Covering Your Bases Through Tax Diversification
If youre not sure where your tax rate, income, and spending will be in retirement, one strategy might be to contribute to both a Roth 401 and a traditional 401. The combination will provide you with both taxable and tax-free withdrawal options. As a retired individual or married couple with both Roth 401 and traditional 401 accounts, you could determine which account to tap based on your tax situation.
You cant really know what future tax rates will look like, so building in the flexibility to use multiple accounts to manage taxes is important and helpful, says Rob.
For example, you could take RMDs from your traditional account and withdraw what you need beyond that amount from the Roth account, tax-free. That would mean you could withdraw a large chunk of money from a Roth 401 one yearsay, to pay for a dream vacationwithout having to worry about taking a big tax hit.
Besides the added flexibility of being able to manage your marginal income tax bracket, reducing your taxable income in retirement may be advantageous for a number of reasons, including lowering the amount you pay in Medicare premiums, paring down the tax rate on your Social Security benefits, and maximizing the availability of other income-based deductions. Be sure to weigh all your available options to maintain your retirement goals.
What you can do next
The Best Choice: Work With A Pro
Heres the deal: Investing is worth the hard work. If you dont save and invest now, you wont have anything to live on in retirement. It can be intimidating and complex, but you dont have to do this alone.
Talk with an investment professional like our SmartVestor Pros. Get someone on your team who will help you stay focused and chasing your dreams. They can walk you through your 401 and Roth IRA contribution options and create a plan for your situation.
About the author
Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.
Think About Opening A Roth 401
If youre looking ahead a few years, you may also want to consider opening a specific type of 401 called a Roth 401. With the Roth version, you fund with after-tax money, but youre able to enjoy tax-free withdrawals at retirement. .)
Tax rates are relatively low, so now could be a good time to fund a Roth 401 rather than a traditional 401.
With the Trump tax law due to sunset in 2025, we are facing higher rates in the future, says Kinder. It could be an excellent time to utilize the Roth 401 option and take advantage of the lower rates now. This is especially true for folks under 40 or folks in the 10 percent or 12 percent tax bracket.
Lower tax rates mean that the cost to take advantage of the Roth plan is lower, since you fund it with after-tax money. Taxpayers in higher brackets may find their break on current taxes is more advantageous, however, and stick to the traditional 401 plan.
This Bankrate calculator can help you decide whether the traditional 401 or Roth 401 is better for you.
Recommended Reading: How Do I Transfer My 401k To A Roth Ira
Retirement In Canada Vs Usa: Cpp Old Age Security And Social Security
Both the Canada Pension Plan and US Social Security are government sponsored mandatory old-age pension systems. They are both funded by wages and provide retirement, disability, and survivor benefits. In Canada, the CPP income thresholds, tax rates, and therefore benefits, tend to be lower than those of US Social Security. The amount an individual will receive is based on their earned income and how much they contributed through mandatory payroll taxes.
In the US, the maximum monthly social security retirement benefit in 2020 is USD$3011* for someone who earned full credits and retired at the full retirement age. The maximum Canadian Pension Plan monthly benefit in 2020 is CAD $1175**
Canada also has an Old Age Security pension that starts at age 65 and is based on time living in Canada, over the age of 18. The average OAS payment in 2019 is CAD $613. It can be clawed back by the government if someone earns more than CAD $75,910, and will be reduced to zero if their income is more than CAD $122,843.
How To Open A Solo 401
You can open a solo 401 at most online brokers, though youll need an Employer Identification Number. The broker will provide a plan adoption agreement for you to complete, as well as an account application. Once youve done that, you can set up contributions. Youll have access to many of the investments offered by your broker, including mutual funds, index funds, exchange-traded funds, individual stocks and bonds.
If you want to make a contribution for this year, you must establish the plan by Dec. 31 and make your employee contribution by the end of the calendar year. You can typically make employer profit-sharing contributions until your tax-filing deadline for the tax year.
Note that once the plan gets rocking, it may require some additional paperwork the IRS requires an annual report on Form 5500-SF if your 401 plan has $250,000 or more in assets at the end of a given year.
If you need help managing the funds in your solo 401, robo-advisor Blooom will manage your 401 at your existing provider. If you want even more comprehensive financial help, you might opt for an online planning service. Companies such as Facet Wealth and Personal Capital offer low-cost access to human advisors and provide holistic guidance on your finances, including how to invest your 401.
