By Brian Elmer – Wealth Advisor, NMLS #524030
Whether retirement is 40 years from now or right around the corner, the thought of getting to the proverbial “finish line” can leave many people confused, anxious, or, in some cases, downright discouraged. With your future financial well-being on the line, where do you start? To help you answer that question, I encourage you to consider these points:
HOW MUCH WILL YOU NEED IN RETIREMENT?
When do you plan to retire? What kind of lifestyle do you desire? How much do you have right now that you can count on for your retirement? What about Social Security — do you know what kind of benefits you can expect? These are all factors to help you determine how much you’ll need. If you are struggling to come up with a target dollar amount, consider completing a financial plan with an advisor who can help you to quantify your goals and guide your progress.
KNOW HOW MUCH YOU HAVE
Take an honest look at your present net worth. If you’re like most people, you’ve got a long way to go before you can afford to retire. Knowing how much is earmarked for retirement now will help you to save smartly for your future.
IMPLEMENT A SAVINGS PLAN
Take an honest look at your current spending. Think about establishing a long-term systematic savings plan to put aside funds for retirement. As the saying goes, failing to plan is planning to fail. If you haven’t already done so, consider the benefits of establishing and sticking to a monthly budget while making it a priority to “pay yourself first.” What does that mean? Warren Buffett said it best, “Don’t save what is left after spending; spend what is left after saving.”
DECIDE WHERE TO PUT YOUR DOLLARS
When you free up some cash, and you want to put it where it will do the most good, consider some options, such as:
TAKE FULL ADVANTAGE OF COMPANY RETIREMENT PLANS
Does your employer offer a retirement plan? If so, take full advantage of it. If your employer has a defined benefit plan (a traditional pension plan, with pension benefits typically based on the number of years you work and your level of compensation), familiarize yourself with the details of the plan. Although most aspects of such plans are beyond your control (e.g., you can’t make contributions), you should know how it works. How long do you have to work before you have rights under the plan (the plan’s vesting schedule)? When are you entitled to a full pension? This information is vital if you’re considering leaving your employment.
If your employer offers a defined contribution plan (such as a 401(k) plan, to which contributions can be made by employer and/or employee), much depends upon the specific type of plan. The one feature these plans have in common is that contributed funds grow tax-deferred. This is significant because investments in these plans can grow more rapidly than identical investments that don’t grow tax-deferred. Depending upon the type of plan you have, you may be able to make voluntary contributions.
MAXIMIZE EMPLOYERMATCHING CONTRIBUTIONS
Some retirement savings plans, such as 401(k) plans, 403(b) plans (tax-sheltered annuity plans for employees of public schools and certain tax-exempt organizations), Savings Incentive Match Plan for Employees Individual Retirement Accounts (SIMPLE IRAs), and thrift savings plans (plans to which you generally make after-tax contributions), allow employers to match your contributions up to a specified level. Since this is basically free money (once you’re vested in those employer dollars), consider taking advantage of it. At a minimum, contribute enough to the plan so your employer contributes the maximum matching amount.
SELF-EMPLOYED INDIVIDUALS SHOULD CONSIDER ESTABLISHING THEIR OWN RETIREMENT PLANS
If you’re self-employed, seriously consider establishing a retirement plan for yourself. For example, a Simplified Employee Pension (SEP) plan is relatively easy to implement (it’s not much more than a big IRA), and allows you to save significant funds for retirement, or consider an individual 401(k) plan. If you’re a business owner with employees, think about setting up an employer-sponsored retirement plan. There are a variety of retirement plans that are appropriate for sole proprietors and partnerships, corporations, and tax-exempt organizations.
IF YOU DO CONTRACT WORK FOR A TAXEXEMPT ORGANIZATION OR A STATE OR LOCAL GOVERNMENT, ASK ABOUT THEIR PLAN
If you work as an independent contractor for a state or local government or a tax-exempt organization that sponsors a Section 457(b) plan (a specific type of deferred compensation plan), you may be able to participate in it. If you can participate, you can defer a significant portion of your compensation to the plan.
CONTRIBUTE TO AN IRA EACH YEAR
IRAs offer significant tax incentives to encourage you to save money for retirement. You can contribute up to $6,000 to your IRA in 2020 ($7,000 if you’re 50 or older), as long as you have at least that amount in earned income for the year. The types of IRAs that you can use (and the corresponding tax advantages) depend upon your income level, filing status, and whether you’re covered by an employer-sponsored retirement plan.
