, $300,000? Can you afford to do 300,000 every year? Because if you can, you're saving yourself 172,000 in taxes.
Paula: That's a huge, and most people don't know about it. It's just not talked about. It's not talked about. I would love to be able to put $300,000 away every year.
Tricia: And it's as simple as opening up a solo 401k. Tacking on a cash balance, and coming up with the right number. We sit down with your CPA, we sit down with you, we sit down with your financial advisor and say, what's the right numbers?
Is it $300,000? Is it maybe somebody wants to build a pool? Maybe the commitment's $200,000, maybe the commitment number is lower. But either way, you're still able to do more than the $73,500 or $66,000 depending on your age bracket that you can currently do just in a regular retirement.
It's the next level of being able to mitigate taxes. It's really amazing.
Paula: Jon, are you ready to sign up?
Jon: It's a podcast. You can't see me, but I'm seeing dollar signs in front of my head right now.
Tricia: It is a great tax mitigation tool. I will say it's run a little bit differently than your typical retirement plans, right?
Cause your typical retirement plans, you're investing in the market. It goes up and down with the market with a cash balance plan with these dollars. It's a "Steady Eddie," you're looking for right around a 5% rate of return, give or take. So it's slow growth designed so that when you hit retirement, if you're making maximum wages, it's $3.2 million that you have at retirement.
And that's something that you can live on. If you're a high-income earner, that is something you can live on.
Paula: I could live on that. I think so. I think so. It's so important to just, no matter if you're 20, if you're 50, if you're 70, you need to sit down with a financial planner and just make sure that you're doing all the right things, because even as you're younger, the whole goal is accumulation.
But once you hit five to 10 years out from a retirement, now you're gonna start going into distribution phase in your retirement. So you're gonna make sure you have enough income, two different strategies, and you just wanna make sure that you're doing all the right things. I sat with a woman the other day.
Her and her husband were 63 and 52. They had $85,000 saved for retirement, and they live on $150,000 a year.
Tricia: Yeah,
Paula: That tells you, I'm like, oh, you can survive for a year.
Tricia: There's not enough there. Now you have to figure out where the income is coming from in retirement.
Paula: I didn't even send them to do that. I said, the first thing you need to do is you need to figure out where your $150,000 a year is going. And you then need to learn how to live on what your social security and your husband's pension is gonna be. And that's what you live on now. And you bank everything that you possibly can bank. At this point, there's no way you're ever going to be able to retire.
Tricia: Not based on those numbers that you just gave me.
And that's unfortunately a sad state. And that's where we are right now.
Paula: Isn't the average 401k balance, like something like $25 or $30,000 or something.
Tricia: It's not high. It is not high enough. It is not high enough. So again, please bring me back for a podcast on SECURE 2.0 because one of the things they're bringing out is plans that in the next few years are gonna be designed to be the automatic enrollment. Like you just don't even get a choice anymore. It's just you get a choice as a participant to opt out. But they're making sure that the plan puts it in so that people are more apt to get into the retirement plan.
Paula: We all know that you have to, if your employer's matching 3%, 4%, whatever it is. At least put enough in to get the match.
Tricia: Who would leave $20 on the ground, everybody would bend down and pick up the $20. I don't understand why it's so hard to get to the match. I don't.
Paula: You know what it is they get this 401k booklet and it's really not about the money. It's that they don't understand what to do with it when they receive it. And the HR person, if you do have an HR person on in within your company, they're not allowed to give advice. So they just don't know what to do. So they do nothing. My son called me the other day, started a new job. Okay, mom, what do I do? At least he has me to go to.
A lot of people don't have anybody to go to and ask those questions.
Jon: If you had a problem with a pipe you'd call a plumber. If you had a problem with your knee, you'd go to a knee specialist. I don't understand why people don't talk to financial experts when it comes to managing their money, cuz the most important decisions they're gonna make for their future.
Paula: I can tell you. It's called embarrassment. They're so embarrassed to say, oh, I've got this much debt, or I've got that, or I've haven't done this correctly. Or, and you know what? Nobody gives a shit. We're not here to judge. We just wanna hear to help you because the better you off financially. Everything else in your life, is it gonna go so much easier.
Jon: That's probably a good place to leave it, Tricia. If somebody wants to contact you about four oh questions. What are the best ways to find you?
Tricia: You can reach out via cell phone at (248) 520-6372. Or honestly reach out to Paula too. She'll be able to guide you in the best possible way. So if we wanna make sure that people are able to save and doing the right things and given all the best opportunities and the best education they can get.
Paula: Tricia, I've learned so much from you today. I really appreciate you being our guest today. If anybody wants to reach out to me, they can reach out to me at paula@paulachristine.com or check out my website at paulachristine.com. Thanks again, Tricia. We will definitely have you back for secure 2.0.