With all of the hubbub around the holiday season you probably missed a nice gift you received from Uncle Sam. And, like the forgetful uncle that he is, he forgot to give it to you until January, but as they say, it’s the thought that counts.
So, what present am I talking about? Why, the $500 increase in IRA and 401k contribution limits of course!
Contribution Limits for 2019
For 2019 the maximum you can contribute to an IRA has increased to $6,000, up from $5,500 last year ($7,000 for individuals 50 or older). And for a 401k the maximum employer contribution increased to $19,000 up from $18,500 (this also applies to 403b, most 457 plans and the governments Thrift Savings Plan). Individuals 50 or older contributing to these plans (401k, 403b, 457, TSP) can still contribute an additional $6,000.
What also increased were the income limits for the phaseout of when you can and can’t contribute to IRAs and Roths. You can find the full rundown of the changes on the IRS’s website here: IRA increases contribution limits for 2019.
But don’t forget about 2018
You also still have the option to contribute to your IRA or Roth for 2018. You can contribute right up to April 15. So, if you haven’t yet contributed this year you still have time to sock away up to $5,500 ($6,500 if your 50 or older) into your IRA and count it against 2018’s taxes.
If your income is above the Roth contribution limits, you are unfortunately too late to enact a backdoor Roth contribution for 2018 since you had to complete those by Dec 31 2018. Maybe a financial planner could have helped make sure your financial tasks were completed on time wink, wink?
What is the impact of that extra $500?
You may yawn and think, “big whoop, an extra $500, what will that get me?” Well I’m glad you asked. Even though it might not seem like much, given it’s only an extra $41.67 a month. Depending on your investing time frame that $500 could add up to a serious bump in your portfolio over time.
If We assume 7% growth within a tax advantaged account, after 10 years you would have an additional $6973. After 20 years it would be $20,624 and after 30 that would grow to $47,479. All from contributing just an extra $500 a year.
Upping your contribution
Now is the perfect time to increase your contribution for 2019 or make one for 2018. If you’re a W-2 employee you should receive your copy in the mail any day now. By comparing your earned income in box 1 of your W-2 to the income limits at the link mentioned above you can figure out if you qualify to contribute to an IRA, Roth, or both. And if you plan to earn the same amount for 2019 this will help you decide where to contribute for the coming year as well.
Another decision to make is when to make your 2019 contributions: in one $6,000 chunk or by dollar cost averaging with an automatic monthly contribution.
The upside with automatic monthly investments is that you don’t have the worry about contributing $6,000 in one chunk then watching the market drop the next day. The downside is if the market decides to move steadily upward throughout the year, the impact of your monthly contribution is reduced each month.
Historically the stock market finishes the year higher than where it started about ¾ of the time. Given this info you are likely better off making the lump sum contribution at the start of the year. But if it helps you to sleep at night by making the monthly contributions then go that route. We humans tend to feel the pain of loss much more acutely than the joy from a gain.If you are in Boise or beyond and would like to talk with a fee-only advisor about your IRA or 401k funding questions, or anything other questions you might have, give us a call. We are happy to help.
A recent article in Investor’s Business Daily got a lot of attention online. The subject of the article was how much the average 401(k) balance has increased over the past 10 years split out by generations. Millennials had an average balance of $137k in 2019 up from $10,500 in 2009. While Boomers had an average of $366k up from $98k 10 years ago.
It seemed that most people responding to the article on social media had a similar reaction along the lines of, “that’s crazy, there’s no way that’s true”. And turns out they were mostly right. The data was taken from a fidelity survey of their 401k plan participants, but what wasn’t stated in the article was that these numbers only considered those individuals that had their same 401k account open for the past 10 years. Once you hear this detail the numbers start to make a bit more sense.
The majority of millennials are still in the early stage of their careers which is typically a time where people take the opportunity to jump around between jobs, companies, and different places to live and see what fits them best. This is especially true for this generation as we have pushed marriage and home buying later either because of preferences, opportunities or both. It makes sense that those that have had a stable job with the same 401k for the past 10 years would have a much higher balance than the overall average. It’s probably a pretty limited set of the millennial cohort included in this data set, but I think there are a few points we can take away from this info, even if the article seems to have been constructed in a way to get people worked up and share it purely from a “would you look at this *#$&?!” angle.
Just stick with it
The accounts included in this group have been open for at least 10 years, which illustrates the amazing effect you can have by continuing to do the little things right month after month and compound them over time. Continuing to contribute to your 401k plan, paycheck after paycheck, is a great first step towards building up your retirement savings. Especially given the benefits that a 401k typically provides vs an IRA: employer matching, higher contribution limits, additional after-tax contributions if available.
It can be tempting when moving from one job to another to cash out your 401k rather than roll it over into a new 401k or IRA. There are a few times where cashing it out makes sense from a financial planning perspective, such as in the case of extreme hardships, but it’s typically a much better option to roll it into another plan and continue making your contributions and grow your funds for the future.
The benefits of having a 401k
If your employer didn’t offer a 401k and you only had access to investing within an IRA (with contribution limits below $7k/year for the past decade) you would be hard pressed to grow your account in the same way without maxing out your IRA contribution every year over the past 10. However, with a 401k you could contribute up to $16,500 yourself and $49k total between you and your employer in 2009, and those numbers increased over the decade to $19,000 and $56k respectively. It’s obvious with a 401k that you could contribute much more, especially as your income grows, than with only an IRA, not to mention the benefits of receiving employer match contributions.
