A Conversation About Retirement; Or, Meghan Learns She Might Be Rich

In 2015, 45% of Americans were financially on track for a comfortable retirement.

I was not one of them.

“But you’re an editor of a financial website!” you might say, if “you” = my dad. Fair point! But it’s hard to save; harder still to know what best to do with those funds, especially if what you’re able to put away seems too insignificant to merit attention.

Zach Teutsch works as an impact specialist and a private financial coach. Our last conversation — about power, sex, and money — delved into the complicated world of gender politics and finances. Today, we talk retirement.

Meghan: Zach! Hello!

Zach: Hello Meghan!

Meghan: THANK YOU chatting with me again. You were so super insightful last time.

Zach: Aww, shucks. Of course, delighted to help.

First question, would you like to retire?

Meghan: Haaaaaah, today? Sure!

Actually, that’s a great question, because I don’t see it as part of my future necessarily. In part because my “career” has been so mutable and strange — unlike, say, my mom, who worked for the Canadian government for 34 years until she retired with her pension. That’s not a life I will ever have.

Zach: That’s a great example of a broader trend. Work is different than in our parents’ generation, and retirement is too. My mom’s dad got a job in his 20s that he kept through retirement. My dad’s dad had two jobs in that span. My dad has had the same job for about 30 years. Ditto my mom. I’ve had almost as many as all of them put together in a decade, and I’m actually pretty stable.

The point is, work is changing. Though pensions have historically been a key part of retirement for many North Americans, they are dwindling. This is a bad development. Retirement is changing, too.

Meghan: Doesn’t it need to change? People are living longer, are healthier later in life, etc — if the 65+ segment of our workforce just checked out, we’d be in trouble. Not only in a practical sense, but in the sense that that’s an incredible wealth of experience and knowledge we’d be missing out on.

Zach: That’s a really positive way to think about it. Certainly, if people live a lot longer, it’s hard to work for the traditional number of years and have everything still balance out.

Meghan: Ha, yeah, that was an aggressively rosy outlook. Is the more accurate picture that we are all going to wither away in abject poverty while our government collapses in on itself because it can’t support the structures necessary to care for an aging population?

Zach: The other take was rosy, that one is horrifying! It is certainly true that most Americans have little savings. This is largely because of unfavorable big developments: though wages have stagnated, the skills of those driving consumerism have not. The average new home built today is more than double the size of a new home built in 1950. People are not twice as tall. But maybe I’m taking us too far afield: the key idea is that we are consuming a lot, saving less than we should, and the system makes that easy, and setting aside money hard.

Meghan: It is! It is hard. Let’s take me as a test case, because this is really about you solving my problems: what should the average 32-year-old with very limited income be doing to prepare? Like what is the BARE MINIMUM I should be doing, provided I want to establish some kind of nest egg to support me when my fingers fall off and I can no longer blog for quarters?

Zach: It’s all about choices. Saving about 15% per year gets a person to retirement in about 40 years. Or rather, a work-free retirement at 85% of current income in 40 years. At 10%, it takes about 50 years. That’s longer than most people want to work.

Meghan: 15% of your total income? ie. putting 15% of each paycheck into an…account thing?

Zach: Yup. That’s a pretty common practice and a good benchmark.

Meghan: That’s a lot. That’s a lot of %.

Zach: Yes. Though, you might find that once you automate it, you get used to it, and don’t miss the money. Humans are very good at adapting.

Meghan: So, okay, in this magical world where I can put that away — where do I put it? I currently have a 401(k)/IRA (I DON’T KNOW WHICH) in the U.S. with about $8k in it, accrued during my last job.

Zach: It’s good that you’ve gotten started. That’s the hardest part!

Meghan: The last two years were the first time I was able to squirrel anything out, and I just stuck it…somewhere. I honestly don’t know the difference between a 401(k) and an IRA.

Zach: That’s a common thing to be confused about.

Meghan: (Thank you for being kind.)

Zach: In the U.S., the tax code advantages retirement savings. Which is great. In a non-retirement scenario, you use money you already paid taxes on to invest, and then pay taxes on the amount that you make (capital gains). If the investment goes from $50 to $110, and then you sell, you celebrate and then pay a share of the $60 profit back in taxes.

With me so far?

Meghan: That’s in a regular investment scenario? “Regular investment” = stocks? Stock…market?

Zach: Right. If, instead, you are using a retirement account, there are two basic options: 1) You don’t pay taxes initially (and invest with pre-tax dollars); or 2) You use post-tax dollars (as above) but when you take your money out later, it isn’t taxed.

