You have probably heard the advice that you should maximize contributions to your employer’s retirement savings plan. Because it lowers your current income taxation by deferring pre-tax dollars to the plan and grows tax-deferred until distributed, you are encouraged to save to your employer plan (401k, 403b, etc.). Employers may also match a percentage of what you contribute. This can be a powerful way to save, but it should not be the ONLY way you save for retirement. The following medal-winning strategies might add flexibility, potential retirement tax savings and a more secure future to your retirement savings mix.
Bronze Medal Winner
The bronze medal winner for savings might seem too simple to have an impact but can add versatility and flexibility when trying to increase tax efficiency in retirement. Many people step into retirement with inadequate non-IRA savings. This forces them to distribute fully taxable income from their employer plan/IRA each time they need cash and increases their tax liability. For those individuals with a mix of IRA and non-IRA savings, more control can be gained over taxation in retirement.
Savings to a non-IRA, regular brokerage account are considered after-tax dollars and there are no limits on how much you can save annually. Once you save and invest this money, you pay tax on interest/dividends and capital gains realized during each tax year. The benefits of a brokerage account are money can be moved in/out without restrictions, taxable interest/dividends can be reduced using municipal bonds and/or growth stocks, and capital gains can be netted against losses to reduce capital gains tax.
The addition of a brokerage account to your savings mix gives you a bucket of money that is taxed differently. This might provide flexibility in how you fund annual expenses in retirement.
Silver Medal Winner
Our silver medal winner is the Roth IRA. In years when you are eligible to contribute directly to a Roth IRA, you should maximize your contributions to this account. While beneficial for clients nearing retirement, this is an excellent savings tool for those just starting out in the workforce where earnings are typically lower and retirement a distant goal. Contributions are subject to income limitations but if you happen to exceed these, there are other (IRS approved) methods to accomplish the same result. Contributions are limited to the lesser of income earned or $6,000 annually, with an additional $1,000 contribution allowed if you are age 50+. Roth contributions use after-tax dollars, grow tax-deferred, and distributions are tax-free if certain rules are met.
Like the Roth IRA but different is a 401(k) plan with a Roth option. It is important to note that while named similarly, these follow entirely different rules for use. Check with your advisor to determine if either will work to your advantage but making use of Roth IRAs and/or Roth 401k options add a high degree of flexibility to your retirement savings. The combination of tax-deferred growth and tax-free distribution makes Roth IRAs and the Roth 401(k) silver medal winners for savings.
You should speak with your advisor to understand the combination of pre-tax and after-tax savings which is most appropriate for your situation.
Gold Medal Winner
The gold medal winner for savings is the Health Savings Account (HSA). If you are covered by a High Deductible Health Plan (1) you are eligible to contribute to a Health Savings Account (HSA). Like an IRA, the HSA is designed as a pre-tax bucket of savings which can be used to pay for eligible medical expenses. However, it is also an ideal way to add retirement assets which are entirely free of taxation when growing and distributed.
For years before age 65 when you are covered by a high deductible health plan, you should maximize your pre-tax contributions to an HSA account. Annual contribution limits are $3,600 (individual)/$7,200 (family), with an additional $1,000 if you are 55+. Once you’ve made the annual contributions, try not to use if for everyday medical expenses. Instead, invest the contributions and let it grow for retirement. Earnings grow tax-deferred and in retirement, you can make withdrawals tax-free for medical expenses. We believe this is the gold medal winner of savings!! Pre-tax going in, no taxation as it grows, and tax-free on the way out. Do not miss out on this amazing opportunity to save for some very necessary future expenses.
By expanding your retirement savings to include one or all these medal winning strategies, you will add a high degree of control and flexibility to the funding of your retirement expenses. While there are no guarantees on income tax rates, it is expected that future rates will be higher than they are today. Therefore, making use of the differently taxed savings vehicles available today can help provide you with better options in tomorrow’s unknown environment. Consult with your advisor and CPA to find the best combination of accounts and withdrawal strategies to effectively navigate current taxation rules.
(1)High Deductible Health Plan – deductible is at least $1,400 (individual)/$2,800 (family) and the max out-of-pocket doesn’t exceed $7,000 (individual)/$14,000 (family)