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Next Steps To Consider
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
The change in the RMD age requirement from 70½ to 72 only applies to individuals who turn 70½ on or after January 1, 2020. Please speak with your tax advisor regarding the impact of this change on future RMDs.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Know When To Start Retirement Planning
When should you start retirement planning? In a word, now. In three words, in your 20s. The earlier you start planning, the more time your money has to grow.
That said, its never too late to start retirement planning. Even if you havent so much as considered retirement, dont feel like your ship has sailed. Every dollar you can save now will be much appreciated later. Strategically invest and you won’t be playing catch-up for long.
» Go deeper: Read how retirement planning and building wealth go hand in hand
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Invest In Safe Bets And Blue
Certain asset types are more secure than others according to their historical performance. Index funds that track a diverse basket of securities tend to perform well over time and net reliably positive returns in the long run.
For example, the S& P 500 fund is a benchmark index tracking Americas 500 largest publicly traded companies. Any investor can buy a share of the S& P 500 fund, each of which represents a small ownership stake in each of the companies held within the fundthese include mega-cap firms such as Amazon, Walmart, and Apple.
The average inflation-adjusted performance of the S& P 500 is about 7% per annum. That means we can assume an initial investment of $10,000 will practically double after 10 years in the market. However, as demonstrated below , the S& P 500 suffers from high volatility, with some years experiencing drastic lows followed by sharp highs.
Fig.1. Source: Investopedia
Retirement investors often cannot afford to allocate all their capital to risky investments. Although index investing is a viable strategy for many, more risk-conscious investors should consider safer assets that experience less volatility year over year, such as:
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How Do I Allocate My Portfolio Do I Have The Right Mix Of Investments
Retirees have the competing goals of keeping ahead of inflation while not suffering undo losses when the market hits a rough patch. Your asset allocation should probably include some equities/stocks to allow for growth with the rest in asset classes like bonds and others that are not subject to as much volatility.
What your allocation pie chart looks like will vary based upon your unique situation. A couple of options include:
1. The popular 60/40 . However, there really is no cookie cutter answer for asset allocation. This may or may not be the right answer for you.
2. The bucket approach is a more personalized option advocated by many retirement experts.
- In one bucket you maintain liquid assets cash or other low risk investments in an amount to fund 1-3 years-worth of your retirement withdrawal needs. The reason for this bucket is to avoid the need to liquidate equities during periods when the stock market is down, realizing steep losses.
- The second bucket might contain up to five years-worth of living expenses and be invested in a combination of income producing investments and some that offer moderate growth opportunities. Bonds are an option for this bucket.
- The third and most aggressive bucket will be predominately invested in stocks or funds and more aggressive fixed and alternative type of investments. This bucket is designed for growth and to help you avoid running out of money by being too conservative.
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Managing 401 Plans For A Small Business
Setting up a 401 can be complicated, but you don’t have to do it alone. Look for a provider with an excellent track record that can help you get started, manage your plan, and even share ideas and guidance to maximize the value to you and your employees. Doing so can go a long way in ensuring an ongoing, positive benefit for years to come.
Tip #3diversify Your Investment Mix
Your investment mix is how and where your money distributes in your 401k account. There are two essential things to know about asset mix, specifically about a 401k:
Odds are they are the same, but sometimes they arent. For instance, if you change your asset mix, it usually defaults to where your future contributions are going, not the past ones. You may need to go in and rebalance your existing portfolio manually. .
Typically, your asset mix is shown on the front page when you log into your account. Most providers show you a pie chart of how it all breaks down.
The goal here is to diversify that investment mix. To be cliche, dont put all your eggs in one basket. Weve talked about this at length, but I want to reiterate a few points.
First, by not diversifying, youre not balancing your risk. If you invest entirely in a fund that focuses on energy stocks, your portfolio directly connects to the performance of that one sector. Likewise, if you think youre cute by investing 100 percent in small-cap stocks, youre betting that these growing companies will carry you into retirement by themselves.
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Taking Withdrawals From A 401
Once money goes into a 401, it is difficult to withdraw it without paying a tax penalty.
Make sure that you still save enough on the outside for emergencies and expenses you may have before retirement, says Dan Stewart, CFA®, president of Revere Asset Management Inc., in Dallas. Do not put all of your savings into your 401 where you cannot easily access it, if necessary.
