To retire, or not to retire. That’s the question yet to be answered by a new IRS ruling that has created a double-edged sword for people participating in 401(k) plans. Under a private letter ruling to an unnamed company, the IRS is allowing employees more flexibility in what happens to employer matching contributions. The employee can continue directing employer matches to retirement savings, or they can have those matches go into health reimbursement accounts, or to pay off student loans.
At the beginning of each year, employees can decide where they want the matching contributions to go. If no choice is made, the funds will automatically go into the employee’s retirement account. The ruling isn’t widespread yet, but it’s a test case for the IRS to see if they’ll expand the rule to all 401(k) programs.
While it may sound good at first blush, is it really a good idea?
Pros
- A recruiting tool for companies. “We can help you save for retirement and get out of debt all at the same time.”
- Employees may save more. According to Fidelity, 22% of employees can’t save enough to claim the full employer match because they’re paying off debt. If some of the match can be directed to pay off the debt more quickly, then the employee can later save more and get the full employer match.
- Even if an employee is maxing out their 401(k), they might want to use the match for a short time to bring down their debt liability.
Cons
- Losing the power of compounding. Money directed toward school and medical debt will not be available for reinvestment and the growth that comes with it.
- Playing catch-up. Many Americans are already behind in saving for retirement. The Federal Reserve says median retirement savings in households with people between 55 and 65 is $185,000—not enough for a comfortable retirement. Redirecting employer matches could decrease that number in the long-run.
- Human nature. Even if an employee gets rid of medical and student debt, will they be disciplined enough to redirect all of the employer match back to retirement savings once the debt is gone.
If more companies adopt the new 401(k) flexibility rules, employees should think carefully before redirecting some of the employer match. Unless the debt is a sizable financial burden, they may be better off sticking with the status quo.
This information is presented for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy any investment products. None of the information herein constitutes an investment recommendation, investment advice or an investment outlook. The opinions and conclusions contained in this report are those of the individual expressing those opinions. This information is non-tailored, non-specific information presented without regard for individual investment preferences or risk parameters. Some investments are not suitable for all investors, all investments entail risk and there can be no assurance that any investment strategy will be successful. This information is based on sources believed to be reliable and Alhambra is not responsible for errors, inaccuracies, or omissions of information. For more information contact Alhambra Investment Partners at 1-888-777-0970 or email us at [email protected].
