Retirement Savings...Where To Begin?

Everyone encounters the all-too-common question, “Where should I be saving my hard-earned retirement money?” A few different places may come to mind including a savings account, an employer sponsored retirement plan, or even under a mattress! Luckily for you, this post identifies some of the retirement savings options available for today’s investors and how to best use them to your advantage. In reviewing 401(k) plans, Roth IRAs, and other savings strategies, we will be discussing a few simple rules that may help maximize the benefits of your retirement savings, regardless of the dollar amount.

For those out there with access to a 401(k) plan, there are several good reasons to contribute to it. What we will highlight in this post is arguably one of the most important aspects of saving in a 401(k) plan, the employer match. Employers offering 401(k) plans will often match the employee’s contribution up to a certain percentage of their salary. A good rule of thumb is to invest at a minimum the amount your employer is willing to match. Any amount your employer will match is free money so why not get as much of it as you can? Think of it as an automatic pay raise or a 100% return on your personal contribution for the year.

For example, let’s say you earn $50,000 annually and your employer will match your contribution, dollar for dollar, up to 4% of your compensation. If you contribute 4% of your salary (or $2,000), your employer will make a matching contribution of 4% (or $2,000).

Once you have maximized your employer’s matching contribution, there is another investment vehicle that has some tax advantages you may want to consider before pouring more money into your 401(k), the Roth IRA. Unlike a 401(k), which is made up of pre-tax contributions, the Roth IRA is made up of post-tax contributions. Because taxes have already been paid on funds contributed to a Roth IRA, there are no taxes assessed when funds are withdrawn in retirement. In other words, taxes for a Roth IRA are paid up front while taxes for a 401(k) are paid on the back end when funds are withdrawn. There is an important distinction between the tax-deferral feature of the 401(k) and the tax-free feature of the Roth IRA.

Tax-free income options are limited in retirement, so a Roth IRA can be a good vehicle to help minimize taxable income in retirement. Having a higher taxable income in retirement can affect, among other things, Medicare premiums and other government benefits available to retirees.

There are annual contribution limits for both 401(k) plans and Roth IRAs. For 2017, an individual may invest up to $18,000 ($24,000 if >50 years old) in their 401(k) or $5,500 ($6,500 if >50 years old) for a Roth IRA. In addition to contribution limits for Roth IRAs, there are income limits to contributions. For 2017, the adjusted gross income limit to make a Roth IRA contribution is $133,000 for single taxpayers and $196,000 for those married filing jointly, subject to phaseouts limitations.

If you do not qualify for Roth IRA contributions, you can always contribute to a Traditional IRA. The difference between a Roth IRA and Traditional IRA is that a contribution to a Traditional IRA is tax deductible. From a tax perspective, withdrawals from a Traditional IRAs are treated identically to those of a 401(k) and are taxed as ordinary income in the year they are taken. One of the key advantages a 401(k) has over a Traditional IRA is that more money can be saved annually. Since more money can be saved in a 401(k), you may as well max out the contribution to it before opening a Traditional IRA.

Lastly, a brokerage account is a more basic investment vehicle that can be used to save additional funds for retirement if the 401(k) and/or Roth/Traditional IRA options are maxed out or unavailable to you. Since this is not a traditional retirement account, there are no tax-deferral or tax-free advantages. Income in the account is taxed in the year it is earned and capital gains are taxed according to the holding period of the investment (i.e. long-term vs. short-term). If an investment is held for greater than one year, the gains are taxed at the lower long-term capital gains tax rate.

At this point, you may be asking, “What if I don’t have access to a 401(k) plan?” or “What if I cannot contribute to a Roth IRA?” There are many scenarios in which use of the described strategies become limited. However, the below decision tree will help clarify what to do in response to different cases.

There are many ways to save for retirement and we feel that by adhering to a simple, rules-based approach we can together make educated and consistent retirement savings decisions.

The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Securities offered through Securities America, Inc., member FINRA/SIPC, Betsy Merritt & Tyler Aubrey Representatives. Advisory services offered through Securities America Advisors, Inc. New Break Financial and Securities America are separate companies. Securities America and its representatives do not provide tax or legal advice. It is important to coordinate with your tax or legal advisor regarding your specific situation.