Smart Money Podcast: Saving at the Pump and 401(k) limits

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Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions.

This week’s episode starts with a discussion of ways to save on gas now that prices are once again rising.

Then we pivot to this week’s question from Chelsea, who can’t contribute more than 8% to her company 401(k) because she’s considered a “highly compensated employee.” Her income also makes her ineligible for a Roth, so she’s looking for other options. “My company does offer a deferred compensation plan, but after reading some of the terms, I am wary of signing up. The biggest one that makes me cautious is the fact that the company can take your money from the deferred compensation plan if they become insolvent. That seems like a high risk. Any advice on how to increase my retirement contributions or other options I'd have to save?”

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Our take

Making too much money sounds like a good problem to have, but it can complicate saving for retirement.

Your ability to put money into a 401(k) can be reduced if you’re one of the higher-paid employees at your company and not enough of your lower-paid colleagues contribute. That’s because of IRS anti-discrimination rules that are meant to keep tax-advantaged retirement plans from benefiting only the best-paid employees.

A high income also could prevent you from contributing directly to a Roth IRA. Roths don’t offer an upfront tax deduction, but withdrawals are tax free in retirement. The ability to contribute phases out with modified adjusted gross income of $124,000 to $139,000 for singles in 2020 and $146,000 to $206,000 for married couples filing jointly. (You could do a “back door Roth” by contributing to a traditional IRA and then converting it to a Roth, since there’s no income limit on conversions, but that could trigger a tax bill.)

Some companies offer deferred compensation plans that allow you to set aside more pre-tax money. But these plans differ from 401(k)s in significant ways. There are no early withdrawal penalties, but the money also isn’t portable — you can’t roll it over to another plan when you leave and the money is paid out. Your deferred compensation also could be at risk if the company can’t pay its creditors. Your 401(k) account, by contrast, doesn’t belong to the company, and creditors can’t take your retirement money if the company goes broke.

Another way to save for retirement is with a regular, taxable brokerage account. You won’t get a tax deduction, but you can qualify for favorable capital gains tax rates if you hold your investments for at least a year. There are no limits to how much you can contribute and no early withdrawal penalties, plus you typically have many more investment options than a 401(k).

Our tips

Understand your options. Each type of retirement account has its advantages and limits. Investigate what’s available, and consider talking with a financial advisor to determine what’s best for you.

Know how much to save. The amount you put aside is typically more important than where you put it. A good guideline is to save 15% of your net income for retirement.

Regularly increase your contributions. Many plans offer automatic escalation, so you can increase the amount you contribute over time.

More about retirement savings options on NerdWallet:

Have a money question? Text or call us at 901-730-6373. Or you can email us at [email protected]. To hear previous episodes, return to the podcast homepage.

Sean Pyles: Welcome to the NerdWallet Smart Money Podcast, where we answer your personal finance questions and help you feel a little smarter about what you do with your money. I'm Sean Pyles.

Liz Weston: And I'm Liz Weston. This episode, we're answering a listener's question about how to manage 401(k) contributions as a highly compensated employee. But first, in our This Week In Your Money segment, Sean and I are giving you some of our favorite tips for saving at the pump.

Sean: That's right. I am sorry to report that our long stretch of low gas prices, largely a result of the pandemic and everyone staying at home, has come to an end. In fact, according to GasBuddy, an app that helps you find the cheapest gas, by the end of February, prices had gone up for seven weeks in a row.

Liz: Wow, that's a lot. So Sean, I know you're somebody who loves to drive, and saving money at the pump is probably important to you as well. So how are you saving on gas?

Sean: All right. Well, for me, it comes down to two different factors. One is how you get gas and the other is how you drive and maintain your car. So let's talk about how you get gas first. Obviously, the station where you get your gas is really important. You want to balance finding the best prices with the quality of the gas. I only typically get gas from two different companies, because I know that some of the ones that might have the lowest prices, they may actually water down their gas, and you don't want that. It's not good for your car. So that's one thing that I do. In my neighborhood, there are two different Chevrons about three blocks away from each other. One has gas that is 20 cents cheaper consistently, for some reason. I think it's because the one that's a couple of blocks away is not on as busy a road, even though it's technically the same type of gas.

