A 401(k) is a powerful retirement savings tool. If you have access to such a program through work, it’s smart to take advantage of any employer matching. If you have money left over, there are other ways to save for retirement.
Retirement planning ensures that individuals live out their golden years in comfort, so it is vital to understand the ins and outs of this practice. This article describes some of the other options available to you to make the most of your retirement savings strategy and help reduce your tax liability.
- Try to max out your 401(k) every year and take advantage of every match your employer offers.
- Contributions are tax deductible in the year you make them, which can leave you with more money to save or invest.
- Once you’ve maxed out your 401(k), consider putting your remaining money into an IRA, HSA, annuity, or taxable account.
401(k) Employer Match
Many employers offer their employees 401(k) plans. And they might even match the contributions to sweeten the pot. This means that for every dollar you contribute to your employer-sponsored plan, the company matches a certain percentage. This increases the amount of money stored in your account. Some match up to 50% of your contribution, while others match dollar for dollar up to a certain limit.
Employers typically match Roth 401(k) plans at the same rate as traditional 401(k) plans. However, some employers do not offer Roth 401(k) plans. A notable difference between traditional and Roth 401(k) contributions is that the employer contribution is placed in a traditional 401(k) plan — taxable upon withdrawal. The employee portion of the contribution is placed in a Roth 401(k).
Some financial planners may encourage investors to maximize their 401(k) savings. On average, people earn about $0.50 on the dollar, for a maximum of 6% of their wages. This is equivalent to an employer writing a $1,800 check to an employee who earns $60,000 each year. Additionally, the $1,800 is essentially free money and can grow over time by investing in the financial markets.
You don’t need to be a professional
Although 401(k) offerings can be difficult for non-professionals to understand, most plans offer low-cost index funds, which are ideal for new investors. As individuals approach retirement age, it is wise to modify their asset allocation by shifting a portion of their retirement assets from stocks or shares to bond funds. Many adhere to the following age distribution model:
- At age 30, invest 30% of your retirement money in bond funds.
- At age 45, invest 45% of your retirement money in bond funds.
- At age 60, invest 60% of your retirement money in bond funds.
Those opposed to the age-based approach may instead choose to invest in target-date mutual funds, which provide investment diversification without selecting every single investment.
“Target-date funds also tend to be more conservative closer to the chosen date. The combination of these advantages can make it a one-stop shop for 401(k) participants,” explains David S. Hunter, CFP and president of Horizons Property management.
Investing after you exhaust your 401(k).
Those who contribute the maximum dollars to their 401(k) plans can grow their retirement savings with a number of different investment vehicles. We list some of them below.
Individual Retirement Accounts (IRAs)
You can contribute up to $6,000 to an individual retirement account (IRA) in 2022 and $6,500 in 2023, provided your income is at least that much. If you’re 50 or older, you can add another $1,000 in both years, although some IRA options carry certain income restrictions.
If you make too much money, you can’t contribute to a Roth IRA. If you make more than a certain amount and are covered by a workplace plan, you can’t deduct contributions to a traditional IRA.
Traditional IRA income limits
Deducting a traditional IRA contribution is subject to income limits if you are covered by a retirement plan at work.
For individual taxpayers, the phase-out of the deduction begins at a modified adjusted gross income (MAGI) of $68,000 and disappears entirely if your MAGI is $78,000 or higher for 2022. That range increases to $73,000 to $83,000 in 2023 .For those married and filing jointly, where the spouse making the IRA contribution has a workplace retirement plan, the phase-out starts at $109,000 and disappears at $129,000 ($116,000 and $136,000 a 2023).
If you don’t qualify to deduct all or part of your traditional IRA contribution, you can still contribute up to the contribution limit. Your investment will continue to grow on a tax-deferred basis.
Roth IRA Income Limits
Contributing to a Roth IRA also carries income limitations and a phaseout. But unlike traditional IRAs, the limit determines your eligibility to contribute.
For individual taxpayers in 2022, the income phase-out begins at MAGI of $129,000 and disappears for incomes above $144,000 ($138,000 to $153,000 in 2023). For married taxpayers filing jointly, the phase-out begins at MAGI of $204,000 and ends entirely above MAGI of $214,000 ($218,000 and $228,000 in 2023).
Health Savings Accounts
Health savings accounts (HSAs) are available to those with high-deductible health plans (HDHPs), whether they access them through their employers or purchase them independently. Contributions are made on a pre-tax basis.
If used for qualified medical expenses, withdrawals from the account are tax-free. And since users aren’t required to withdraw the money at the end of each year, HSAs can act like another retirement plan, making them ideal vehicles for saving for health care expenses during retirement.
For 2022, the Internal Revenue Service (IRS) defines a high-deductible health plan as one with a minimum annual deductible of $1,400 for self-only coverage ($1,500 in 2023) or $2,800 for family coverage ($3,000 in 2023 ).
Also, under a high-deductible plan, annual out-of-pocket costs (such as deductibles, copayments, but not premiums) do not exceed $7,050 for self-only coverage or $14,100 for family coverage for 2022; but for 2023, don’t exceed $7,500 for self-only coverage or $15,000 for family coverage.
The contribution limits for 2022 are $3,650 for an individual and $7,300 for a family. however, in 2023 The contribution limit is $3,850 for individuals and $7,750 for families. The top-up contribution for those aged 55 for both 2022 and 2023 is an extra $1,000.
Taxable investments are a viable way to build retirement savings. While dividends and capital gains are taxable, long-term capital gains on investments held for at least one year are taxed at preferential rates.
If you’ve completed a 401(k), be aware of asset position to ensure investments are held in taxable versus tax-deferred accounts.
Annuities often get a bad rap — sometimes deservedly so. However, a variable annuity can provide another means of allowing after-tax contributions to grow on a tax-deferred basis.
Variable annuities generally have calculations similar to mutual funds. Along the way, the contract holder can cancel the contract or redeem it in part or in full, where the profits are taxed as ordinary income.
However, you should be aware that many contracts have onerous fees and significant delivery charges. If you are considering a variable annuity, perform thorough due diligence and seek help from a financial advisor beforehand.
How Much Do You Need to Save for Retirement?
The amount a person will need to save for retirement will differ for everyone based on their current lifestyle, desired retirement lifestyle, expenses, health and dependents. One suggestion is to take the desired income you need in retirement and divide it by 4%. So, for example, if you need $70,000 in annual income, you’ll need a retirement nest egg of 70,000/0.04 = $1.75 million.
What are the 4 common retirement plans?
Common retirement plans include 401(k)s, traditional and Roth IRAs, SEP IRAs, SIMPLE IRAs and Solo 401(k)s.
What is the best retirement plan?
One of the best retirement plans is a 401(k) retirement plan. Not everyone has access to a 401(k), as it must come from an employer and not all employers provide it. However, 401(k)s have high contribution limits, are tax-advantaged, and many employers match the contributions made by the employee.
The bottom line
When it comes to your future, investing money is always a good thing to do. Diligent savers who max out their 401(k) contributions have other retirement savings options available to them.