Rid yourself of some or all taxes
Most of our clients and followers already know about certain retirement hacks you should be thinking about in markets like we're facing right now. Even though most of us remember them when we're reminded, it's a topic worth revisiting. You know there are choices in most of your retirement plans at work. You choose to have money held out of your paycheck to invest in the income your future self will use in retirement. We call those retirement plans and they come in all sorts of flavors; 401(k), 403(b), 457, and so on and so forth.
We handle tons of small to mid-sized companies' retirement plans and work with the business owners and sponsors to draft the plan design. There are tons of choices they make for their staff long before any notices go out and the plan goes live. We put a ton of effort into plan design to meet the needs of the employees and customize the chassis. With that being said, our focus is on the pre and post-tax options. Roth options are not right for every single person. You'll want to discuss things with your CPA or accountant to make sure you're making the right choice for your circumstance.
We often get asked how much a person should be saving. Is it a fixed dollar amount, a percentage, and what are 401(k) plans paying these days? First, the amount of savings varies quite a bit depending on your lifestyle, time horizon until retirement, and how much income you'll need when you decide to call it quits. Percentages tend to work out best as they'll adjust based on your earned income versus a flat and stagnant amount that requires you to make changes manually. Above and beyond is to ensure that you're revisiting your deferral percentage each and every year. If you're able to afford it, increase your savings by at least one percent until you max out.
Once you set up your deferrals, you're going to look at savings to defer taxes or square up right now. Making pre-tax elections allows the participant to defer taxes and save towards their retirement goals. That can be a great option for high-income earners who are looking for the reduced tax liability. It's a good choice with an immediate incentive so it has some level of reward you don't have to wait years to realize.
Choosing to pay the taxes now and draw income-tax-free, later on, can be an enticing consideration. You may have to do a bit of guessing when it comes to the impact of the tax benefits. Ask yourself if you see yourself in a tax bracket that's higher or lower in retirement. It's not often that brackets go lower, but it's not that simple. You have to consider how old you'll be when you retire and what your income sources look like. Things like social security, pensions (if you're lucky), non-retirement investments, real estate, or business income.
Our blog title implies that you have more than just pre-tax and post-tax options and that's true. We get this question every now and again, but you are able to choose both if your plan allows. Most of the plans we work with have a Roth component to them and if it's a plan design we're helping clients with, it will allow the participants to make this choice. You could make the choice to save part pre-tax and some post-tax. This choice will give you an immediate benefit with the reduced tax liability today and tax-free distributions when you take money out.
Where does that leave plan participants with respect to their company match or profit-sharing? That's a great question and it often leaves employees confused. Your savings option has no bearing on the company match or profit share. That's right, those employer contributions are always made on a pre-tax basis. It's nothing you can change, but it's good to know because you may think your election to contribute 100% in a Roth 401(k) will leave you a nest egg that's completely income tax-free. That's not the case. Your company's contributions will get taxed down the road. If you're one of the lucky employees that have a company willing and able to help contribute to your retirement plan, embrace it. Be sure you contribute enough to max out the company matching incentive and give yourself that well-deserved raise you've worked hard for.
And that's only the beginning...Reach out and schedule a consultation to discuss your situation. We'll walk you through your options and help you make the right choice for your goals. Click below to take a listen to the latest PennyWise Financial Podcast and hear more commentary on the stuff you need to know, and much more.