Liz: Yeah. I think that's a real key to it. If you're in a place where there's a lot of traffic, I think you pay more for gas, right?

Sean: Yeah. Right. And one thing I learned, actually from GasBuddy, is that if you get gas earlier in the week, you can save at the pump. Apparently, Monday has the least expensive gas, and it just goes up over the week. And Friday is the busiest day for folks to get gas, and it tends to have the highest prices too.

Liz: OK. Well, I have a Volt, which is a hybrid plug-in, so I rarely go to the pump anymore. But when I do, I don't want to use a debit card. I'm just thinking that's not very safe.

Sean: Well, you give up certain protections when you use a debit card versus a credit card. And I know that most of us, myself included, don't tend to have cash on their person, but if you do, you can use that, and that can often save you some money as well. It also might be worth your while to look into getting a credit card that does give you benefits at the pump. I've been driving a little bit more lately just to get out and see different areas. I've been cooped up at home for the past year or so. I'm getting that itch. And I've been looking into these cards, and I'm thinking about taking one out. Haven't really pulled the trigger yet. Is this something that you've ever done, Liz?

Liz: My husband has a gas-guzzling sports car, so the last time gas prices went up, I started really paying attention, and we found one that has a pretty good rate of rewards. Some people like just a general cash-back card, and maybe some of those give you extra rewards on gas. And some people like, specifically, a gas card. We chose one that gave us a good return on groceries and on gas.

Sean: OK. Because that's where you spend your money, so that makes sense for you.

Liz: Yeah, exactly.

Sean: And one thing that is kind of particular to where I live. Portland is right at the border with Washington State, and Washington actually has some of the most expensive gas in the country. I think it's right behind California and Hawaii. They're in the top three for most expensive gas in the country. And I occasionally venture into Washington, and even if my gas is less than a quarter of a tank, where I like to fill it up, I'm going to wait until I get home to Portland, because gas is less expensive.

Liz: Do you guys still have that thing where you have to let somebody else pump your gas?

Sean: Yes. And it is the bane of my existence. As an impatient person, I like to just get out, fill up my gas, and go. But alas, it is illegal to pump your own gas in the state of Oregon. And so, even though I have to wait for someone to pump my gas, I'm fine waiting through that if it means I'm going to save some money at the pump.

Liz: OK. I grew up in the Northwest, and I should remember it, and I forget it every time I'm up there. It's like, "Why can't I do this? This is ridiculous."

Sean: I know. Well folks who are from here don't know how to pump their gas. I have friends in college, in New Jersey, same thing. They have no idea how to do it, which is mind-boggling to me.

Sean: But anyway, I want to move on to the second part now, of how you can save on gas. And this really comes down to not using as much, how you drive your car, really. So Edmunds, the car shopping website, has some great tips for this. They ran some tests on some common myths about how to improve your fuel efficiency, and their findings were pretty surprising.

Sean: So one is that, when you can, use cruise control. And this is something I've heard a lot growing up, it's just better when you're on the highway, especially, to use cruise control. But what they found is that when you use cruise control, it can actually result in up to 14% savings in fuel efficiency. Mileage is going to vary depending on your terrain. If it's hillier, like where I am in Oregon, you might not want to use it as much. But if it's a flat road, go ahead and use cruise control. It actually makes driving a lot easier too.

Liz: That's a great suggestion.

Sean: And next one  — this is something that I have to tell myself almost every time I get on the highway, especially with the slow Oregon drivers — is to cool it on the road rage. Edmunds found that when you drive slower, steadier, being a little bit less of a manic driver, it can save you up to 37% in fuel efficiency compared to more aggressive driving, which is enormous.

