Nov 20 2017
One of the most important things Americans need to do is save money for retirement. While retirement may seem far off, small steps today can make a big difference tomorrow. Which is why I pushed the Ways and Means Committee to ensure retirement savings remain untouched throughout the tax reform negations.
A Roth IRA is taxed before the money goes into the account, whereas a traditional 401(k) has its money taxed when the money is withdrawn from the fund. Currently, Americans have the freedom to choose which type of fund they would like to invest in. Additionally, the law also enables you to save more as you near retirement; you are able to contribute a maximum of $18,000 annually to your 401(k) if you are under 50, and $24,000 if you are over 50.
When deciding which retirement fund to use, whether a Roth IRA or a traditional 401(k), there are a few factors you should consider. First, you must make a prediction – will the individual tax rate be more favorable now or in the future. The second factor that you need to compare is your financial reality today as compared with your expected financial reality in the future. For example, your family may have child care expenses, student loan payments, or mortgages, forcing you to live paycheck to paycheck for a period of time. These significant expenses, which can occur early and mid-career, impede your ability to save. On the other hand, those later in their career are likely at their wage peaks, with a much greater ability to save. They’re also more likely to be focused on retirement savings at this point.
When making decisions about retirement savings, it is also important to consider how interest compounds. This is essentially interest on interest. For example, if I begin saving $100 a month starting at 25 years old, with a compounded interest rate of 5%, then when I turn 65 I will have more than $150,000 saved. Whereas if I only begin saving when I turn 40 years old, even if I invest more money in the short term, I will still have less in retirement. For example, if I invest $200 a month with a 5% compounded interest rate (double the amount of the first scenario), then when I retire at 65 I’ll only have just over $56,000. Meaning that if I begin saving early, I’ll have almost 3x as much money at my retirement then if I only begin saving later in life.
Moreover, each retirement fund has its benefits, which is why the American people should be able to choose which is better for them. By investing in a 401(k), there is a degree of uncertainty as to the rate at which your savings will be taxed at, whereas with a Roth IRA, you know exactly how much money you’ll have at the end of the day. With a 401(k) there is the psychological benefit of seeing your money grow at a faster rate, thereby incentivizing you to save even more. At the end of the day, it is crucial to bear in mind the effects of interest compounding, employer match, and contribution limits when deciding how to invest in your retirement. Of course, good financial habits would dictate that it’s better to save, but when the majority of Americans have less than $1,000 in their bank account at any given time, we really need to do better.
Throughout the tax reform process, I have been a consistent and active voice in ensuring that no significant changes be made to our retirement system. Some have proposed that we eliminate the option to invest in a traditional 401(k) – an idea that would take choice away from the American people. The American people deserve to be able to choose how to save their money. That is why throughout this process I fought for 401(k)’s, and have worked with the rest of the Ways and Means Committee to ensure they remain untouched. I am proud to say that our efforts have paid off and that there are no significant restrictions on retirement savings in the Tax Cuts and Jobs Act.