It’s 9am. Do you know where your 401k is right now? What do you really know about that account that takes a bit from your paycheck every 2 weeks? While I’m here, let's talk about Retirement in general. What it means to you, how best to achieve it, what type of investments are best for your situation and how you should be maximizing these accounts for your long term financial wellness.
In the traditional sense retirement means a time in life after you've worked a considerable amount of years (62 in the United States) where you are finally able to kick your feet up and relax. However with the lack of social security, the rising cost of everything and new technology being developed every day that outsources workers, if you have plans of eventually kicking your feet up you need to understand exactly where you're at in the world today. Understand that while retirement is a time to relax it also is a time where you'll experience several years of little to no income. Think of all your monthly expenses right now and then consider paying them with no money coming in for let’s be optimistic 20 years.
More modern concepts of retirement like the FIRE model which stands for financial independence, retire early look to remove the age barrier by developing ways to generate continual income from assets like real estate or stock dividends that are greater than the fixed expenses like a mortgage needed to live. They encourage living below one’s means, adding additional income through side hustles and investing aggressively.
Retirement planning is a multistep process that evolves over time starting with thinking about your retirement goals and how long you have to meet them, Then the types of retirement accounts that can help you raise the money to fund your future. Retirement planning should include assessing risk tolerance, determining time horizons, estimating expenses, calculating required after-tax returns, and doing estate planning.
There are several different types of retirement accounts. Those specifically designated as retirement accounts typically grow the contributions tax deferred. What this means is the earnings you get through your investments in the account whether its through dividends, interest or capital gains accumulate tax free until its time to retire. Retirement planning is important because the type of lifestyle you envision when you want to retire should correspond with the retirement investment account you have.
401K
Pros
Available through employment mostly offered by established companies to their employees.
Money comes directly from paycheck before taxes
Some companies offer matches where they'll contribute up to a certain percentage to match your contribution which is basically free money.
Can take a tax free loan from overall balance with a favorable repayment schedule to cover a short term liquidity need. In most cases, it will be less than the cost of paying real interest on a bank or consumer loan.
Cons
No real input on the investment choices. Determined by the company. If the company makes poor investment choices could affect your retirement plans.
If you leave the company you can no longer make additional contributions to the account, it may continue to grow but not at its full potential. At that point you might want to consider rolling it over to another company 401k plan or your personal retirement account.
Additional Info
Often you can select an allocation of risk within your 401k plan. They say the younger you are the more risk you can afford to take. The idea being you should be trying to maximize the effect of compound interest as long as possible and on the off chance that the market crashes you still have time for it to recover before youll need the money. As you get closer to retirement age it would make sense to pull your funds out of more risky investments and focus instead on persevering your capital for retirement.
Traditional IRA
Pros
If you're in the income phase-out range, you can deduct a portion of your contributions from your overall tax liability
When you withdraw funds at retirement age you only pay the tax of your current income level. (Since you're retired and therefore not receiving any income your tax level should be lower than it was when you were working and making contributions.)
More discretionary control over the investments in the account vs 401k
Cons
If your income is higher than the maximum income limit, then you can't deduct your IRA contributions.
The maximum annual contribution per individual is only $6,000 Married couples can make a contribution of $10,000. If you are 50 or older you can make a contribution of $7,000
While you have more control there’s still a limit on the kinds of investments you can put in a Traditional IRA account typically only securities like Stocks and Bonds or Options.
10% early withdrawal penalty.
Additional Info
For my folks who own their own business there are retirement investment accounts just for you. look into Solo 401k, SEP & Simple IRAs. retirement plans available that typically offer a much higher contribution limit than what’s available for a regular IRA
ROTH IRA
Pros
Money grows tax deferred and theres no tax penalty when you withdraw it at retirement age.
Wider variety of investment options that can go into the account including real estate private company stock and crypto currency.
Same contribution limits as traditional IRA.
Easy to open up available at most brokerages
Cons
Contributions are taxed at the depositors tax current tax rate. The idea is that if you feel as if you're going to be richer than you are currently when you retire then you can pre pay the taxes upfront now. They'll grow tax deferred and when you retire you can take them out tax free as you've already paid the tax.
Can only make contributions to one qualified retirement plan a year. Meaning if you make the full contribution to a ROTH then you cant also add those funds to a traditional IRA.
Limits based on income. If you’re single, you can only contribute to a Roth IRA if you earn less than $144,000.
Additional Information
There are methods currently available for higher earners to make a contribution to a ROTH by first putting the money in an IRA and then moving the funds to your ROTH account. This is called a backdoor transfer. A backdoor Roth IRA is not a tax dodge because it may incur higher tax when it’s initially established but the investor will get the future tax savings at retirement age.
Bottom line no matter what kind of account you open you need to be stacking now! The majority of our people don’t even have simple brokerage accounts. Twenty-two percent of Americans have less than $5,000 saved for retirement, and 15 percent have no retirement savings whatsoever and will have to work until they die because they aren’t properly planning for retirement right now.
Ill leave you with this. The Japanese people have a much higher average lifespan than those in America 85 vs 67 one of their secrets to a longer life is a prolonged retirement, they actually encourage their citizen to work at their jobs longer. Something to consider.
Remember I may be a financial advisor but I’m not your financial advisor. Nothing in this blog post should be considered financial advice. If you have any questions or would just like to discuss how to improve your financial wellness please feel free to contact me.