Liz: It is. And it's true, even if you've got a hybrid or an electric car. My car is mostly in electric mode, and I love the zippiness of just stomping on that accelerator. But yeah, not too great for energy savings.

Sean: Yeah. I have to lighten my lead foot, because I love to just speed down the highway. But anyway, I end up paying for it at the pump, so that's it. All right. And then one last one that I really want to put out there, because I don't think a lot of people think about this, is that it's really important to avoid idling as much as you can. And it can be hard to do this, especially in the colder months. But Edmunds recommends turning off your car if you're going to idle for more than a minute, because it saves gas, and it's also better for the environment.

Liz: A lot of new cars actually do this for you, and it can be really startling if you're not used to it. And some people actually turn that feature off, because every time they stop at a stop light, their engine is turning off. But these are not like the olden days when cars had to warm up. They actually function fine that way. You can leave that feature on.

Sean: Right. Well, one thing my car has is an eco mode, and I turn that on every time I get in the car, because I play a little game with myself, where I like to see how many extra miles per gallon I can get from one time I fill up my gas to the next, because it keeps track of that. And then it also tracks my overall MPG, my average of that. And when I bought my car last May, it was at 22 miles per gallon, which is not great. It's a crossover, so it's not the smallest car, but in the months that I've had it, I've been able to raise my average MPG up to 25 miles per gallon, so I'm pretty proud of that.

Liz: That's a pretty significant increase. Yeah.

Sean: Yeah. Right. It's the combination of eco mode and mostly using cruise control when on the highway, I think. Yeah. All right. So those are some pretty easy go-to ways to save on gas. I know it hurts every time you have to fill it up, it gets more and more expensive, but I hope this helps you all save some cash out there.

Sean: Let's get onto this episode's money question, which comes from Chelsea. She writes, “I have a question that has made me pretty confused over the past couple of years. I'm a pharmacist for a grocery chain, and because the income levels vary so greatly at my work, I am considered a highly compensated employee to my 401(k) plan. This limits the amount of my paycheck that I can contribute to my employer-sponsored 401(k) plan. I've done some research on it, and it looks like I would not be qualified to open a Roth IRA due to this income status. I'm trying to figure out what other ways I can invest for my retirement. I'm only able to put 8% of my paycheck into my 401(k) without triggering a check sent back, so no, I'm not able to contribute the max yearly allowable. My company does offer a deferred compensation plan, but after reading some of the terms, I am wary of signing up. The biggest one that makes me cautious is the fact that the company can take your money from the deferred compensation plan if they become insolvent. That seems like a high risk. Any advice on how to increase my retirement contributions or other options I'd have to save? Thanks for your advice.”

That is a doozy of a question, but fortunately, I have investing Nerd Kevin Voigt to help answer Chelsea's questions. So let's get on to it. Hey, Kevin, welcome back to the show.

Kevin Voigt: Thanks for having me back, Sean.

Sean: So let's just dive into it. Our listener Chelsea is in quite the pickle with her retirement contributions. Her question is quite technical, so I want to unpack what it means to be considered a, quote, "highly compensated employee," as it relates to 401(k) contributions. So what's going on there?

Kevin: Well, I think the first thing I would recommend in this particular situation is for Chelsea to consult with a fee-only financial advisor. Her situation is complex enough that it would be beneficial to lay out her full financial situation with a trusted professional to get the most accurate, bespoke advice possible. Also important to note, we are not licensed financial advisors, so you would definitely want to have somebody in the room with you to go through the pros and cons and what's best for your particular situation.

Sean: Our role at NerdWallet is to provide you with all the information so you can make your own decisions. We are not telling you what to do. And again, a fee-only advisor is the best route for something as technically complicated as this.

Kevin: Right. And that said, OK, so your question’s regarding what does it mean to be a highly compensated employee, as it relates to 401(k) contributions. The IRS allows some companies to limit contributions if you receive compensation from the business of more than $130,000 in 2020. And if so, if the employer so chooses, they can also limit the top 20% of employees ranked by compensation, and limit their amount of contributions during the year.