Meghan: Which is better?

Zach: It depends! Sorry!!

Meghan: Sigh. Pre-tax is a 401(k), yes?

Zach: Exactly. And huzzah!

Meghan: Zing!

Zach: Let me give an example of that. What should our hypothetical person make in a year?

Meghan: $80,000.

Zach: And, what should zir name be?

Meghan: Harry Styles.

Zach: Gender pronoun?

Meghan: That is an excellent and poignant question for my perfect little noodle Harry! He identifies as “he.”

Zach: Great, so he makes $80k. If he puts no money towards retirement, he’ll be taxed on $80k (it’s a pinch more complicated but I am simplifying for effect). If, instead, he puts $12k into his company’s 401(k) (15% per our earlier chat), instead of being taxed on his whole income, he’ll get taxed on just $68k. Which makes a pretty big difference. In other words, setting aside $12k for retirement only costs him the equivalent of $8400. That tax advantage is pretty substantial. It’s sort of like retirement being on sale.

And, if Harry’s employer matches each $1 he puts to retirement with $1 of its own up to 3% of his salary (a common arrangement), then they’d chip in another $2400. He’d end up with $14,400 at a cost to him of about $8400. Thing is, that money would have to wait for retirement.

Now, if Harry got a historically average return on investing his money, and he waited for 35 years to use it, that money would grow to about $215,000.

Meghan: Harry’s rich!

I was told once that if your employer doesn’t match, you should do the Roth IRA by default…is that wrong?

Zach: Great question. That’s often correct. Because of progressive taxation (which as the name implies, is good), in most countries no matter how much one makes, the first $X is taxed at the same rate. In the U.S., for instance, the first $9225 for a single filer is taxed at 10% (which can be offset for low-income individuals through the earned income tax credit, but that’s for another chat). By contrast, income for a single filer between $189,300 and $411,500 is taxed at 33%. And that’s just the Feds — most states and municipalities also have income tax. The key is to notice that the rate on the upper income (33%) is much more than the 10% on the first amount. If the system is working, higher income people also pay a higher % of their money in taxes. So the tax break is worth the most when a person (Harry, Meghan, Zach, etc) is earning the most.

If someone is making a modest salary as a young person, then using after tax dollars is not so different than before tax dollars, so it makes sense to use a Roth IRA. Which, to be clear, is from bucket two above — tax break later. Not only will you enjoy the tax break when you will hopefully be making more money, but you will also be protected against rising tax rates.

The cookie cutter approach is usually: 1) max out the match at an employer; 2) max out Roth IRA; 3) invest more in retirement accounts to get to 15% or more.

Regarding #1, why do you suppose it’s so good to max out the match?

Meghan: That’s free money. Always take the free money, right?

Zach: Right! It’s one of the few times in life we ever get a guaranteed instant 100% return. And by we, I mean that British pop star, Harry.

Meghan: Harry is going to be so grateful for this information.

Zach: Okay, so we covered getting money into accounts — the next big thing is what to do with it once it is there.

Meghan: You have to do MORE?

Zach: Sorry. It depends, there might be a good default option in your retirement plan, and if so, maybe that’s enough. In general, the keys are diversification, low fees, and asset allocation.

Meghan: “Default option,” as in someone or some robot manages it for you?

Zach: Exactly. It’s like Marco Roboto, but with experience doing the thing. So, fundamentally different.

The research shows that most mutual funds charge more in fees than they produce in additional returns beyond the low-fee index fund alternative, so it’s usually wise to choose low-fee index funds. The details would involve more time than we have now — suffice it to say, a person can learn about it online or seek a financial advisor, coach, etc. When choosing such a person, it’s best to retain someone who doesn’t take commissions, and instead charges hourly, or perhaps by a fixed % of assets. The time spent getting a good plan on the books will be well worth it in the long run, for most people. If someone wants to do it themselves (most people can!), there are good books to read on the resources page of my website.

Meghan: Are those options available in both 401(k)’s and IRAs?

Zach: A company can choose what to offer in its 401(k), so offerings vary. Were I in charge, there would be a requirement that all 401(k)’s have low-fee index fund options or low-fee retirement target date funds, and ideally both. Harry can choose whichever firm he wishes for his IRA(s), so he should choose a place with a good set of low-fee index fund options.

Meghan: Also, please: what is the difference between a Roth IRA and a regular ol’ IRA?

