Barbara O'Neill: The 403(b) Lifecycle Catch Up Strategies for Late 403(b) Plan Savers
May 17, 2022
Guest post by Dr. Barbara O’Neill, CFP®, AFC®
In an ideal world, every eligible 403(b) participant would enroll in a (preferably 403bwise A rated) 403b (or 457b) plan on their first day of work. Doing so provides the maximum amount of time to build wealth.
In the real world, this often does not happen. Instead, people get a late start for a variety of reasons (e.g., tight budgets, procrastination, and student loans). Some even reach their late 30s (or mid-40s) with little or nothing set aside for retirement.
Unfortunately, compound interest is not retroactive; i.e., you cannot earn interest on money that was never saved years before. However, that does not mean that you cannot make up for lost time. You can.
This post describes two types of catch-up strategies: before retirement to increase total savings and after retirement to decrease the amount of savings required. All of these catch-up strategies involve trade-offs; e.g., spend less to save more or downsize to reduce living expenses.
The post concludes with a brief research summary, three “need to knows,” and six take-away action steps.
“Front End” Catch-Up Strategies
Increase 403(b) Contributions
The easiest times to save more are when pay increases or household expenses (e.g., child care and car loan payments) end because cash flow is not affected. According to the Retirement Booster calculator from Advantage Publications, saving 1% more of a $60,000 salary starting at age 35 will produce $70,002 at age 65 assuming contributions to age 65, a 6% average return, and 3% annual pay increases.
Accelerate Debt Payment by Spending Less
The sooner debt is repaid, the sooner monthly payments can be reallocated to savings. To “find” money for larger debt repayments, track spending for a month and identify discretionary expenses that can be cut out or reduced. Next, decide how to pay off debt faster. Some people pay more on highest-interest debt first and others start with their smallest balances. Both types of calculations can be done using PowerPay.
Generate “Side Hustle” Income
Many 403(b) plan participants have skill sets that can provide extra income as tutors, consultants, and much more. Income earned from freelancing can offset smaller “day job” paychecks resulting from larger 403(b) contributions. In addition, self-employment income provides an opportunity for tax-deductible business expenses and Simplified Employee Pension (SEP) deposits.
Work Longer (Than Planned)
Delaying retirement, even by 1 to 2 years, provides additional income to save, postpones asset withdrawals so savings can continue to grow with compound interest, and may increase Social Security and pension benefits. Social Security benefits are based on a worker’s highest 35 years of earnings and defined benefit pensions use a formula based on earnings and years of service.
Invest More Aggressively
Stocks have historically outperformed other asset classes (e.g., bonds and cash assets) over the long term. Placing a higher percentage of 403(b) deposits in stocks could result in a larger accumulation at retirement vs. more conservative plan choices. Key factors are investment risk tolerance and access to steady income via a pension and/or Social Security. Take this online quiz to determine your personal risk tolerance level.
Reduce Investment Costs
Both within and outside a 403(b), select low-expense investments so fees don’t erode account earnings. When playing catch-up, it is important to keep as much return as possible. Review the 403bwise web site and Facebook Group for information about vendor ratings and how to exit a bad 403(b). For mutual funds in taxable accounts, compare expense ratios in the “Fund Operating Expenses” section of prospectuses.
“Back End” Catch-Up Strategies
Trade Down
When someone downsizes to a smaller and/or less expensive home, proceeds from the sale are available to invest as a nest egg for future living expenses. For example, selling a $350,000 house and buying a $200,000 condo would provide $125,000, assuming $25,000 in sales costs. In addition, home maintenance costs, property taxes, and utilities are generally reduced on a smaller property.
Practice “Geographic Arbitrage”
Moving from a high-cost geographic area to a less expensive area (e.g., urban Connecticut to rural Texas) can substantially reduce living costs and reduce the amount of money needed for retirement. Some older adults seek out states without income taxes (AK, FL, NV, SD, TN, TX, WA, WY) or those that don’t tax all or part of pensions, 403(b) or IRA distributions, and/or Social Security. Online tools can assist with this.
Work After Retirement
Paid employment after leaving a pre-retirement career reduces the amount of money required to be withdrawn from investments. This stretches out how long a limited amount of savings will last. For example, $20,000 of earnings is equivalent to a 4% withdrawal from a $500,000 nest egg. Continued work also provides opportunities for socialization and a sense of purpose.