Sean: OK. So do you know why that might be? Is it beneficial for the business or for the individual to have this distinction?

Kevin: It's definitely for the business. This does not help the individual at all, unfortunately.

Liz: Well, it doesn't help this individual, but this is known as a discrimination test, and it's meant to ensure that tax-advantaged plans don't just benefit a handful of highly paid executives. The idea is that the average amount saved by the highly compensated employees shouldn't exceed the average amount saved by the non-highly compensated employees with the rank-and-file by more than about 2% generally. And most plans have no problem meeting that standard, but some do. And that's when you get checks back from your company.

Sean: OK. I was going to say, this seems like a big headache to have to deal with.

Kevin: But it does offer a greater complexity than the typical 401(k) contribution limits, which would typically be in play for most people.

Liz: Definitely. Chelsea could also help herself and her coworkers in the long run by encouraging them to save more and maybe suggesting the company increase its match to make the plan more attractive. But for now, she'll want to explore some alternatives.

Sean: All right. So what options does someone in this position have to save for retirement?

Kevin: OK. Well, saving for retirement, just to zoom out for a moment, you really have three big tools in your toolkit. One is your employee-sponsored plan, such as 401(k), that we're talking about, and there's a host of others. And then there's a traditional IRA and a Roth IRA. Those three things, they offer tax advantages. For example, all three of them allow your money to grow tax-free over time, which means you don't have to pay capital gains every year if you've increased your amount.

It also — in the case of 401(k) and traditional IRA — it can reduce your amount of taxable income for that year, within certain limits, so your tax bill would be smaller. On the other hand, with a Roth IRA it's after-tax money that you contribute, which grows tax-free. But then when you take that money out in retirement, that income is now tax-free. It won't be counted. If you have a 401(k) or a traditional IRA, and you're 70 years old, and you're taking out what you've contributed, you'll have to pay taxes on that as income. So those are the advantages, and each plan has their own pros and cons.

Sean: All right. And each plan also limits the amount that you can contribute each year, based on income. Is that right?

Kevin: Yeah. Bum-bum-bum. This is where Chelsea has some head scratching going on, because not everybody can do this, and it's based on your available income. For example, for a traditional IRA, if you're covered by an employee plan, a separate 401(k) or others, for individuals, you're allowed to contribute with some tax advantages if your income is between $65,000  and $75,000 if you're single, and between $104,000 and $124,000 if you're married and filing jointly. With a Roth IRA, it's a little bit higher. MAGI, their modified adjusted gross income, goes from $124,000 to $139,000. And if you're married, filing jointly, it's from $196,000 to up to $206,000. And after that limit, topmost of it, you don't qualify for these plans.

Sean: OK. And that brings me back to Chelsea's question, because we can just say that we don't know how much Chelsea makes annually, but she believes that she would not be qualified to open a Roth IRA due to her income status, which maybe would make a third option that you alluded to a good thing for her to consider, and that's a taxable brokerage account. And what should she know about that?

Kevin: Sure. Well, a taxable brokerage account is basically, it's a brokerage account. You open it up. Once you open it, you make your choice of investments, decide to make regular contributions if you so choose to, but this is all after-tax money, so it doesn't reduce your tax bill the year that you contribute to it.

Liz: With a taxable account, you actually have more control over your tax bill. You'll owe taxes on any dividends and interests that are actually paid out, but you won't owe taxes on capital gains until you sell the investment. And if you hold a stock or another investment for at least a year, you can get really favorable capital gains tax rates. There's also tax-efficient mutual funds, and some advisors will do tax loss harvesting to better manage your tax bill, so you have some options. And you get similar returns to what you get inside of a 401(k).

