Retirement planning can be overwhelming. This is especially true in the current environment where more responsibility has been pushed to individuals to save for and meet their own retirement income needs.
Gone are the days where most people could depend on a monthly pension and Social Security to provide for most of their income needs. Individual investors today are now charged with the responsibility of saving for a large portion of their retirement needs.
As a financial planner, one of the first questions new clients often ask is how much they should be saving for retirement. The answer, of course, depends on several factors but a good rule of thumb is to save at least 15 percent of gross monthly income for retirement.
If they are getting closer to retirement and have not been saving at that level, there’s a good chance they are behind and need to save more.
After determining how much to save, the next step is to determine where to save those dollars. There are a lot of different choices and it can be difficult to know where to start. Below is a list of common types of retirement plans and a general ordering rule to follow:
Employer retirement plans: commonly a 401(k) or 403(b) plan — up to the employer match. Many employers offer matching contributions up to a certain level. Participants should do everything they can to maximize the matching contributions. This is “free” money from the employer that should not be left on the table.
A pre-tax retirement plan contribution also reduces an investor’s tax bill.
Health Savings Account (HSA): It may be surprising to see an HSA on this list, however this vehicle has some exceptionally valuable tax benefits and can be used for retirement savings.
HSAs are “triple tax-advantaged.” Investors receive a tax deduction when the contributions are made, earnings inside the account grow tax-free, and distributions from the account are tax free if used to pay qualified medical expenses.
An additional tax advantage is that if contributions are made via an employer payroll deduction, they also avoid the 7.65 percent in payroll taxes.
Many employers have also started matching HSA contributions.
Health savings accounts can be invested for the long-term and used for medical expenses in retirement.
Individual Retirement Account (IRA): After funding an employer-sponsored plan up to the maximum matching level and maxing out the HSA, the next option to consider is an IRA.
There are two primary types: a traditional IRA or Roth IRA. A traditional IRA offers a current tax deduction and tax-deferred growth, while a Roth IRA contribution goes in after-tax, but can grow tax-free forever under current law.
Generally, it is better to use the traditional IRA if the investor is in a high income tax bracket and expects to be in a lower tax bracket in retirement. A Roth IRA is likely to be a better choice if the investor expects to be at the same or higher tax bracket in retirement.
The maximum an investor can contribute to an IRA in 2019 is $6,000. If age 50 or older, the maximum is $7,000. There are both minimum income requirements and income limits affecting the deductibility of contributions, so be sure to check these out before funding either.
Employer sponsored plan, up to the maximum. After maximizing an IRA, the next place I suggest saving dollars for retirement is back in the employer-sponsored plan, up to the annual maximum. The maximum in 2019 is $19,000, and $25,000 if age 50 or over.
It is also worth noting that many employers now offer the ability to make a Roth 401(k) contribution. The decision about which type to choose is the same for the IRA vs. Roth IRA decision addressed above.
Taxable Brokerage Account: This is usually the last stop in the retirement-savings pecking order. Current income generated in these accounts may be taxable and long-term growth in the accounts is usually taxed at the lower capital-gains tax rates.
Another advantage is that a taxable brokerage account can be liquidated easily if the funds are needed before retirement.
Retirement planning can seem overwhelming at times. It’s important to get started early and to target saving at least 15 percent of one’s gross income. There are several tax-advantages vehicles out there to help people save and invest more for retirement.
Carefully allocating resources across these various account types can help maximize an investor’s retirement savings over time.
Lucas Bucl is a Certified Financial Planner and a principal at Aspyre Wealth Partners in Overland Park. He helps clients define what success means to them, and then build a plan to achieve it.