Year-End Strategy #3: Have I Maxed Out My Workplace Retirement Savings?
If you are employed with a 401(k) plan (or other employer-sponsored retirement savings plan), the best gift you can give yourself is a big year-end boost to your retirement savings.
Your workplace retirement savings plan, and the savings that you accrue in it while employed, may be the most important factor determining what your future retirement looks like. As a financial advisor who has worked with many clients over the years to align their assets with their retirement goals, my advice to anyone with a 401(k) or other employer-sponsored retirement savings plan is to contribute as much as you can, when you can. It’s really as simple as that.
With just a handful of weeks remaining in 2021, now is a good time to take a moment to check your 401(k) contributions to date and ask these questions:
How close have you come to reaching the maximum 2021 contribution of $19,500 ($26,000 if you’re over age 50)?
If reaching the maximum 401(k) contribution level is not a realistic goal for you at this time, can you reach a contribution level that will allow you to maximize an employer match, if offered? This is essentially a “bonus” your employer adds to the contributions you make yourself—i.e., real money with potentially significant future value that you don’t want to pass up.
If you find that you’re falling short of where you want to be with your 2021 contributions, can you make an extra push with your end-of-year paycheck deferrals to close the gap? It may not be the most exciting gift you get this year, but your future retired self will thank you.
While we’re on the topic of reviewing your 401(k) and retirement savings options, here are some other questions to consider:
If My Workplace Retirement Savings Plan Offers a Roth Option, Should I Take It?
It is more and more common for employers to offer a Roth savings option as part of their retirement plan benefit. The Roth option allows you to make after-tax deferrals (as opposed to pre-tax deferrals) to your retirement account.
With the Roth savings option, you’ll pay taxes on your contributions up front, but the funds and any future gains can then grow tax free, and you will not pay taxes on any distributions in retirement.* For younger savers who are in relatively low tax brackets earlier in their careers (and expect to move to higher tax brackets as their careers advance), this can be a highly tax-advantaged way to save for retirement.
But even older workers may benefit from the advantages of having Roth retirement savings. For example:
Unlike a pre-tax retirement account, Roth accounts have no required minimum distributions (RMDs) in retirement, giving you more flexibility on how and when you access your savings.
If you do not use the Roth savings during your lifetime, there is a significant tax benefit for heirs to inherit a Roth IRA compared to a pre-tax IRA. While they will still need to distribute the funds within 10 years of inheritance (per the 2019 Secure Act), they will not pay any taxes on the distributions. With a pre-tax IRA, by comparison, heirs will have to pay ordinary income tax on the entire IRA distribution within the 10-year timeframe, a potentially burdensome tax bill, especially for heirs who may be in their peak income and tax years.
So, if your retirement plan offers a Roth savings option, I believe it’s worth looking into and considering whether the benefits make sense for your situation. And if you’re not sure, I’m happy to discuss.
* Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.
I’ve Maxed Out My Workplace Retirement Plan Contributions … Now What?
Well, first of all, congratulations! Your super-saver efforts will most certainly pay off over the long run. As for the “now what,” here are some ideas:
Individual Retirement Account (IRA): For most people, the next savings option to consider if you have extra money after maxing out your 401(k) is making a contribution to an individual retirement account (IRA), which may be a pre-tax IRA or after-tax Roth IRA. For 2021, you can contribute up to $6,000 ($7,000 if you are over age 50) to an IRA. Certain income eligibility requirements apply. We generally recommend waiting until early 2022, when you know your final 2021 income, to make your IRA contributions.
Important: IRA contributions must be completed before you file your taxes and before April 15. Even if you go on extension, April 15 is the hard deadline for IRA contributions.
For more information, check out our earlier newsletter article about IRAs and how they work.
Mega Backdoor Roth 401(k): For some highly compensated employees who have extra money to save and whose 401(k) plans are structured a certain way, there may be an opportunity to “super size” your 401(k) with a Mega Backdoor Roth 401(k) contribution up to an annual total savings limit of $58,000.
For the Mega Backdoor to work, your 401(k) plan must allow:
After-Tax Contributions; and
In-Service Distributions (you can transfer money out of the plan to a Roth IRA) OR In-Plan Conversions (you can transfer money within the plan to a segregated Roth 401(k) within the plan).
The Mega Backdoor Roth is complicated and can carry hefty tax implications if not executed correctly. In other words, it’s not for everyone. But if it’s something you think you may be eligible to do and are interested in exploring, let’s discuss.
Non-Retirement, After-Tax Investment Account: We recommend that you max out other retirement savings options first to take advantage of the tax benefits. But if you have done so, and still have cash to spare for savings, a non-retirement, after-tax investment account is another option. There are no eligibility requirements or limits to saving money in an after-tax account. After-tax funds also have no restrictions on distributions (other than tax implications of selling securities) and can be a flexible and low-cost source of funds in retirement.
What If I Don’t Have a 401(k) or Other Employer-Sponsored Retirement Plan?
If you do not have access to a 401(k) or other employer-sponsored retirement savings plan, you may wonder what retirement savings options are available to you. Here are some scenarios and related ideas:
Situation #1: I work for an employer who does not offer a 401(k): Depending on your household income, you may be eligible to contribute up to $6,000 ($7,000 if over age 50) to a pre-tax IRA or Roth IRA. You can read more about IRA options HERE.
Situation #2: I am self-employed. If you work for yourself, contributing to an IRA or Roth IRA may be one option (see #1 above). For larger and more flexible savings opportunities, you may also want to consider setting up a SEP IRA or an Owners Only 401(k). I am happy to discuss how each of these retirement accounts work and which may be right for your situation.
Situation #3: I do not have earned income but my spouse does. In this scenario, it may be possible for the working spouse to open a traditional or Roth IRA for themself and also open a Spousal IRA for the non-working spouse. The contribution amounts must be the same to each account (which are held in each individual’s name), and certain eligibility requirements apply.
* * * * * * * * * * * * * * * *
As this newsletter highlights, there are many options and nuances to retirement savings, but the most important message I can communicate is to have a savings plan and stick to it. Retirement will be here before you know it, and what you save today will be invaluable to helping you live the future life you desire. If I can help in any way to explain the options or review your retirement savings situation, please reach out.
Securities offered through Raymond James Financial Services, Inc., Member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Estes Wealth Strategies is not a registered broker/dealer and is independent of Raymond James Financial Services.
Any opinions in this newsletter are those of Estes Wealth Strategies and John Estes and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information presented herein has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. It is not a statement of all available data necessary for making a recommendation, nor does it constitute a recommendation.
Roth 401(k) plans are long-term retirement savings vehicles. Contributions to a Roth 401(k) are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. Unlike Roth IRAs, Roth 401(k) participants are subject to required minimum distributions at age 72 (70 ½ if you reach 70 ½ before January 1, 2020).
Matching contributions from your employer may be subject to a vesting schedule. Please consult with your financial advisor for more information.
While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.