Kevin: Oh yeah. I mean, it's wholly determined on what investment choices you make. For example, most 401(k)s, you would have — a target-date fund is a common thing. Well, with a taxable account, you could choose a target-date fund as well, or other funds, and so forth.

Sean: Right. And that, again, is one of the key differences between each of these retirement accounts, is when and how you're taxed.

Kevin: Yeah. Exactly. The tax breaks.

Sean: Well, one other thing that Chelsea mentioned was a deferred compensation plan. And she was pretty skeptical of it. And after looking into this sort of plan, I am too. But for folks who aren't familiar, can you explain what a deferred compensation plan is?

Kevin: Sure. For certain — especially if you have higher income — some companies do allow a deferred compensation plan, which as the name suggests, is like, "Hey, 10% of my income, let's defer that, and don't pay me until I'm 65, or 67, or what have you." And that part is set aside into either a savings account or investment account. Different companies may have different choices. The good news there is it does allow for those savings to grow tax-deferred. In other words, if you're deferring your compensation and throwing it into an investment account, you won't have to pay capital gains.

Liz: It's also a little more flexible than a 401(k) or an IRA, because there's often no penalty for early withdrawals.

Kevin: But the biggest risk, as Chelsea noted, is what if your company goes bankrupt? And that is a very real risk. If your employer goes bankrupt, then suddenly you become a creditor standing in line behind the supplies and the whoever they paid rent to and so forth, hoping to get some of that money back. So I guess you would have to evaluate it based on, hey, do you think this company is going to be around for another 10 to 20 years in some form? So, understandably, it can make some people nervous.

Liz: Yeah. This is very different from a 401(k), because 401(k) accounts are held separately and they're not subject to a company's creditors. What that means is you won't lose your retirement money if your company goes broke.

Sean: OK. Well, I have a follow-up question. So it seems like, in terms of tax structure, a deferred compensation plan is analogous to a 401(k), where you pay your taxes at the end. Correct?

Kevin: Right.

Sean: OK. But with a 401(k), if you leave an employer, you can roll that 401(k) into your new employer's account, or move it over to a Roth, something like that. Do you have that option with a deferred compensation plan?

Liz: You don't, unfortunately. They're not portable, which means they can't be rolled over. You also want to find out if you'll lose any part of this money if you leave the company. Deferred compensation is sometimes used as golden handcuffs to keep employees from leaving, although that's usually the executive-level folks, the CEOs, CFOs, things like that.

Kevin: Just to make sure you fully understand what your options are, what the risks are, if there's any way to mitigate those risks, and so forth.

Sean: OK. Always good advice. All right. Well now I want to zoom out a little bit and talk about retirement savings in general. And there are some benchmarks that we like to recommend for how much people should be saving for retirement. And Kevin, I'd love to hear you outline some of those.

Kevin: Sure. I mean, there's some things to keep in mind, like Fidelity's rule of thumb is to aim to save at least one times your salary by the age of 30, so if you make a hundred thousand dollars a year at age 30, you have a hundred thousand dollars in savings, all the way up to 10 times your earnings by age 65. So that's hard to keep in mind, an easier goalpost to think about, most experts we speak with suggest saving somewhere between 10% and 20% a year toward your retirement savings, whether that's through your 401(k), or employee-sponsored plan, or that plus any additional savings you may do.

Sean: Right. And then with 401(k) plans, we like to recommend that people save as much to at least get the match from their employer. Because that's just free money that, otherwise, you would be missing out on.

Kevin: Absolutely.

Sean: I have a question about the Fidelity rule of thumb. To me, having one times your salary saved by 30 is just unrealistic for many people in this world. And I'm wondering what you think about that. Are people really expected to have one full year's salary saved by the time they hit their 30th birthday?

Kevin: Retirement savings is hard for everyone. I recently did a story. I think the average 55-year-old has $12,000 saved, which I'm sure is pretty far down one times versus 10 times you're saving. So, these are obviously gold standard rules of thumb that they like to go out with, but it's frankly a bit scary to look at some of these, compared to what the actual savings rate is for most people, which is pretty low.

