Where to start retirement saving?
Congratulations, you are ready to start saving for retirement. Or perhaps, you just want an idea of how to potentially do it a little more efficiently. It can be overwhelming putting together a strategy of where you should be saving your money.
I want to share with you my general thoughts on where clients should be saving money for retirement and why.
The first thing you want to do is budget how much you are able to save for retirement. This can be difficult when you are starting out because you are likely working on multiple financial goals. For the purpose of saving for retirement, this is money you are able to part with until age 60 and beyond.
Go ahead…figure out what you can save.
A good goal is to work toward is saving 15% of your income toward retirement.
Now, lets talk about where to save your money.
A quick note on Roth vs Traditional 401k contributions. Your election may depend on your tax bracket, time frame and if your employers offers a Roth 401k. Roth contributions tend to make sense the lower your tax bracket and the younger you are.
#1 - 401k up to employer match
This is free money that you don’t want to leave on the table. There are no other retirement plans or investments that I know of that give you up to a 100% return on your contribution. Be sure to take advantage of this employee perk if you employer offers it.
Verify with your benefits department the terms of employer match. Here are some examples of employer match terms....
- Matching contribution up to 3% of compensation. You need to contribute 3% to get full 3% match. If you only contribute, 1% you receive 1% match.
- 2% nonelective contribution. Employer automatically contributes 2% even if you contribute nothing.
- Matching 50% of your contribution up to 6% of your compensation. You need to contribute 6% to receive a maximum 3% match. If you contribute 4%, employer would match 2%
#2 - Max out your Roth IRA
A Roth allows you to contribute after tax dollars, grow investments tax deferred and for eligible withdrawals come out tax free. As of 2021, the maximum amount you can contribute to a Roth IRA is $6,000 ($7,000 for over age 50). A married couple under 50 would be able to contribute $12,000 total ($6,000 each).
There is also a income limitation on contributions. If your modified adjusted gross income is above a certain amount, you would not be able to contribute directly to a Roth IRA. In this scenario, you would need to see if the “back door” Roth is an option for you.
#3 - Max out you employer sponsor retirement plan
Time to circle back to your employer sponsor plan, such as a 401k. Contribute the rest of your budget up to the maximum allowable contribution. The maximum contribution in 2021 for a 401k is $19,500 ($26,000 for those age 50 and over).
#4 - Non qualified investment account
Finally, if you have maxed you employer plan and Roth IRA. Consider saving the remaining amount in a taxable investment account. There are pros and cons to every type of accounts.
Some of the advantages of a taxable investment account can include…. long term capital gains tax rate on investments gains rather than ordinary income rates on 401k withdrawals, access before age 59 1/2 without penalty, tax loss harvesting opportunities and step up in cost basis at death.
Here are some examples to help figure it out for yourself…
In conclusion, there are specific details to consider for your personal situation, and as tax rates and rules changes you may want to update your strategy. An example of a rule that could change is the step up in cost basis at death. Generally speaking, having assets in tax-free, tax-deferred, and taxable accounts can allow you to manage your withdrawal/legacy strategy over your life time.
-RCL
Disclosure:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
