Thursday, May 03, 2007

The Kids Are Alright

This article on the savings habits of young adults (25 and under) is, how shall we say? Ah yes: DUMB. It is dumb.

Why is it dumb? Let's examine!

1. The author is shocked--shocked!--he is clutching his pearls!--that only 4% of workers 25 and under max out their 401(k)s. Do you know why that is the case, Paul J. Lim of U.S. News and World Report? It is because for a majority of workers 25 and younger (hey look! MSN says that "the median income for families headed by people aged 20 to 29 was just under $28,000 in 2004"), maxing out a 401(k) would involve cutting their after-tax income in half or nearly in half. Paul J. Lim, if I maxed out my 401(k), I would be making $17,000/year before taxes. I pay $7,200/year in rent alone. That is why I am not maxing it out. Seriously, even at a 15% savings rate, you'd have to be making $100K to max out your 401(k). How many 25-and-under folks make that kind of money? Around 4%, you think? Less? As we Gen Y-ers are so fond of saying, DUH.

2. DUH, too, to the only-19%-of-young-workers-fund-an-IRA thing. Consider that most 401(k)-eligible folks who do not contribute to a 401(k) are not likely to contribute to an IRA. Then consider that of the percentage that do contribute to their 401(k)s, many will exhaust their capacity to save before exhausting the employer match, and nearly all will do so before exhausting the contribution limit. There's also a lot of really dodgy language in here, but it looks to me that we're only talking about full-time employees and their IRA savings tendencies, so is it actually that shocking that only 1 in 5 employees age 25 and under has sufficient capacity to save and is sufficiently on top of things to divide her retirement savings between her 401(k) and her IRA? No. It is not that surprising.

3. I particularly like the graphic of the tattooed, soul-patched hip-football-jersey-wearin' youngster that accompanies the article. He is scratching his head in confusion, people. Gosh darn it, U.S. News and World Report, young people never have reasons for our financial decisions! It's just that we're baffled by pieces of paper! In fact, we've almost never seen a real, live piece of paper. What's a "letter"? Is that like an email that you carve into a stone tablet and send by Pony Express?

4. Since we've established that young people tend to be in low tax brackets, how about considering that tax breaks are of substantially less value to us? Not no value, mind you, but less. (Hence the whole point of the Roth.) In the example about medical FSAs, I wouldn't at all be surprised if the margin of error incurred in young people's estimates of their medical expenses were equal to or greater than the tax break, and that money's nonrecoverable. There's also the question of how much hassle it's worth to save forty bucks a year in tax breaks, given young people's lower overall medical costs. I don't use my medical FSA for this reason.

5. Consider what that there are other financially responsible things young people can do with their money. We can save cash for an emergency fund or a down payment on a house. We can pay down student loan debt or consumer debt. These things are all contributors to a strong financial foundation.

Please don't misunderstand me. I would of course encourage all young people to save aggressively, and to do it in the best vehicles available--youth is a great financial opportunity. But do I blame my fellow Manhattan-living, little money-making coworkers for not contributing to their 401(k)s (let alone Roth IRAs and medical FSAs)? Am I surprised that they might find it difficult to do so? Not at all. It's hard. I think there are two main obstacles to utilizing these savings vehicles:

1. We don't have that much money to begin with. It's difficult to give up 10% of your paycheck just to see a 401(k) balance growing in what feels like a pitifully slow fashion. My 8% contribution with dollar-for-dollar match (up to $1,500) will bring me to around a quarter of the maximum contribution level.

2. There is a veil of impenetrability that surrounds savings vehicles. I continue to suspect that these things are made to seem difficult on purpose, when in reality they are not that difficult (email HR person, fill out form, dump contribution in target fund, done). Nevertheless, young people feel baffled by the whole prospect--I certainly did--and there is a serious dearth of accessible information.

I'm just saying, we are not financial morons because we're not all plugged into 401(k)s and Roths. These aren't particularly meaningful statistics, and alarmism about the financial habits of people who by and large have only been working for 2-3 years is patently unwarranted. We're young, we're poor, we're working on it. Chill out.


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Wil said...

Great post!

Older people thinking young people are dumb for not doing the things the older people are (not usually) doing sounds about right. You are abso-friggen-lutely correct that many of the "smart" things that older people do are either impossible or have little current benefit for young people.

The best we can do, is continue to help young people with the things we can, and let the old people go the way of the dinosaur. Even though I've spent 15 years in finance, my parents (nurse and retired x-ray tech) still believe that I don't know what I'm talking about because I haven't "lived" yet. Go figure.

mOOm said...

I think that young people who are maxing out retirement accounts are dumb :) unless they are earning a truly huge amount...

Mercedes Lopez said...

Max out, that would be the day. I'm contributing the full match now to my 401k. Once I realized that it really was free money and that I really do spend most of my money on crap. I'm actually 100% vested which is why I like my 401k; if I quit I still get it all except the fees associated with cashing out early on some of the funds as I switch them to an Trad IRA.

I have no real plans of maxing out my Roth until my finances improve. Hence, I'm making plans to find other employment if I can't get the position that I want.

Caroline said...

I would also think that time is a major factor. By contributing to your 401(K) or IRA (sorry if that's wrong, I'm not American, so I'm a bit unsure of the terminology), you're basically gambling that you will live to retirement age, as morbid as that sounds.

If you're a baby boomer, you'd probably want to contribute as much as you can because the chance that you won't die in the next five to ten years, is pretty high.

If you're only 25 years old, then you have to gamble that an accident or illness won't befall you, and that you will still be alive in 30 to 40 years.

Even if you assume you will live to benefit from your retirement savings, why would you put all your spare money in your 401 or IRA when you could put it towards a mortgage, which is a form of retirement savings in itself, as you can save yourself housing expenses when you no longer have a salary.

Mercedes Lopez said...

One someone can still benefit if I die early; my brother in this case and my mother.

I can use the funds without fee for buying my first home if I read the terms correctly.

So really, it just makes me manage my money better. I was literally buying junk all the time. Eating out virtually every day plus there was money that went missing literally. I had been pretty good at managing my money before so I decided that I better get back to it especially when I got a couple of setbacks like getting sick and stuck with large medical bills in relation to what I made.

SavingDiva said...
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