That’s my primary gripe with 401k plans; although they are much more portable than fixed benefit pensions, they push the effort and the risk of actually knowing how to invest onto the eventual retiree. Which is one thing if we’re talking business school graduates and other highly educated and paid types who can presumably learn it themselves, or at the very least have the sense to pay someone else to do it for them.
But for that guy with a high school education who works in a warehouse? What does that guy know about small cap value vs. large cap growth, beyond what his company’s 401k service company tells him? And if the market tanks 2008-style a few years before retirement, why should he be on the hook for that? Is it fair to expect him to be able to go out there, figure out how much he’s going to need in retirement, and formulate a plan to set aside the right amount so that he and his will be taken care of when he retires? If he’s already having trouble making ends meet, expecting him to voluntarily forego some of his income like that may not be reasonable either.
401k plans just feel to me like they’re a way for companies to throw some money at employee retirement, and just wash their hands of it after each quarter; there’s no long-term responsibility to their employees. Market crashes? Tough shit, you should have invested in lower risk stuff. Run out of money when you’re 92? Tough shit, you should have saved more when you were 47, or invested more wisely. And so on…
I would consider myself to be one of those highly educated types. When I signed up for the company’s 401K plan at my first job right after college I found having to decide how to invest my savings completely overwhelming. Having an engineering degree does not translate to knowing how to invest.
I did eventually discover the Target Date Funds my plan offered, and just put everything in the 2045 Retirement Date fund. Some people apparently don’t like the target date funds because they generally have higher fees than other investments, but I like the idea that someone who actually known what they are doing is figuring out the right balance of investments. In a sense I guess that might count as “paying someone else to do it for me”.
Apparently some companies are trying to simplify their retirement plans to try to make it less overwhelming, by offering just a few investment options, or just defaulting everyone to a target date fund unless they really want to invest in something else.
One of my brothers was/is a college grad, a former USN pilot, and now an airline pilot. Fairly smart dude. Very into finance. Made much better investments over the years than I did. Back in the day I had a bad habit of buying highly speculative stuff then ignoring its progress until after it had boomed and crashed, then I’d sell off the few remaining ashes and do it again. He watched his stuff much more closely & did well.
Anyhow at one point he got laid off from airline piloting & wanted to take up long-haul trucking as sort of his personal attempt at being Mike Rowe in Dirty Jobs. It was intended as a temporary gig as much for the adventure as for the relatively small money it earned.
He tells the story of the day he and a bunch of his truckin’ school classmates started at one of the larger interstate trucking outfits in the Midwest. The HR type hands out the 401K packets & proceeds to drone on for 20-30 minutes and it’s clear nobody has any idea what’s being said. At the end it’s time for Q&A.
Everybody else is asking questions like “Where do I sign on which page again?” “Will this reduce my pay?” Meanwhile Bro is asking about why there are so few fund choices and why they’re all no-name funds with stupid high management fees and low pre-fee historical returns.
That is 80-90% of America right there. His classmates had no business being asked to self-manage their retirement. They were being led to slaughter by a financial gaming system designed by lobbyists and sold to Congress as a way to eventually get away with gutting social security, so we too could have an impoverished mass populace overseen by oligarchs just like the Philippines.
I don’t know if this has been mentioned yet, but I have personally known people who turned down a job or promotion because it would “put them in a higher tax bracket”
Some of them got it when I explained that the higher rate only applies to the money earned after the last bracket limit. Everyone pays 10% on the first $10275. Everyone pays 12% on the income between $10276 and $41775. etc. No one gets re-taxed on the lower brackets if they land a 100k position (24%). Sadly, too many of them didn’t get it.
I blame it on the lack of life skills classes in Jr high and high school.
I have a good friend who owns and operates a couple of small businesses. Last December, he asked me to help him figure out how, using expenses and/or deductions, to get his annual income down below $75k so he wouldn’t have to pay the higher tax rate.
Unfortunately, this is reinforced when someone gets a bonus or a larger than normal paycheck due to overtime. The payroll system withholds taxes at a higher rate since it assumes that you always will have paychecks that large. A $1000 bonus may only show up as a $600 increase in the paycheck due to this higher withholding. Of course, you recover it when you file your taxes, but quite a few people don’t seem to understand. I’ve spent an hour trying to explain it to an engineer who should be good with math. I gave up.
I work in applied science with a bunch of folks with STEM MSs and PhDs and remember with vague horror the time one April (of course it was tax season) I had to explain to some folks on my team how tax brackets and marginal tax rates worked, i.e. not the top rate on all income.
Took about 18 minutes more than it should have (it took 20)
When I think of financial literacy, this is exactly the kind of thing I’m thinking about. Understanding and optimizing investment decisions is well and good, but without decent literacy many people are not going to be in the position of being able to think about investing.
