Rosy Wage Projection Now, Wilted Retirement Later
TONY COX, host: And now to matters of personal finance. Retirement has different meanings, depending on the stage of your career. Many finance experts agree that given today's economy, retirement planning should be first on your priority list. But new data suggests a lot of people aren't taking their future retirement as seriously as in today's economy, retirement planning should be first on your priority list, but new data suggests a lot of people aren't taking their future retirement as seriously as they should. Want proof? A record number of consumers are taking out loans against their retirement accounts.
Not only that, they're often overestimating the future value of their retirement because of lower contributions based on lower wages and periods of unemployment. All that could lead to a double-barreled shortfall when the time to retire comes.
We wanted to find out just how consumers could avoid this retirement nightmare and get some practical advice to start using now before it's too late. So we called money coach Louis Barajas. Louis, how are you?
LOUIS BARAJAS: I'm doing fantastic, Tony.
COX: A research firm based in Chicago looked at just under two million employees and found that nearly 28 percent of people who have 401K retirement savings plans also had taken out loans against them. This was last year. That's a five percent rise from 2005. Typically, retirement accounts are for retirement, of course. And there are penalties for dipping into those accounts early. So, why are so many people tempted to tap into them prior to retirement?
BARAJAS: Well, the problem, Tony, is that most people are starting to use their 401K as their emergency reserves, their emergency money. And they can't look at it that way. They actually have to reframe how they're putting away their retirement money and see it as very sacred money.
But, you know, when we take a look at the numbers, it seemed like last year about 28 percent of the people had actually taken out loans. And the problem is of that 28 percent that have taken out loans on their 401Ks, 70 percent will default on those loans and then the people have to pay taxes on that, federal taxes, state taxes. They'll have to pay the federal penalty and you'll have to pay a state penalty on that. And it can amount to as much as 50 percent of what you've pulled out.
COX: I want to go into that a little deeper with you, because loans that you get against your retirement usually have lower interest rates than credit cards, let's say. So it may appear to some consumers that loans against your retirement could be cheaper and that it may also be assumed that there is less of an impact on you financially.
Now, you've mentioned the problem with having to pay taxes. Are there other financial consequences of taking out this money early?
BARAJAS: Well, the consequence is that you're not going to have enough for retirement. But we have to understand what people are - or figure out why they're taking out their money. Now, the problem is that we've been in a really tough economy. The recession supposedly ended, but it's not - the economy is not getting any better. People are still losing their homes.
And, you know, if you're caught in a bind in which you need money and you have to make a mortgage payment, you have to feed your children, it might be the place that you're going to have to pull money out. But if for some reason you haven't taken a vacation in two or three years, and all of a sudden you're looking at that 401K as vacation money, then you need to start thinking about, you know, what are your needs versus your wants and how this money is going to affect your overall retirement long term.
So that's what I'm mostly concerned, because, you know, Tony, I don't need a crystal ball to let people know what their future is going to be like when it comes to retirement if they're not putting any money away. And if they are, if they're actually using it.
COX: You're listening to TELL ME MORE from NPR News. I'm Tony Cox sitting in for Michel Martin.
And we are talking with money coach Louis Barajas about retirement savings and the pitfalls of dipping into them early. Now, Louis, here's another part of this story that I want to talk to you about. Data collected from the U.S. Census Bureau is suggesting that American workers can expect to see a plateau in their earnings by their 40s.
Now, this finding might deliver a blow to the confidence of those who think that their pay will continue to increase right up until retirement. It means you're not going to be able to put as much in as you think you may be able to put in.
BARAJAS: Absolutely. What's happening is that most Americans have become overconfident of what their earning potential is. The reality is that most people, like, in their late 40s, have reached their earning potential. And what I see consistently among the average person out there working with financial planners, is they haven't factored that information into their financial plans or their retirement plans.
They assume that their income is going to grow proportionately when they get in their 40s and 50s and 60s. And the problem, Tony, is that if you're losing your job and you're in your early 50s, it's very difficult to find another job earning the same amount of money that you were earning before. And these are factors that people need to understand and also apply to their retirement plan.
COX: What specifically would you suggest that people do? Let's say, for example, Louis, that you notice that your salary was stagnant and you only saw an increase for cost of living or annual salary increases that are small. What things should you be doing to prepare for retirement in those situations?
BARAJAS: First of all, what I like to do is I want to make sure that if we're projecting towards the future, of what somebody's retirement needs are going to be. They need to actually be very conservative with the numbers that they're using of what they think their return on their retirement plan is going to give them.
I've seen plans where people are projecting, you know, 9, 10, 11 percent rates of return on their money. And I think that's way too high. They need to bring those numbers down. Secondly, they need to project - instead of making more money than think they're going to make, is maybe take a 20 percent deduction on what they're earning just so they can be conservative, just so they can see what actual numbers they need to get to. That's the one thing.
The second thing is that, you know, we're in a new economy. People have to become very open to moving in other directions and learning specific new skills for the new job market because what - there's plenty of good-paying jobs out there. But some people have become very stagnant in their jobs and have stopped learning.
So another way to look at it is, also, are you investing in yourself and in your skills and are you becoming better and providing more value out there to either the employer or to your clients or customers.
COX: When it comes to your retirement account, is there such a thing as putting too much money into that account too soon?
BARAJAS: Not for most people. And the problem is that, you know, you have to start right away. What we have is this wonderful thing called compounding of money. And that's based on the whole issue of time. And the sooner you begin, when I mean the sooner, meaning today, the easier it is.
Now, most people that I see that are retiring in their 60s and 70s and have saved a significant amount of money, almost 100 percent of this is coming from their 401Ks. And the only way they've done it, Tony, is that they had automatic payroll deduction plans coming from their payroll going into a retirement plan.
And if they did not touch that money and let it grow for 20, 25 years, they're going to have a very good - or decent retirement, what I call financial dignity in retirement. And that's what people need to understand. Because left on your own - and you have to cut a check every week to put into a retirement plan, you're rarely going to do it because there's always some obstacle that gets in your way.
And so pay yourself first, do it through a payroll deduction plan, have it taken out from your checking account into a retirement plan, but get it done automatically and get it done right away.
COX: Louis Barajas talks matters of personal finance with us on a regular basis. His new book is called "My Street Money: A Street Level View of Managing Money from the Heart to the Bank." He joined us from Costa Mesa, California. Louis, thank you again.
BARAJAS: It's always a pleasure, Tony.
NPR transcripts are created on a rush deadline by a contractor for NPR, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of NPR’s programming is the audio.