Above is a historical chart of US household retirement assets that helps visualize the shift from mostly pensions to mostly a combination of defined contribution plans (401k, 403b, etc) and IRAs. Pension share has gone from nearly 80% of total assets in the 1980s to about 40% today. The blips upwards in 2001 and 2009 are more a function of stock market drops than anything else. I find it interesting that annuity use is not increasing at all, i.e. people are not creating more “DIY pensions”. Found via WSJ Daily Shot.

Below is a graphic of the percentage of households who have any retirement plan at all, grouped by income percentile. This means it counts any family with one person with any retirement plan of any type with any amount saved. Via Bloomberg article about state-mandated Roth IRAs.

My big-picture concern is – What happens when those who started jobs in the 1980s and 1990s retire in the 2030s and 2040s with no pensions? As shown above, the majority of the lowest-income workers have no retirement plan at all. If you include the highest-paid workers, the average 401(k) at retirement age is currently about $100,000. In contrast, I ran an annuity quote and a pension that pays $50,000 a year inflation-adjusted is roughly the equivalent of having $1,000,000 saved in a 401(k).

More individuals are finding themselves in charge of their own retirement every day, whether they like it or not. This is a very serious responsibility. Warren Buffett has a plaque in his office with the following saying on it:

A fool and his money are soon invited everywhere.

Lots of money floating around means lots of “helpers” will pop up. Big banks. Start-up smartphone apps. Even Overstock.com now wants to help you with investing. Read the Gotrocks parable and beware high-fee helpers.

Employer-based retirement plans like the 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan are not perfect, but they are often the best available option to save money in a tax-advantaged manner. For 2018, the employee elective deferral (contribution) limit for these plans increased to $18,500 (they are indexed to cost-of-living). The additional catch-up contribution allowed for those age 50+ is $6,000.

Here’s a historical chart of contribution limits for the last 10 years (2009-2018).

The limits are the same for both Roth and “Traditional” pre-tax 401k plans, although the effective after-tax amounts can be quite different. Employer match contributions do not count towards the elective deferral limit. Curiously, some employer plans set their own limit on contributions. A former employer of mine had a 20% deferral limit, so if your income was $50,000 the most you could put away was $10,000 a year.

Also see: IRA Historical Contribution Limits 2009-2018

Sources: IRS.gov, IRS.gov COLA Table [PDF]

Individual Retirement Arrangements (IRAs) are way to save money towards retirement that also saves on taxes. Each year, an individual’s total contributions to both traditional and Roth IRAs cannot be more than a certain dollar limit. If you are age 50+ at some time during the year, you can also contribute an additional amount. (You can’t contribute more than your taxable compensation for the year.)

Note that there are also income restrictions on Roth IRA contributions, although you may be able to get around these income restrictions with a Backdoor Roth IRA (non-deductible Traditional IRA + Roth conversion).

If your income is low enough (less than $63,000 AGI for married filing joint), the Saver’s Credit can get you back 10% to 50% of your contribution (of up to $2,000 per person) when you file your taxes.

Since I enjoy visual aides, here’s an updated historical chart and table of contribution limits for the last 10 years. I’m happy to say that we’ve both done the max since 2004. Have you been taking advantage of your potential IRA tax break?

Also see: 401k, 403b, 457, TSP Historical Contribution Limits 2009-2018

Sources: IRS.gov, IRS.gov COLA Table [PDF]

In 2010, the tax laws were changed to eliminate the income limits on conversions from Traditional IRAs to Roth IRAs. Since Roth IRAs still have income limits on direct contributions, this opened up a “backdoor” where high-income individuals could first contribute to a non-deductible Traditional IRA and then immediately convert to a Roth IRA. If there were no capital gains upon conversion, there would be no taxes due. Thus, the term “Backdoor Roth IRA”.

Some financial experts fretted about the legality of this move due to something called the step transaction doctrine. Some financial advisors instructed people to take special steps to help ensure the legitimacy of their Roth IRA conversions. You also have to be careful if you have other Traditional IRA accounts that you are not rolling over (“IRA aggregation rule”).

Even with all this discussion, there was never any official acknowledgement of this tax move. In past years, there were explicit budget proposals that would have curbed this option. Some argued that this talk itself was implicit acknowledgement that it was legal. Confused yet?

Apparently, the official acknowledgment finally came with the new tax law when they stopped allowing Roth IRA recharacterizations (undos). According to this Forbes article Congress Blesses Roth IRAs For Everyone, Even The Well Paid, a conference committee report by Congress included the following footnotes. Thanks to reader Abel for the tip.

²⁶⁸ Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA, as discussed below.

²⁶⁹ Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.

²⁷⁶ The provision does not preclude an individual from making a contribution to a traditional IRA and converting the traditional IRA to a Roth IRA. Rather, the provision would preclude the individual from later unwinding the conversion through a recharacterization.

²⁷⁷ In addition, an individual may still make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA, but the provision precludes the individual from later unwinding the conversion through a recharacterization.

Do these footnotes end all speculation? Ed Slott seems to think that this indicates “intent” by Congress, and he is a respected tax source. The same conclusion is also drawn by Natalie Choate in this Morningstar article.

Both my wife and I have made non-deductible Traditional IRA contributions every year since 2010. I think if it was really an “unintended loophole”, they would have closed it by now (as with Social Security benefits). I am not a tax professional, I’m just a guy who wishes we didn’t need experts to interpret every little thing. If there were any people who needed additional convincing, perhaps this will give them the confidence to proceed.

Instead of just looking at one year of returns, here’s an annual exercise that helps you look at the bigger picture. You may know the 10-year historical return of the S&P 500, but most of us didn’t just invest a big lump sum of money a decade ago, and most of us don’t just invest in the S&P 500.

Investment benchmark. There are many possible choices for an investment benchmark, but I chose the Vanguard Target Retirement 2045 Fund. This all-in-one fund is low-cost, highly-diversified, and available in many employer retirement plans as well open to anyone with an IRA. In the early accumulation phase, this fund is 90% stocks (both US and international) and 10% bonds (investment-grade domestic and international). I think it’s a solid default choice where you could easily do worse over the long run.

Investment amount. For the last decade, the maximum allowable contribution to a Traditional or Roth IRA has been roughly $5,000 per person. That means a couple could put away at least $10,000 a year in tax-advantaged accounts. If you have a household income of $67,000, then $10,000 is right at the 15% savings rate mark.

A decade of real-world savings. To create a simple-yet-realistic scenario, what would have happened if you put $10,000 a year into the Vanguard Target Retirement 2045 Fund, every year, for the past 10 years. You’d have put in $100,000 over time, but in more manageable increments. With the handy tools at Morningstar and a quick Google spreadsheet, we get this:

For every $10,000 you put in annually over the last 10 years, you would have a ~$80,000 investment gain on top of the $100,000 in contributions. For example, if you were a couple that both maxed out their 401k and IRAs at roughly $20k each or $40k total per year, that would leave you with a gain of roughly $360,000 over the last decade (and a total balance of $760,000).

Some of that money was invested right before the crash in 2008/2009, and some has only been in the market for a few years. $10,000 invested in the beginning of 2008 would have dropped down to $5,500 in value before the rebounding. Not every year will turn out to be as good as this year, but taking it all together provides a more balanced picture.

Earn money, save a big chunk of it, and then invest it in your choice of productive assets. Keep calm and repeat. The investment side of our path to financial freedom can be mostly explained by such behavior. (Add in maxing out a 401(k) each year as well if you can.) Something as accessible and boring as the Vanguard Target Retirement Fund can make you rich. You don’t need a secret trading strategy or exclusive hedge fund manager.