Saving for retirement involves more than just putting money into a 401(k) account and hoping for the best. Strategies that maximize savings, minimize taxes and help you achieve the retirement lifestyle you want and deserve are a must. For 13 weeks, starting today, we will cover everything you need to know to get the most from your retirement savings accounts.
Your Nest Egg
Your nest egg consists of the money you set aside for retirement, along with investment earnings generated by that money. Your overarching goal should be to protect your nest egg by managing investment risks and utilizing appropriate investment strategies throughout your saving years and into retirement.
Setting age- and risk-appropriate investing goals will help ensure you don’t find yourself trying to play catch-up later in life. You should, for example, front-load savings in your 20s to take advantage of the power of compound interest and employer matching with 401(k) retirement plans even if it means not paying off your student loans early. The age at which you want to retire should also be a factor in determining your savings goals. (See The Pros and (Mostly) Cons of Early Retirement.)
Employer-based retirement savings plans such as a 401(k), 403(b) and others will often be your main savings tools. Employer matching funds – try to find jobs that offer them – multiply your savings at no cost to you. (For more, read How 401(k) Matching Works.) Employer-based plans typically also provide automatic pretax savings withholding along with investment education and other tools.
Individual Retirement Accounts (IRAs)
Traditional and Roth IRAs are helpful even if you also have an employer-based plan. IRAs can provide access to a wider variety of investments and the ability to save even more for retirement. Many financial advisors counsel their clients to have both types of IRA due to the unique tax status of each. (See Pros and Cons of Creating a Backdoor Roth IRA.)
Keeping Track of Withdrawal Rules
The magic age to withdraw funds from IRAs or borrow from your 401(k) without penalty is 59½. (You will still owe income tax, unless you're withdrawing from a Roth IRA or 401(k).) There are exceptions, but unless you qualify it’s best to avoid early withdrawal and the additional 10% tax penalty that comes with it. Besides, you lose that valuable compound interest from any funds you withdraw early. (See Should You Borrow from Your Retirement Plan?)
Avoiding Unnecessary Taxes
You don’t pay capital gains taxes on income from tax-advantaged retirement accounts, but you do pay regular income taxes at retirement. Jon Heischman of Heischman Financial Services recommends a strategy that includes placing low (or no) dividend paying stocks in a taxable account and high dividend stocks and taxable bonds in a tax-deferred account. Heischman suggests putting mutual funds that pay dividends and capital gains in a taxable account along with municipal bonds, which are not taxed at a federal (and sometimes even state) level.
A Retirement Income Buffer
As you approach retirement, consider supplementing your income to provide a buffer against market fluctuations and unexpected expenses. This could include real estate in the form of income property, additional investment accounts, starting a small business or getting a part-time job. If any of these options appeal to you, it’s best to do your research and start making plans before you retire.
Timing Retirement with Your Spouse
The rules for spousal benefits for Social Security are complicated. Know their ins and outs to protect your savings and avoid paying unnecessary income taxes due to poor timing when it comes to signing up for benefits. You and your spouse need to make sure you are both on the same page when each of you nears retirement. (Should you need it, see Divorcing? The Right Way to Split Retirement Plans.)
Late Career Strategies
At age 50 you are eligible to start making catch-up contributions to your retirement accounts. You won’t have the advantage of compounding, but you will likely be able to add to retirement savings without cramping your lifestyle. This is also an appropriate time to review your investment mix to make sure your risk tolerance matches the fact that you are getting close to retirement. (See 6 Late-Stage Retirement Catch-Up Tactics.)
Plan for major expenses such as home repair or expensive medical procedures before you retire. Whether you need a new roof or a new hip, do it while you still have a salary coming in and are covered by employer-provided health insurance. Make charitable contributions when your income is high, not after you retire and have less need of the deduction.
Continue to monitor your financial situation even in retirement. Make financially smart moves before required minimum distributions (RMDs) kick in and make sure the spend-down plan for your 401(k) or IRA is aligned with your retirement dreams and goals. (Read 6 Important Retirement Plan RMD Rules.)
The Bottom Line
Retirement is a time to relax after a lifetime of labor, not a time for stress and uncertainty. Employing the strategies you will read about in this series will help you protect your nest egg by getting – and staying – on track. Your reward will be a safe, happy and prosperous next chapter in your life. And a chance to start working on your bucket list.