April 1, 2023 | Todd Little, CFP®, AIF®
I remember Alpha-Bits cereal as a kid. It was a frosted, alphabet-shaped cereal. I didn’t eat it often, but whenever I did it was fun to play a game. You would get a spoonful of cereal and see if you could spell any words out of the random letters of the cereal. Usually, though, it was just a jumbled mess.If we add numbers to the mix, it may seem to explain how we arrived at the different types of retirement savings accounts available today: 401(k), 403(b), 457, IRA, TSA, HAS, ESOP and the like. Whether or not the name makes sense to you, there are still some characteristics you should know and some questions you should consider in determining how they can benefit you.To begin, it’s important to understand their basic purpose. All these accounts are designed to help you save and invest money today so that you can spend it in retirement. In our office, we define retirement as an income goal. In other words, I can successfully retire when I can replace my working income from other sources. It used to be that for many people there were three main sources of retirement income: a company pension, Social Security, and their own savings. However, with pensions mostly a thing of the past and concerns about the financial stability of Social Security, more than ever there is pressure on the individual to save for their own retirement. These accounts can be a great way to do that as they can offer advantages for doing so.Here are six questions you should consider:1) How much can I contribute?
This question has two answers. The first answer is more obvious. Each of these plans has a maximum allowable contribution amount as set by the IRS. And they can be quite different. For example, in 2023 the maximum you can contribute to an IRA account is $6,000, but the maximum you can contribute to a 401(k) account is $22,500. There can be additional amounts (called “catch-up contributions”) and the amounts can be increased each year for inflation, so it’s important to stay up to date.
The second answer is more important and more personal. How much can I contribute? Meaning, how much can I realistically afford to defer from my income now. It goes without saying that the more you can save today, the better off you will be in retirement. And the sooner you start, the better.2) Does my employer match any of my contributions or make any other contributions?
Although most companies have discontinued pension plans, they still want to incentivize and help employees save for retirement. One of the biggest ways they do this is by making contributions to employees’ retirement plans. Some contributions are considered matching contributions where the company will match an employee's contribution with a contribution of their own up to a certain limit. Other contributions are considered profit-sharing, where the company makes a contribution to all employees based on the company’s profitability. Either way, you want to understand how the employer match works and make sure you are doing everything you can to maximize it. After all, it’s free money.3) Are there any tax advantages, now or in the future?
The IRS also wants to motivate people to save for retirement and what bigger motivation is there than not wanting to pay taxes? Most of these accounts have tax advantages to them. Keep in mind, we’re talking about tax advantages, not tax avoidance. The bottom line: the IRS will always get their taxes. However, you may be able to decide when you pay them – now or later. While it may be attractive to consider paying less taxes now, it may also be short-sighted. You really should consider not just the taxes you pay this year, but the taxes you will pay over your lifetime. We recommend you work with a financial professional and tax advisor to fully understand your options and the best choice for you.4) How is my money invested?
One of the biggest advantages of retirement accounts – and a reason you should start early – is the power of compounding. In other words, saving is great, but having my savings grow over the years through investment returns takes it to a whole new level. You’ll want to understand your investment options so you can select the best option(s) for you. How much time do you have until retirement? How much opportunity for growth do you want and how comfortable are you with the potential risks including loss of value? Again, a financial professional can provide some much needed assistance and clarity.5) When can I take my money?
One of the disadvantages of retirement savings accounts is your access to the money. Since some of the money may not be all yours (employer contributions) and since you may have received a tax advantage, you may be limited as to how and when you can get your money out. As implied in the name “retirement savings,” it is intended that you would not take the money until you retire, but that can mean different things to different people, especially the IRS. The key is to understand at what age or under what circumstances can I take my retirement savings out and how is it taxed?6) What if I change jobs or employers?
As many of these retirement savings accounts are offered through your employer and given that many people change jobs, often multiple times, this is a fair question. Leaving your company may provide you with some options about what to do with your old plan. Can you leave it there? Can you move it to your new company plan? Can you move it somewhere else? Not to sound like an attorney, but it depends. The good news is that all of your contributions, including any gains or losses, always belongs to you. Changing jobs should, hopefully, improve not just your current financial picture, but your future one as well. Whenever you change companies, you should always find out what that means for your retirement account(s) and how to best simplify and maximize them going forward.These six questions are important, but they are not a complete list. Indeed, the answer to any one of them may lead to additional questions. Further, to answer them thoroughly would require significantly more time than I have to write (and you care to read) right now. Bottom line: if you can’t answer at least these six questions about your retirement savings, find someone who can help you.Contact us to learn more about how Kemp Harvest Financial Group can support your financial life.The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including loss of principal. No strategy assures success or protects against loss. This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.