Zach: A Roth IRA has its tax savings later (during retirement), and a standard IRA is much like a 401(k). In fact, a lot of IRAs begin life as 401(k)’s. When you leave an employer, you get the choice to keep your 401(k) with them, or roll it over into a new 401(k) (at your new job, for example), or into a traditional IRA (not a Roth).

If a person’s situation is complicated (such as they want to convert a non-Roth to a Roth), they would be wise to seek a tax expert, who may (or may not) be a financial planning expert as well. Most of these topics can be understood well by someone with average intelligence, a high school education, basic math skills, and time/focus.

Meghan: Alas, Harry didn’t finish high school. Also, Zach, I have all of those things and it still boggles me!

Zach: Just because you could learn the tax and investment topics, doesn’t necessarily mean you should. Lots of people like to have a financial coach to help hold them accountable, and give them confidence that they are on the right track.

Meghan: I think for many people — and, unfortunately, for many women — there’s this fundamental white noise that gets really loud whenever money shows up.

Zach: That’s a really keen and important observation about gender: it matters a lot in how people invest and whether they feel comfortable. There is a whole industry designed to make it seem complicated so that people will pay financial institutions a lot of money. So you’re feeling confused, in part, because people paid to make you feel that way.

And regarding gender, there was a great study done that looked at non-professional investing groups. It compared the results of all-men groups, all-women groups, and mixed-gender groups. The male groups underperformed by taking on too much risk; women’s groups underperformed by taking on too little risk. Mixed-gender did best. It’s good information to have as we think about whether we are making the right decisions.

Meghan: That’s fascinating and not at all surprising, I guess. My reaction to financial issues feels involuntary — it’s not that I don’t WANT to think about it, more that I CAN’T think about it — like something in my brain actually says, “Oh, this is too complicated for you, shhhh.”

Shut up, brain!

So in my situation, I left my job, thereby losing my 401(k). I did nothing with it. I think (I assume) it is just still sitting there. If one doesn’t immediately go to a new job, or goes back to school, or goes freelance, what options exist? Rolling it over into an independent IRA?

Zach: Well, your situation is complicated because you moved to Canada. Let’s assume a simpler case for a second. If you earned the money in the U.S., live in the U.S., and plan to retire in the U.S., you can just leave the money where it is, including updating how it is invested over time. You might be wise to roll it over into an account at a firm that has good low-fee index fund investment options.

Meghan: Can you give me an example?

Zach: I’m not endorsing any particular firm, but I can say that the idea was pioneered by Vanguard founder John Bogle, which continues to be a major provider. Fidelity, Schwab, and several other firms compete in this space.

Meghan: So my $8k could in theory just accrue some extra bucks if it sat in an IRA with one of those firms and I didn’t touch it ever?

Zach: That’s precisely the idea! Even more broadly, that’s the key idea of capitalism. That money is your capital, and it works *for* you. If it earned 8% interest per year for 35 years, it’d be worth $100k at retirement. So, on the one hand, it’s a lot of money now — but it’ll be quite a bit more then.

Meghan: WAIT WAIT WAIT

If I don’t add ANY money to that 8k and just…leave it be…I will have $100k in 35 years????

Zach: If you get a historically average rate of return and pay low fees, then yeah. Maybe more!

Meghan: ZAC\\\\\\6

Sorry, my cat stepped on the keyboard, but that is an accurate expression of my current feelings!

Zach: If you run it out to 40 years, you are looking at more like $175k.

Meghan: !!!!! I was thinking, like, maybe it will grow to be $10k. Maybe. You just somehow made me rich! How did you do that? Is that real math? That can’t be right. I only have $8000!

Zach: Compound interest is your friend with regard to investment. And your enemy with regard to credit card debt.

Meghan: All of my worries have evaporated! How could I screw this up? I shouldn’t touch it, right?

Zach: Well, that depends. : ) You want to get it setup so that you have good low-cost investments. If you have them now, then yeah, leave it alone. Let your money work for you.

Meghan: That gets us into my complicated post-border situation, which I need to talk to someone about. That would be the responsible thing to do. I know we have something in Canada called RRSPs. I don’t know what they are, or how they work, but we’ve got ’em. See, you learn one system, and then things change!

Zach: As I understand it they are much like 401(k)’s, but with fewer rules and stipulations. That said, I don’t even really know much about hockey, so am unreliable with regards to Canada. Though I did spend a wonderful weekend in Montreal once.

Meghan: Well, that’s more than most.

Retirement questions for Zach? He’ll try to answer some of them here! Retirement advice for me? You’ll be rewarded handsomely in the afterlife.

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