Investors have had the old adage of socking away everything possible into their 401(k) and/or Traditional IRA pounded into their minds for years. While the general notion makes complete sense, there are ways to strive towards the same end goal, while eliminating some potential pitfalls down the road. A little bit of planning today can make all of the difference in an effort to supercharge your retirement.
Many people refer to their retirement savings plans as 401(k)s even when they aren’t actually a 401(k), as the majority of financial advice centers around utilizing these accounts. While 401(k)s are a solid tool for contributing on an ongoing basis towards your retirement, these can sometimes be complicated and expensive, which oftentimes is passed on to the unaware consumer. You generally fund a 401(k) for the long-term, as the dollars are all contributed on a pre-tax basis, which means every dollar that is withdrawn is taxable. These dollars are also often subject to early withdrawal penalties, which can restrict when you access the funds. Generally, most 401(k) plans are very limited in the scope of which they can be invested, meaning you have very little choice in how the dollars are working for you. Simply put, 401(k)s were designed to help workers save for retirement in a relatively easy way. Go to work, fill out the investment allocations, be sure they add up to 100% and watch your contributions get deducted from your gross wages each pay period.
A Traditional IRA is a type of account in which the investor contributes dollars on a pre-tax basis much like a 401(k), but there are much lower contribution limits. Also like a 401(k), earnings grow tax-free, but every withdrawal is taxable. A Traditional IRA can be ideal for investors if you exceed the income limits for contributing to a Roth IRA, or if you anticipate being in a lower tax bracket in retirement. Keep in mind that there are penalties involved for early withdrawals (currently age 59 1/2), and you are required to being distributions at age 70 1/2.
While 401(k)s and Traditional IRAs are fine ways to accumulate retirement assets, there are more efficient ways to approach your retirement goals. One way to supercharge your retirement is by utilizing a Roth IRA. A Roth IRA is funded with after-tax dollars, while the growth and subsequent withdrawals are not subject to tax. This can be especially helpful for investors who might be in a low tax bracket now, but anticipate being in a higher bracket in retirement.
Roth IRA Basic Rules
- You can contribute to a Roth IRA if you make less than $133,00 for single filers and $196,000 for married couples (click here to see full IRS breakdown)
- The maximum contribution to a Roth IRA is $5,500 per year, unless you are 50 or older, in which case it jumps to $6,500 per year
- You have 15 months to contribute for the current tax year (January 1 until tax filing deadline of the following year)
- Roth IRA account owners are subject to a penalty if they withdraw earnings or interest before age 59 1/2 and at least five years have not elapsed since your initial contributions have been made
Supercharge Your Retirement – While Maximizing Today
Now that the basics have been covered (be sure to consult with a tax professional for advice), let’s look at some ways that an investor can not only supercharge retirement, but also maximize today. While earnings or interest have restrictions in regards to withdrawals, your contributions can be accessed tax and penalty fee at any time for any reason. Additionally, there are some exceptions that allow you to access funds:
- Most think of 529 Plans when saving for education expenses, and that’s a solid choice for many because you can save above and beyond what you can in a Roth IRA. However, a Roth IRA can provide more flexibility as you can simply leave the funds for retirement if you don’t end up using it for college costs.
- Unlike 529 Plans, money in a Roth IRA isn’t counted towards estimated family contributions for college. This could possible help lead towards a more generous financial aid package.
Buying a Home
- You can withdraw up to $10,000 of your earnings (in addition to any amount of contributions) without being subject to taxes or penalties if you’re a first-time home buyer. If you’re married, your spouse can withdraw the same. This money can be extremely useful for applying towards a down payment or closing costs.
A Backup to Your Backup
- If you’re faced with a difficult situation that has erased your emergency savings, your Roth IRA can provide additional funds to help out in a tough time. This should not be thought of as a cash reserve, but rather a tool to help out with major unexpected issues (major medical bills, etc.). Again, make your Roth IRA a last resort, but it can help you to avoid racking up expensive credit card debt.
Leaving a Legacy for the Next Generation
- As noted earlier, 401(k)s and Traditional IRAs are subject to Required Minimum Distributions (RMDs) at age 70 1/2. Roth IRAs are not subject to this requirement, which means you are never forced to withdraw from this account. Oftentimes we forget that while passing on a generous amount of money in a Traditional IRA is a nice gift, it can be very troublesome for the recipient in terms of taxes. This makes a Roth IRA a fantastic way to pass along money to your heirs, as there won’t be an potential tax issues to worry about.
- Be sure to have your beneficiary designations set and reviewed often, because it prevents assets in this account from passing through probate before being distributed. Non-spousal beneficiaries will have to make a withdrawal from that money each year, but they will not be subject to taxes.
Plan for Tomorrow, But Don’t Ignore Today
In summary, there are many ways to utilize your Roth IRA as it is a very flexible vehicle to save for major financial goals. As always, be sure to plan and review that plan before making a withdrawal as using your Roth IRA contributions today means there’s less money to have the potential to grow between now and retirement.
Adam M. Sutton is the founder and president of Cornerstone Financial Partners. Adam is a financial planning professional, specializing in retirement income planning and wealth optimization strategies. He is a Series 66 licensed Investment Advisor Representative (IAR), as well as life, accident & health insurance licensed and is certified to address long-term care. Cornerstone Financial Partners is a privately held, independent financial planning firm.
Full Disclosure: This information does not constitute investment advice. This article is published and provided for informational purposes only. None of the information contained in the article constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. To the extent any of the information contained in this article may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Cornerstone Financial Partners does not provide legal or tax advice, and the contents of this message are not intended to constitute such advice. Please seek an appropriately licensed individual for legal or tax advice in relation to your individual situation.