IF YOUR SPOUSE DOES NOT HAVE COMPENSATION, CONTRIBUTE TO AN IRA FOR YOUR SPOUSE
You may be able to set up and contribute to an IRA for your spouse, even if he or she received little or no compensation for the year. To contribute to a spousal IRA, you must meet the following four conditions:
- You must be married at the end of the tax year.
- You must file a joint federal tax return for the tax year.
- You must have taxable compensation for the year.
- Your spouse’s taxable compensation for the year must be less than yours.
CHOOSING INVESTMENTS WITHIN YOUR RETIREMENT PLAN
It’s important to understand that the earnings potential offered by a retirement plan (e.g., 401(k) or IRA) is not generated by the plan per se, but by the investments held by the plan (e.g., stocks, bonds, mutual funds). Choosing the right mix of investments within your plan is just as important as choosing the right plan itself. When making your choices, consider many factors, including your time horizon, your tolerance for risk, and tax implications. For example, it may not make sense to hold tax-exempt securities within a plan that is tax-deferred. This does not mean that such investments are inappropriate for retirement plans, only that you should consider carefully your overall investment portfolio when deciding what investments to hold within, and outside of, a retirement plan. Keep in mind that all investing involves risk, including possibly losing principal, and there can be no assurance that any investment strategy will be successful.
EVALUATE NON-QUALIFIED INVESTMENT PROGRAMS, SUCH AS ANNUITIES
Annuities, which are funded with aftertax dollars, grow tax-deferred. When you retire, if you’re over age 59 ½, you may make withdrawals or begin taking payments that continue as long as you live (any guarantees are subject to the claims-paying ability of the insurer). The tax-deferred earnings portion of these withdrawals or payments will be taxed as ordinary income. Keep in mind that, as with IRAs, if you withdraw any money from an annuity before you’re 59 ½, you’ll generally have to pay an additional 10% penalty tax.
ASSESS LIFE INSURANCE
Some life insurance has certain tax advantages, such as tax-deferred growth of the cash value of permanent life insurance. This type of life insurance can be a supplementary source of retirement income in addition to providing financial protection to your beneficiaries.
REVIEW OTHER INVESTMENTS
Carefully consider your current investment portfolio. Are you putting your money in appropriate investments that align with your plan? Are you taking too much risk or not enough? How does your current allocation fit in to the bigger picture? Your advisor can help you answer these questions as part of your financial plan.
INCLUDE OTHER CONSIDERATIONS
Does your employer offer or are you in a position to take advantage of any of these options?
- Non-qualified deferred compensation plans
- Stock plans
- Other employee benefits
CHOOSE THE RIGHT STRATEGY TO SAVE FOR YOUR RETIREMENT
You should take advantage of employer-sponsored retirement plans, make yearly contributions to IRAs, and consider all of your other options. How do you decide which to do first? If you have the cash, you should probably do all three. If not, conventional wisdom says you should always consider taking advantage of any employer-matching contributions within an employer-sponsored retirement plan. Contribute at least enough to capture the full match offered by your employer.
Beyond that level of savings, think about whether it’s better to make additional voluntary contributions to your employer-sponsored retirement plan or to put those dollars into an IRA or elsewhere. Annuities and life insurance, for example, play an important role for many in retirement planning. Certainly, if you have not reached the pre-tax contribution limit at work, funneling more dollars into your 401(k) or other employer-sponsored plan probably makes the most sense. Making systematic contributions straight from your paycheck is a huge practical plus for most individuals, and the power of tax-deferred savings can be great. Although the traditional IRA also provides tax-deferred growth, the ability to deduct contributions is phased out for high- and middle-income taxpayers also participating in qualified retirement plans. If you earn too much to make a deductible IRA contribution, you should probably fully fund your employer-sponsored retirement plan before making non-deductible contributions to a traditional IRA.
The Roth IRA and Roth 401(k)/403(b) offer yet more options. With these arrangements, you invest after-tax dollars, but you don’t pay income tax on the earnings for qualified withdrawals. Tax-free earnings are even better than tax-deferred earnings because tax-deferred earnings will eventually be taxed when you start taking distributions. When you decide between a Roth IRA and a traditional IRA or other alternatives, or between pre-tax and Roth 401(k)/403(b) contributions, consult a financial professional who can make some planning assumptions and crunch the numbers to see what makes the most sense.
By asking yourself these questions, you’ll take the first step toward securing your financial future! To continue down the path towards success, I encourage you to establish a relationship with a financial professional you can trust who will meet with you regularly to assess your financial situation and develop a comprehensive plan customized around you and your goals. Like a “financial GPS,” the Private Wealth team at First Business Bank is here to guide you turn-by-turn to help you reach your destination — please reach out to your local team if we can help you along your journey.
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