How much do I need to retire? How should I be funding my retirement? What type of account should I fund first? According to a recent survey, 47% of people polled had less than $25k in retirement savings. The even scarier fact is that 24% said they have less than $1,000! Saving for retirement can be intimidating, or for some may seem too far away to worry about. We hope this post offers a little guidance on where to start.
- Employer Matching in your 401(k)/403(b):
An employer match is free money that your company contributes to your retirement plan if you make a certain contribution to your account. You immediately get a 100% return on your investment. Also, the contributions will grow tax-deferred until you begin taking withdrawals (which we discourage until at least age 59 ½ to avoid a 10% penalty). Make sure you are contributing enough to get your full employer match, or else you are missing out on free money!
- Roth IRA:
For contributions to a Roth IRA, you pay tax now (i.e. no tax deduction), but the account grows tax free, which is a powerful investment tool. Depending on your income eligibility, you can contribute $5,500 ($6,500 if over age 50) to a Roth IRA. Another great feature of a Roth IRA is that you can pull out contributions, if need be, tax and penalty free.
The rules get more complicated on withdrawing your earnings. Generally you have to wait until age 59 ½ to withdraw growth on contributions. Typically, we do not recommend withdrawing Roth funds before retirement, but it can be comforting to know that in an emergency, tax-free money is available. Another great benefit of a Roth IRA is that there are no required distributions at age 70 ½, which there are for IRAs and 401(k) accounts (if no longer active in the plan).
- Max your 401(k)/403(b):
A pre-tax 401(k) deduction is an immediate deduction that will reduce your tax liability, since it reduces your taxable income dollar for dollar. Let’s say you are in the 25% marginal tax bracket (i.e. your highest income tax rate). For every dollar that you contribute to your 401(k), you get to keep 25¢. And as mentioned earlier, this money will grow tax deferred until you withdraw it. One of the benefits of delaying your tax liability is the possibility that you are in a lower tax bracket in retirement, when you need to begin taking withdrawals. If you are contributing to a company sponsored retirement plan, the contribution limit is $18,000 (or $24,000 if you’re over age 50) each year, and usually part of this is matched (as mentioned in #1).
We find that once people begin making the maximum 401(k) contribution, they will continue to do so for all of their working years. This is because you do not notice this “expense” in your monthly cash flow. Remember, always pay yourself first!
The health savings account (HSA) is one of the most powerful savings vehicles. If you have a high deductible, HSA eligible health insurance plan, you should be taking advantage of your HSA. You may not think of this as a typical retirement tool, but the tax savings on an HSA is hard to beat.
The money you invest is tax free, so you get a deduction when you file your tax return. The account then grows tax free while you are waiting to use the funds. Then, when you withdraw money for qualified healthcare expense, you still don’t pay taxes. That is a triple tax savings! You might be surprised on what qualifies as an HSA expense. Here is an updated list from the IRS: https://www.irs.gov/pub/irs-pdf/p502.pdf.
The balance in your HSA rolls over every year, so you never lose dollars that you do not use. If you still have money in your HSA once you reach age 65, you can pull out cash for any reason. You will pay income tax on non-healthcare expenses, similar to a traditional IRA or 401(k), but there will be no 10% fee incurred. In 2017 you are able to contribute $3,400 (individual) or $6,750 (family). If you are over age 55, you can contribute an additional $1,000.
In conclusion, we believe the most important takeaway is that you should be saving TODAY! The sooner you put money away, the sooner it can start working for you and your retirement goals. The earlier you start, the more financial freedom you will have later in life.