When it comes to retirement planning, it’s hard to know where to start. Many people put it off for years, only to discover that they’ve put themselves at a distinct disadvantage. They often have to sacrifice to catch up financially, or work for far longer than they would have otherwise.
When we talk to clients, they are interested in two things: they want to maintain their quality of life while saving for retirement, and they don’t want to make sacrifices once they have retired. We’ve put together a helpful guide that can help you do just that! To simplify the many options available to you, we’ve laid these out like a pyramid – you shouldn’t think about progressing to the next level before you’ve completed the other levels from the base up. We think that this makes it easier to understand by helping clients strategically, thoughtfully, and thoroughly build the retirement of their dreams, and to have a roadmap to understand what they should be doing now, and what comes next.
Level one: Make sure you’re investing enough to receive your company match
If your employer offers a 401(k) with matching contributions, that is essentially free money. Although you have to contribute some of your own money, it will be matched at a certain pre-determined rate ($.50 on the dollar up to 6% is the most common), which is like giving yourself an immediate raise. Generally speaking, and even if the match is relatively small, it’s still guaranteed money, which is more than we can say for most investments. However, if your 401(k) does not offer matching contributions, then it’s time to skip directly to level two.
Level two: An IRA for you (and for your spouse too)
Sometimes, it doesn’t get any better than a company 401(k), especially if it offers lots of choices, like low costs and Roth options. It also can afford legal protections that some other accounts do not. But often times, company 401(k)’s will come saddled with a layer of administrative costs, or will not offer as many opportunities as other types of accounts. They also often come with a relatively small list of investment choices, which also may have higher associated costs. With an IRA, investors are free to invest in a range of options, including low-cost options like exchange traded funds or mutual funds. It may also be a good idea to consider an IRA for your spouse – especially if they do not work. You then have the ability to essentially double your tax-advantaged retirement savings by making the maximum contribution to both your IRA and that of your spouse. Of course, if your 401(k) is excellent – offering all of these features and low costs – then we recommend that you maximize contributions to your 401(k) before considering an IRA.
Level three: Maximize 401(k) contributions
Maximizing your 401(k) allows you to enjoy tax-free compounding (ROTH) or tax-deferred compounding (traditional) that can add up over time. In the case of a traditional 401(k), these contributions also decrease your adjusted gross income, which can increase eligibility for important tax deductions or credits. It’s important to stress the fact that these strategies are far more beneficial over long time periods. People who are closer to retirement may want to consider investing in a taxable (nonretirement) account over making additional contributions to their 401(k) – in that case, skip to level five.
Level four: Maximize after-tax contributions
Investors who make the maximum 401(k) pre-tax contribution of $18,000 annually, ($24,000 if over age 50) in 2017 can contribute at an even higher level – up to $54,000 in total contributions for those under 50, and up to $60,000 in total contributions for those who are 50 plus – provided, of course, that their plans allow for contributions of after-tax dollars. Those contributions can eventually be converted to ROTH IRA assets after you begin taking distributions, leave the company, or retire. However, it’s important to remember that if you have a particularly costly plan, expenses can overtake any tax savings that might be realized from having more ROTH assets.
Level Five: Taxable Accounts
If you already have a significant amount of your assets in tax-deferred and Roth accounts, it may be a good idea to consider a taxable, nonretirement account. This option often affords the most options, although without the tax advantages of the 401(k), IRA, or ROTH IRA. On the plus side, you can invest in nearly anything inside of a taxable account, and there are no withdrawal requirements. You can access the money whenever you want, or let it build for as long as you want, and any money that your heirs inherit from you will receive a step-up in basis as well. You’ll also be taxed at the capital gains rate when you sell, which is lower than ordinary income taxes.
Whether you’re a level 1 or a level 5 retirement planner, we can help. There are so many options available, that it’s often difficult to know which is best for you and your family. We’re happy to answer any questions you have, and we offer a brief, no-obligation phone call to anyone who is planning their retirement. We’d rather people reach out to us and get the information they need to plan the best possible retirement than to put off planning or saving. Waiting often costs people more money in the long run, or even worse, puts them in a position of needing to work longer, sacrificing months, or even years they could have been enjoying their retirement.
Information contained herein is not tax advice and should not be considered as such. Each individual’s tax situation is unique and different. For advice related to your specific tax situation, please contact your personal tax professional.