Sean: Right. And I think when people see such an unrealistic standard, it can be really discouraging. People can throw up their hands and think, "Why even bother? There's no way I can meet this. I'm just going to work forever, and there's no point in saving for retirement," which isn't what we like to recommend, but I understand how people can get to that mindset through something like having one times your salary saved by 30 years old.

Kevin: Well, I think the goal is to start saving and to start having a savings mindset. Because just every little bit counts, and every step and every success along the way encourages a next step along the way. For example, starting just inching up your contribution levels can be really helpful. If you get a promotion, or a new job, you want to transfer whatever additional cash you may get from that promotion directly into your 401(k), and just continue operating by your existing limits.

Sean: Right. Well, that actually leads me to Chelsea's last question, which was around how to increase retirement contributions. Kevin, what do you think would be a good first step?

Kevin: The first thing is to take advantage of catch-up contributions if you qualify. For example, if you have a 401(k), you're limited to $19,500 contributions a year, but people over 50 can contribute up to $26,000, so $6,500 more. So, that's a good way to do it. Traditional and both Roth IRAs, they also have a catch-up limit that increases, I believe from $6,000 to $7,000 a year for 2020 and 2021, so that's important to keep in mind. And also just, as much as you can, increase those contributions with every salary increase, with every promotion, use that as an opportunity to do so.

Sean: Yeah. I actually am trying to practice what we preach here at NerdWallet. So last year, when I got a raise, I actually ended up thinking it was pretty exciting, but I ended up actually seeing less money in my paycheck once my raise came through, because I increased my retirement contributions accordingly. And I set myself up on a plan where every year at January 1, my contribution goes up 1%.

Kevin: Oh, that's fantastic.

Sean: Yeah. I'm trying to find ways to automate this and, as you mentioned earlier, get in the savings mindset, so that I have this money already directed into my retirement account. And it's like you don't miss what you don't have. I don't even see that money. I don't think about it being my money.

Kevin: It's ... the whole “set and forget" way to financial success is you just pretend the money isn't there.

Sean: Right. Another way for folks to up their retirement contributions is, once you pay down high-interest debt, they can continue actually making that payment. But instead of getting it to their former creditor, they can direct however much they were paying monthly toward that retirement fund or tax-advantaged IRA. That's a really nice way, where you have that money already blocked out. You're not going to miss it because you were already spending it, and then it's going toward your retirement contributions instead.

Kevin: It's the same principle, isn't it? Yeah. So just keep forward motion toward savings and keep those priorities high toward your savings.

Sean: Well, I think that about does it for Chelsea's question. Again, Chelsea, you or anyone else that's in a similarly complex retirement situation, please talk to a fee-only advisor. But with that, Kevin, do you have any other final notes or advice for someone in this position?

Kevin: I think just staying on it. And obviously, Chelsea is asking the right questions and doing the right things. That's what you really need to do, no matter your situation. So don't be discouraged and stay on it.

Sean: All right. Thank you. Well, I can kick off the takeaway tips. First up, understand your options. 401(k)s, traditional IRAs, Roth IRAs and deferred compensation plans all have their pros and cons. Do some research and talk with a financial advisor to determine which is best for you.

Liz: Next, know how much to save. A good guideline is to save 15% of your net income for retirement.

Sean: Lastly, boost your contributions. Think about putting any pay increases toward your retirement savings, or once you pay down high-interest debt, also direct that monthly payment toward your retirement fund.

Liz: And that's all we have for this episode. Visit nerdwallet.com/podcast for more info on this episode, and remember to subscribe, rate and review us wherever you're getting this podcast.

Sean: And here is our brief disclaimer, thoughtfully crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This Nerdy info is provided for general, educational and entertainment purposes, and may not apply to your specific circumstances.

Liz: And with that said, until next time, turn to the Nerds.