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Retirement Saving Tips for Workers Who Earn Tips
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By Clifton Linton
Senior Writer, mPower |
Many waiters, waitresses, hair stylists and other
workers who earn income from tips are stiffing themselves when it comes to retirement.
These employees commonly work in environments where
thinking or planning for the long term is a luxury. For a number of reasons, many
tip-employees don't save in employer-sponsored retirement plans.
But savings opportunities have become more widespread in
the last few years. What's more, new laws taking effect in 2002 may make it easier for
tip-earning workers to save for retirement.
If your employer offers this benefit, it's a good idea to
take advantage of it. We'll tell you why and offer some strategies on how to get the most
out of your plan.
Tough Customers
Tip-workers are a tough crowd. Job turnover is high. Many
live on tight budgets. Often, they don't want to contribute to a retirement plan because
that would require them to report all their tips on their income tax return.
(Contributions to a retirement plan or IRA have to be based on earned income reported to
the IRS.)
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| "In an environment where there are
substantial tips, there is pressure to (underreport)." |
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| — Ted Benna, the creator of the
first 401(k) plan. |
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"In an environment where there are substantial tips,
there is pressure to (underreport)," said Ted Benna, the creator of the first 401(k)
plan. He knows — his wife used to wait tables.
When workers receive cash tips they have more leeway for
not reporting this income. However, when customers pay with credit cards or debit cards,
the employer has to report these amounts to the IRS and employees cannot underreport.
Tip-employees who can underreport often do so in order not to owe taxes on the
income. As many tip employees live on a tight budget and don't feel they can afford to
plan for the long term, they report just enough income so that their paycheck covers their
taxes and all their tip money can be used for living expenses. For this reason, the
argument that 401(k) contributions will help lower their federal income tax burden doesn't
mean much to tip-employees.
Also, generally tip-employees work for small businesses,
which historically have found it too expensive to offer retirement plans to their
employees.
Even when a 401(k) plan is offered, tip-workers often don't
help themselves. Laura Kelly, a partner in Kelly's Tavern in Neptune City, N.J. says she
gets her staff to participate by "putting a guilt trip on them" for not saving.
At the employers interviewed for this article, tip-employee
participation rates typically were 30 percent. Comparatively, in a recent general survey
of employers, participation rates were typically above 70 percent, said the Profit
Sharing/401(k) Council of America.
More Savings Opportunities
Nevertheless, many of the obstacles that used to hinder
tip-workers from saving seem to be falling away. Anecdotally, it seems that more employers
are offering retirement plans. Of the six restaurant firms contacted for this article, all
offer 401(k) plans, and two of them said they began offering their plans just this year.
These offerings may result from government initiatives in
1997 and 2001 designed to help small businesses offer retirement benefits. The 1997 tax
bill created several new low-paperwork retirement plans designed for small businesses,
which could often ill-afford the costs of a traditional 401(k) plan.
This year's tax bill contains two rules important to
tip-employees. First, it raises the percentage-of-pay contribution limit from 25 percent
to 100 percent starting in 2002. That means you could contribute your entire salary to
your 401(k) plan provided you stayed within the maximum annual pre-tax contribution limit
of $11,000 in 2002.
In the service industry, this rule applies primarily to
paycheck earnings because 401(k) contributions must be made through paycheck deferrals.
Tips generally aren't covered because most employers pay out the tips at the end of the
shift. Employers that require tips to be pooled and distributed later may be able to take
an employee's 401(k) contribution out of that check. The old 25-percent-of-pay rule tended
to limit the amount tip-employees could contribute to the plan, since they often took home
small paychecks.
The second important change for tip-employees is the
introduction of a tax credit for low-income savers, based on reported adjusted gross
income. This non-refundable tax credit will apply to the first $2,000 of savings to a
401(k) plan. This credit will only be available for the 2002, 2003, 2004, 2005 and 2006
tax years.
Our Tips
Here are a few common questions and comments from
tip-employees, and our answers to them:
I have a long time until I retire. I can wait.
If you need all the money from this job to pay for college,
there's no question that's a better investment.
However, if, like many tip employees, you see your job as a
temporary stop before starting on your career, that's not a good reason to delay
starting to save for retirement.
You want to start now because you have one of the most
powerful retirement tools working for you — time. Saving consistently over a long
time will give your money more time to grow through interest compounding. When your money
compounds, that means that your earnings generate more earnings.
I can't afford to save much, so what's the use?
A little can go a long way when you have interest
compounding working for you. If you save early and regularly, here's how it can work:
Suppose you saved $10 a week for 50 weeks, starting at age
23. That's $500 a year. By age 65 you would have contributed $21,000, but assuming your
savings earned an average return of 8 percent, your final balance would be $152,121.
That may not be enough to provide a luxurious retirement,
but it's a pretty good start. And if you increased your contributions, the end result
would likely be even larger.
What's in this for me?
If your employer offers a matching contribution, as many
do, you could be getting free money. In 1999, almost 80 percent of employers with 401(k)
plans offered some kind of matching contribution, the PSCA reported.
Another bonus is that a 401(k) plan is an easy way to take
advantage of investments and expertise ordinarily not available to small investors. Also,
the employer and plan provider have pre-selected the funds for you to invest in, meaning
that much of the investment decisionmaking has been done for you. Finally, "you have
someone looking over the system (your employer) to make sure that it works right,"
said PSCA President David Wray.
What pitfalls are there?
The most common pitfall is the possible year-end surprise
you may get when preparing your taxes and finding you owe money.
This is a big reason some employees at the Big Burrito
Restaurant Group don't want to participate in their plan, said Allison Glancy, the firm's
401(k)-plan administrator. "Our workers thought they were paying more in taxes,"
she said.
The reason is that 401(k) contributions reduce your federal
taxes, but they won't reduce state taxes, FICA (Social Security taxes) and other benefits
deductions from your paycheck.
In many cases, your paycheck may not be large enough to
cover your 401(k) contributions, taxes and any other benefits deductions. Something will
have to give. What that is will depend on the priorities your employer uses for making
payroll deductions. If your tax deductions are shortchanged, you will find you owe the IRS
money at the end of the year. If your employer allows you to run a negative balance on
your benefits, you may owe your employer money.
Okay, you've convinced me. How do I make this work?
Be opportunistic. If your boss offers a savings plan, sign
up, especially if there's a matching contribution. It's a chance to take control of your
retirement future, and a match is free money.
The tough part for most tip workers is managing their money
to cover a year-end tax bill. One solution is to set up a savings account for the taxes
you may owe at year-end. If you regularly contribute to the account through the year, you
will have the money at tax time.
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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