People obviously can’t really understand interest rates, or spending less than you make, or inflation - or tax rates. Tell someone who doesn’t understand these basics about small cap funds and you’ll lose them.
It might also be reinforced by many badly-designed tax credits/deductions, benefits, state/local taxes, etc. that do allow for additional income to be taxed at over 100%. In Ohio, your 26,051st taxable dollar costs $360.69. That’s a pretty narrow window to fall through, but lots of people who have been on food stamps or other similar programs will have had experiences of losing more money than they made, so why wouldn’t they assume that the same idiots who did that also screwed up the tax brackets the same way?
That would make sense if the people who think you pay the higher tax rate on all your income /pay more tax on larger than normal paychecks were people who were eligible for and participated in the sort of programs where one extra dollar of taxable costs you hundreds in benefits - but loads of them aren’t. I worked with people earning close to six figures and when union contracts were settled , we almost always got a large paycheck with retroactive pay. Half of them moaned about how much tax they would “pay” (and didn’t really understand why it wouldn’t matter in the end) even while the other half were filling out new W4s to change the withholding for that paycheck.
This reminds me of my younger brother. We were doing his taxes one year (he always asks me to help him, which is probably a good thing), and when we were finished, he said, “My refund is a lot smaller this year than it was last year.”
I told him, “That’s because you made more money this year than you did last year.”
He nodded, like a man who has just discovered a great bit of wisdom, and said, “Okay, so next year I need to make less money!”
That happened to me this year. It was very confusing, so I Googled it. It took me a while to find a decent explanation, and even then it seemed bizarre that the accounting software couldn’t handle a bonus properly so I ended up contacting HR to confirm it. This is a very strange quirk and it really makes no sense to do it this way.
Knowing it definitely is not basic financial literacy. Not being able to understand it after an hour of a knowledgeable person explaining it definitely betrays a lack of basic financial literacy.
It’s not that the accounting software can’t handle it.
It’s that the tax code as written does not permit anything but the assumption that each paycheck, whether regular or bonus, must have taxes withheld as if that check will be coming regularly all year. The Feds could fix this routine over-withholding of bonuses if they cared to. They don’t seem to care to.
Only at the expense of opening up a bigger can of worms. The current system is simple for employers to implement. Any system that requires some kind of averaging of FUTURE paychecks into the current paycheck tax withholding calculation is going to sink hundreds of thousands of payroll departments.
You know what’s worse than getting a tax refund because you couldn’t adjust withholding on the bonus/retro paycheck? Millions of people having huge tax bills at the end of the year and not having the money on hand to pay them.
Imagine trying to set up a table for withholding for employees whose income is between $800 and $1100 a week for 48 weeks (averaging $950) and between $800 and $5000 for the other four weeks. There could be dozens of such patterns for a single employer.
This is a case where ignorance could be fought, the paystub could include a message “How did we calculate your taxes” with a link to a site that explains it in clear simple terms.
Just kidding. We all know you have to subtract line 17a from line 34 and enter it on line 42. If line 42 is greater than $0, your tax is the greater amount of either line 14, or the amount determined by tax table (23A or 23B, depending on your filing status). If line 42 is less than $0, use form 8263 to determine your tax.
A surprisingly uncommon thing is putting money aside for periodic expenses that WILL come up; or in bookkeeping terms, operating on an accrual basis instead of a cash basis. Having a fund to cover a once-a-year insurance payment instead of scrambling to make the payment for example.
That describes an escrow account, for purposes of property tax and homeowner’s insurance. But that’s often imposed as a condition of the loan, so it’s not exactly something people usually think about or plan. They just make the monthly payment.
People will put the money aside if they are forced to (like an escrow account required by a loan) or if they can choose monthly billing/payments , like paying your estimated yearly electric charges in 12 equal monthly payments rather than paying twice as much in the summer as in the winter. But lots of people don’t do that if they don’t have those options, like property tax/insurance on a paid off house. Some people don’t have to scramble to make those payments but I don’t really understand why the same people who set up the balanced billing for the electric bill don’t put aside a little each month for bills that come once or twice a year.
If you’re financially savvy enough to think like that, you may be investing that money elsewhere for a better return and simply making sure you have sufficient liquidity once a year to pay off the insurance or whatever.
If you’re not, both investing and setting aside money in an escrow account are foreign concepts.
To be fair, there is going to be that group of people who are financially savvy but are also sufficiently risk averse to want the security and predictability of a fixed monthly expense. They also set aside monthly for vacations or expected big ticket expenses like appliances though perhaps not always in dedicated accounts. It’s not a large group from what I can tell.