Celebrate the Fourth by planning for financial independence in retirement years

We work hard to save for financial independence in retirement. But some are smarter about it than others. Here’s my list on how to get the biggest bang for your (savings) buck.

▪ The best strategy when saving for retirement is to snare your company’s match in the defined contribution pension, often a 401K. If your company matches 50% on 6% of salary, that’s free money. You don’t pay income tax on the amount you deferred into your pension. The money grows without getting taxed until retirement — you pay tax when you withdraw it.

▪ The next best strategy is to contribute $6,000, plus a $1,000 catchup if you’re over the age of 50, to an IRA. You can locate IRA accounts with brokerage firms that have low fees on a wide array of investments. Few pensions offer that.

Use a Roth IRA if you qualify. There’s no tax deduction but your money is not taxed again.

If you cannot use a Roth, then contribute to a deductible IRA if you qualify. You get the deduction, your money grows without getting taxed until retirement and you pay taxes when you withdraw.

▪ Your next smart move is to maximize your contribution to your employer’s defined contribution pension. That’s $19,500, plus a $6,500 catchup if over 50, for most pensions. Amounts are different for a SIMPLE IRA Plan. You don’t pay tax on your contribution; it grows tax-deferred until you withdraw during retirement.

Should you use the pension’s Roth version? If your marginal tax rate is higher now than what you’ll experience in retirement, favor taking the deduction now. Is your tax rate higher now? A $50,000 withdrawal from a 401k later is taxed as heavily as a $50,000 salary now. You may have fewer dependents and higher taxes later. Often a blended approach using both versions works well.

Most people meet their annual savings goal at this point but some target early retirement and save even more.

▪ Saving in a health savings account can make sense if you qualify and have low medical expenses so contributions actually accumulate. Many brokerages are vying for your investment dollars through these, but avoid providers where fees cut into your return. You get a tax deduction, it grows tax-free and you don’t pay taxes on withdrawals for qualifying medical expenses.

▪ Contribute to a non-deductible IRA if you couldn’t qualify for an IRA above. There’s no deduction but your money still grows tax-deferred. Use tax Form 8606 to track contributions so you won’t have to pay taxes on those when withdrawn later; only the earnings are taxable.

▪ In my opinion, a variable annuity is useful if you are in a high marginal tax bracket and expect to remain there over 10 years. You don’t get a deduction but your money grows tax-deferred. Earnings are taxed later. Use a low-cost annuity with low fees and quality investment choices.

▪ Finally consider saving in a brokerage account. Earnings are taxed yearly but your investing style and investment choices can mitigate taxes. These savings are a better emergency fund than your pensions or IRAs.

Not all financial planners agree on this list in this order. Using non-deductible IRAs is controversial. Some planners include fixed income annuities, a viable alternative for some.

What’s most important? Think through where your next savings dollars should go.

Sandi Weaver is a Certified Financial Planner professional and member of the Financial Planning Association of Greater Kansas City. She works on the Wealth Management Committee in the Missouri Society of CPAs.