The earnings in a 401 account are tax-deferred in the case of traditional 401s and tax-free in the case of Roths. When the owner of a traditional 401 makes withdrawals, that money will be taxed as ordinary income. Roth account owners have already paid income tax on the money they contributed to the plan and will owe no tax on their withdrawals, as long as they satisfy certain requirements.
Both traditional and Roth 401 owners must be at least age 59½or meet other criteria spelled out by the IRS, such as being totally and permanently disabledwhen they start to make withdrawals.
Otherwise, they usually will face an additional 10% early-distribution penalty tax on top of any other tax they owe.
Some employers allow employees to take out a loan against the money they have contributed to a 401 plan. Basically, theyre borrowing from themselves. If you consider this option, keep in mind that if you leave the job before the money is repaid, youll have to repay it in a lump sum or face the 10% penalty for an early withdrawal.
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Figure Out How Much Money You Need To Retire
The amount of money you need to retire is a function of your current income and expenses, and how you think those expenses will change in retirement.
The typical advice is to replace 70% to 90% of your annual pre-retirement income through savings and Social Security.
For example, a retiree who earns an average of $63,000 per year before retirement should expect to need $44,000 to $57,000 per year in retirement.
» Go deeper: Our free retirement calculator will help you figure out how much you need to save
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Why You Can Trust Bankrate
Founded in 1976, Bankrate has a long track record of helping people make smart financial choices. Weve maintained this reputation for over four decades by demystifying the financial decision-making process and giving people confidence in which actions to take next.
Bankrate follows a strict editorial policy, so you can trust that were putting your interests first. All of our content is authored by highly qualified professionals and edited by subject matter experts, who ensure everything we publish is objective, accurate and trustworthy.
Our reporters and editors focus on the points consumers care about most how to save for retirement, understanding the types of accounts, how to choose investments and more so you can feel confident when planning for your future.
Roth Ira Vs : What Are The Major Differences
The main difference between a Roth IRA and 401 is how the two accounts are taxed. With a 401, you invest pretax dollars, lowering your taxable income for that year. But with a Roth IRA, you invest after-tax dollars, which means your investments will grow tax-free.
Okay, folks, does anybody else feel like theyve been drinking water from a firehose? That was a lot of information! Lets review the main differences between the Roth IRA and the 401 so you can easily compare their features:
Penalties for withdrawals before 59 1/2.
Penalties for withdrawals before 59 1/2.
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How Much Should I Be Putting Into My 401k
Aim to save between 10% and 15% of your income toward retirement. Another piece of general advice is to put all of those funds into your 401k up until your employer’s matching contribution amount. Once that has been reached, maxed out your Roth IRA contribution. If there are funds leftover then consider putting those funds into your 401k.
Another way to determine how much you will need to save is to look at what income amount you will need in retirement. Fortunately, there are a lot of calculators out there that will help you figure out your magic number. Here are two of our favorites.
Nerdwallet provides a great basic calculator that lets you play with different contributions and matching amounts.
CalcXL makes a recommendation on how much you should be saving based on projected inflation. Tip: You should aim for a retirement income of roughly 80% of your current salary.
How Much Does It Cost To Set Up A 401 For A Small Business
Costs to set up a 401 plan will vary depending on the size of your business and the types of benefits you select. Initial setup fees can generally run anywhere from $500 to $3,000, depending on the chosen retirement service provider. Other costs to consider are fees associated with rolling assets over from another plan and initial consulting costs for investment advice.
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Is My Money Invested So That It Will Be There When I Need It
Figuring out how to align your investment portfolio with your necessary withdrawals might be the most important investing issue that retirees deal with. And, you are no dummy if you figure this out!
To do this, you need to know:
Your Retirement Spending: What do you need or want to spend for the rest of your life?
Beyond your day-to-day living expenses and thinking about how those will change over time, you also need to plan for anticipated major expenses such as purchasing a car, a major trip or any number of other big expenses. Plus figure out when debts will be paid off, what your out of pocket outlay will be for medical expenses and more
Your Retirement Income: How much income you will have for the rest of your life? What will you collect from Social Security? Pension? Will you have a job for any period of time? Will you collect an inheritance? Downsize your home?
The Gap: What and when are there gaps between your spending and your income? These gaps will need to come from your savings.
Matching your fixed sources of income with your projected expenses will tell you how large of an income replacement gap you need to fill, in other words how much of your monthly and annual outlays will need to come from your investments in retirement and non-retirement accounts.
Sound overwhelming? Even smarty pants can feel defeated.