Get the biggest bang for your retirement buck
Today, few employees have guaranteed pension plans. Since living only on Social Security benefits is not the retirement that anyone wishes, most people must save from their current earnings to have an abundant retirement.
Step one of my Seven Steps to Financial Abundance is “Spend less than you earn.” After this is accomplished, the question becomes, “Where do I put my savings?” The choice many people make is to put all of their savings into a company-sponsored tax-deferred plan, such as a 401(k) plan. This may not always be the best choice. For many people, the following retirement savings strategies will likely yield the maximum in after-tax retirement savings:
- For companies that provides a 50 percent or 100 percent match with their 401(k) type plans, always contribute up to the plan’s maximum matching amount. The company match is “free money.” If your company will match $6,000 of your plan contribution, contribute $6,000 to your plan for a 100 percent investment return. No taxes will be paid on these contributions and their investment growth until the funds are withdrawn.
- Once you have contributed the maximum amount that is matched by your company plan, (if your company has no match, this amount is $0) fund a Roth IRA. For a single person with taxable income below $110,000 or a married couple with taxable incomes below $173,000, the individual and their spouse (if applicable) can contribute $5,000 ($6,000 if age 50 or over) to a Roth IRA. While Roth contributions are not tax-deferred, their growth can be tax-free, not only for your lifetime, but the lifetimes of your beneficiaries as well.
- Everyone needs an emergency fund, providing funds to cover at least six months of expenses. These funds are required in case of a job loss, a temporary disability or any other financial emergency. If an emergency fund is not in place, use any remaining savings to build this fund as quickly as possible. Remember, if emergency funds are withdrawn from a tax deferred retirement account, all of the funds withdrawn are taxable plus (if under age 59½) an additional 10 percent withdrawal penalty is assessed on the withdrawn funds.
- After items 1-3 are funded, where should any remaining savings be placed? For those in the highest tax brackets, the tax deferred nature of a company retirement plan may make maximizing company plan contributions worthwhile. However, people in the 28 percent tax bracket or below (singles, with taxable income under $178,000 or a couple with taxable income under $217,000), may be better served putting any remaining savings into a taxable savings/ brokerage account. If you have children that have not yet completed college, funding a 529 College Savings plan may also be appropriate for any additional savings.
Whether funds may be needed for a child’s college education or to take a few expensive vacations before retirement, be careful not to overfund a company retirement plans. If adequate savings are not available in after-tax savings/brokerage accounts, you could be faced with large taxes and penalties on early withdrawals from a tax-deferred retirement account. If your only retirement savings account is your current employer’s plan, you may not even be able to access your retirement savings funds.
By retirement, you would ideally have as much or more savings in after tax accounts as in tax deferred accounts. After tax accounts can be managed to minimize taxes in retirement. Tax deferred accounts will be taxed as ordinary income whenever a withdrawal is made. Having significant savings in both types of accounts can maximize retirement savings.
For most of us, pensions are a thing of the past. Optimizing retirement savings increases our ability to have the abundant retirement that we desire. If retirement savings options seem too confusing, seek help from a fee only Certified Financial Planner (CFP®). Only you can take care of your financial future. Start doing it now!