On Thursday, the House GOP tax plan is set to be released. It’s unclear what happens to tax incentives for 401(k) deductions. Business Correspondent Rhonda Schaffler spoke to the head of retirement investments for Prudential Retirements, Sri Reddy.
Schaffler: Sri, welcome, good to have you here.
Reddy: Pleased to be here, Rhonda.
Schaffler: We don’t yet know what’s going to be in this tax reform bill that’s going to be announced. One thing we did hear was that maybe something might change with 401(k)s and how much you can deduct. Are you surprised that’s even under discussion at all, changing anything about 401(k)s?
Reddy: When it comes to 401(k) savings, of course it’s going to be on a list when you think about it because there’s a big amount of tax deferral that people are advantaged with and the government is going to have that on the list of items it considers. That being said, I for one am confident that not a lot of tax changes will impact retirement savings. And, I can say that for a couple of reasons. First and foremost, with an aging population of demographics in the U.S., you need people to have their own safety net beyond Social Security and any pensions they may have accumulated. Second of all, when you look at the 401(k) system, which has only really been around for 30 or 40 years, it’s doing remarkably well. When people have access to a workplace-based retirement savings plan they not only use it, they start saving early and they often end up with a nest egg which will take them to and through retirement.
Schaffler: The problem is not everyone takes advantage of 401(k) plans and this is the time of year that people are looking at benefits to sign up for next year. How much arm twisting do you have to do these days to convince people that even putting a little bit more in 401(k) makes a big difference in the end?
Reddy: Great question. First and foremost, if you haven’t saved, if your viewers haven’t saved so far, whenever you start saving is better than deferring it by another year. Second of all, even if you could only afford to save a small amount, small amounts do make a difference. So, anything else that you can forgo, or anything else that you think you can save for tomorrow, would be a good way to get a head start. Both of those things being said, I would never overlook an employer match. So if you’re fortunate to work at a place that gives you a match for the first 3 or 4 percent, take it. By all means, at least save that amount. If you can save a little bit more than that, terrific. And, if you know you’re going to get something like a raise starting in January, it may be a good time to save at least half of that because it’s money that you’re not used to anyway so you’re not going to miss it.
Schaffler: Sri, what about the fact that a lot of these 401(k) plans are just a little bit confusing for people. There are sometimes a lot of options which can be good, but just sorting out is difficult. It doesn’t seem like we’ve reached the financial literacy we should for some people on the retirement front. And, I know you of course, the firms are trying their very best to impart some of that financial wisdom, but for the average person sorting through 20, 30 plans, it’s difficult.
Reddy: So, the good news, Rhonda, is when it comes to most employer-based savings plans, there’s usually one or two investments that are meant for the average group of employees. You have a lot of choice because different employees have different needs. But in today’s investment menus, for example at Prudential, we offer something called day one target date funds. A target date fund is something where you don’t need to know a lot more than what year you think you’re going to retire and it does everything for you. Diversification, asset allocation, etc. And many providers and many employers offer their own flavor of those type of vehicles.
Schaffler: Are you worried that people will realize too late that it’s time to start their 401(k) savings and really set themselves back in retirement? We’re seeing baby boomers in particular — the next big bump in population that’s working its way through retirement — that they just won’t be able to do it, especially in a state like New Jersey which is so expensive to live.
Reddy: I don’t disagree with you. I think that’s why there are tax benefits such as tax deferral that are possible on 401(k) savings. The sooner you start saving, the better off you’re going to be. And, because of the tax advantage nature, saving $10 from a paycheck, you may only feel an impact of six or seven dollars on an after tax basis. So, it’s a great way to start saving without necessarily feeling an impact.
Schaffler: Should the government incentivize 401(k) savings in any other way?
Reddy: You know I think the regulation has done a number of things in the last 10 or 15 years which have been meaningful. Starting in 2006, there was something called a Pension Protection Act which introduced automatic savings. So a lot of employees and a lot of workers in New Jersey and other states may not know this, but their employer may automatically enroll them in the 401(k), they may automatically help them set aside some portion of their check into an automatic default investment which automatically diversifies for them and make it possible to take advantage of their match.
Schaffler: Sri, thanks for your time.
Reddy: My pleasure, Rhonda.