Tap Home Equity
Reverse mortgages are available to homeowners age 62+. Borrowers receive a lump sum, line of credit, or monthly payments based on three factors: age, amount of home equity, and current interest rates. Reverse mortgages are repaid when borrowers no longer own the home because they decide to sell it, cannot live independently, or die. With sale-leaseback arrangements, homeowners sell their home, typically to a close family member, and lease it back. The proceeds from the sale of the home are available to spend or invest.
Tax-Efficient Withdrawals
Savings lasts longer when withdrawn in a tax-efficient manner. Generally, this means first tapping taxable accounts (i.e., savings outside traditional IRAs and 403(b) plans), since taxes were already paid each year on investment earnings, and/or tax-free assets, such as municipal bonds, where no tax is due. If possible, most late savers should wait until age 72 to start tapping tax-deferred accounts so they can grow longer. Exception: 403(b) account holders with large account balances. Withdrawals from Roth IRAs can come last because they have no minimum withdrawal age.
Other Income Sources
Some retirees play catch-up with a variety of other strategies including income from rental properties, accessing public benefits (e.g., Extra Help for Medicare Part D, SNAP, senior food programs, and utility assistance), taking in borders for income, ongoing financial support from family members, a settlement or an inheritance, mortgage principal pre-payment, and shared housing arrangements with family or friends.
Research Results
A 2019 study compared the relative impact of working longer versus saving more in helping late savers catch up. Results indicated that delaying retirement by just 3-6 months has the same impact on retirement standard of living as saving 1% more of earnings for 30 years. Further, the relative power of saving more money is lower if the decision to save more is made late in someone’s career. Example: increasing savings by 1% ten years before retirement has the same economic impact as working between 1-2 months longer.
Three (More) Things
- Workers age 50+ can make an additional $6,500 catch-up contribution to 403(b) plans on top of the maximum $20,500 for all workers, for a total of $27,000 in 2022. Ten $6,500 deposits made over a decade, earning 6% on average, would grow to $85,675.
- For 403(b) plans, there is an additional catch-up contribution in addition to the one described above. Plan participants who work for the same employer for at least 15 years can contribute up to $3,000 more per year, up to a total of $15,000, if their plan permits.
- 403(b) participants who earn under IRS income limits ($34,000 for singles and $68,000 for married couples filing jointly in 2022) can receive a federal income tax credit of 50%, 20%, or 10% of their plan contribution (depending on adjusted gross income), which effectively reduces the out-of-pocket cost.
Six Smart Strategies
No. 1: Stop Beating Yourself Up
Stop dwelling on what you could/should/would have done- but did not- to prepare for retirement. I got a late 403b start too. The past is over. It is now time to create a personal retirement catch-up plan by selecting one or more strategies described above. Remember this saying: “If it is to be, it is up to me.”
No. 2: Automate Your Finances
Take action- once- to automate financial transactions; e.g., investment deposits and mortgage principal pre-payments. Automation sets people up for success without the need for ongoing thought and discipline.
No. 3: Practice Tax Diversification
Catch up in taxable and tax-free accounts, as well as a 403(b). This way, you will have assets that are taxed differently in retirement. For example, for taxable accounts, many stock index funds offer automatic investment plans where regular deposits can be made to purchase shares. Roth IRAs are a popular choice for tax-free investing.
No. 4: Start Small
Any retirement catch-up savings is better than none. Examples include saving 1% more of pay in a 403(b) or $50 monthly deposits into a taxable account investment. Ramp up the amount as cash flow improves.
No. 5: Combine Catch-Up Strategies
Individual catch-up strategies can also be combined for greater economic impact. For example, investing more money in a 403(b) plan while working and moving to a smaller home and/or less expensive geographic location after retirement or retiring later and working after retirement.
No. 6: Monitor Your Progress
Some people compare themselves to savings benchmarks by age. For example, Fidelity investments recommends saving 3x your salary by age 40, 6x by age 50, 8x by age 60, and 10x by age 67. Others use annually updated net worth statements (assets - debts) or online retirement calculators.
In Summary
It is never too late to take action to achieve financial security in later life. Even if you are a late 403(b) saver, you still have options! Investment time horizons are the length of peoples’ lives- not their age at retirement. If you are 40 years old and live to age 90, you have 50 years for savings to grow. Long time frames also reduce market volatility. Today is Day #1 of rest of your financial life. Make the most of it!
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Dr. O'Neill is the owner/CEO of Money Talk: Financial Planning Seminars and Publications where she writes, speaks, and reviews content about personal finance. She is a Distinguished Professor Emeritus at Rutgers University and a long-time 403(b) plan participant.