If you don’t have access to a 401k consider asking your employer to offer one. Many small businesses do not offer a 401k because of concerns about cost and matching contributions, but in recent years 401k plan administration costs for small businesses have decreased and companies do not need to offer a full or even any match if they don’t want to. 401k plans have been shown to be great for retention of employees and I’m sure the individuals in the fidelity study are glad that they had the opportunity to invest in theirs over the past decade.
What else can you do
So, what can you do if you don’t have a 401k and it doesn’t look like you will get access to one anytime soon?
If you are a 1099 employee consider setting up a SEP-IRA. With a SEP you can contribute up to 25% of your earnings or $57k, whichever is lower, for 2020. This can be a way to goose your contribution above the traditional IRA limit of $6k. If you are not a 1099 employee but are considering it make sure to consult with a tax professional whether or not it makes sense to switch from a W-2 to self-employed because there are additional tax consequences to consider.
If you can, contribute to an HSA. Stack that on top of your IRA adds an additional $3,550 ($7,100 if you are married) that you can contribute to tax advantaged accounts. HSAs are also one of my favorite stealth retirement accounts because they are triple tax efficient if used correctly. You can contribute tax-free, the funds grow tax-free inside the account, and the funds can be withdrawn tax-free if used for qualifying medical expenses.
So, there are steps you can take if your 401k or other retirement savings accounts aren’t at the level of those in the article, or otherwise where you’d like them to be. And if you’d like someone to help you put together a plan to boost your 401k or IRA contributions consider reaching out to a fee-only financial planner today.
As we head into the last quarter of the year, many of us are coming up on the time to re-enroll in our employer benefit programs. This leads nicely into a discussion of one of the best retirement accounts available. A secret retirement account, that wasn’t designed as for retirement savings in the first place. The Health Savings Account.
Where did the HSA come from?
The Health Savings Account (HSA) was created in 2003 as a way to help those with high deductible health insurance plans save for future healthcare costs. These plans were created for people that didn’t expect to need as much health insurance throughout the year. The health insurance company offers a less expensive plan, but the catch, is there is a higher deductible if you do get sick and need to get healthcare. The HSA is an account for someone with this type of plan to save money to use for future healthcare expenses in a tax-advantaged account.
Retirement accounts are designed to save you on taxes, but you do have to pay them at some point. With a traditional IRA or 401(k) you get to contribute pre-tax dollars, but the withdrawals are taxed as ordinary income in retirement. With a Roth IRA or 401(k) the reverse is true, you pay taxes now and can withdraw the funds tax-free in retirement. So why is the HSA one of the best retirement accounts available?
The beauty of the HSA is that you get to deposit pre-tax dollars into your account and as long as you have qualifying medical expenses, you can withdraw your money tax-free. This is the only account where you can both contribute and withdraw tax-free.
HSA basics
2018 Individual Contribution limit: $3,450
2018 Family Contribution limit: $6,900
Contributions are made with pre-tax money, and can be made by you and your employer.
Contribution limits apply to the money contributed by you and your employer.
You can open an HSA if you have a high deductible plan at any time in the year.
If you switch to a high deductible plan during the year, you get a prorated contribution limit. So, if you’re single and switched to a high deductible plan in September, and have it through the end of the year, your contribution limit would be $1,150 (4/12 x $3,450).
Money can be withdrawn tax free when used for qualifying medical expenses.
After the age of 59 ½ money can be withdrawn for any purpose and is taxed at ordinary income tax rates; essentially the HSA can function the same as a traditional IRA.
How to use an HSA as a retirement account
If the HSA was created for healthcare expenses how do you use it as a retirement account? The key lies in a little bit of planning ahead. With an HSA you are allowed to withdraw money from the account to pay for qualifying healthcare expenses. You can withdraw the money any time after the expense occurs and you don’t have to withdraw it in the same calendar year or within a period of time after the expense occurs.
You can allow the money in your HSA to grow by paying for healthcare expenses with after-tax dollars today, and reimbursing yourself from the HSA in the future.
By paying out of pocket, you allow your HSA contributions to continue to grow tax-free until you withdraw them. That could be another 30-40 years of tax free growth!
Example
Let’s say I have a high deductible health plan for my family. That means I can contribute $6,900 into an HSA for the year. I estimate that my healthcare expenses that aren’t covered by insurance are around $500 per year. I can pay those costs with after-tax dollars and keep that $500 in my HSA to keep growing tax free. I just have to keep track of my healthcare expense receipts to withdraw the money at a later date.
If you happen to lead an exceptionally healthy life and don’t need to spend much on medical expenses, your HSA turns into a quasi-IRA after you turn 59 ½. You can withdraw your money tax-free for healthcare expenses as before, or you can withdraw it and pay income tax as you would with a traditional IRA.
Your HSA always belongs to you, not your employer. Even if you decide to switch away from a high deductible plan, you can still use your HSA for medical expenses and the money you contributed can continue to grow.
Don’t forget!
There are a few things to keep in mind when researching your HSA. More employers are starting to contribute to employee HSA’s so take that into consideration when deciding whether and how much to contribute. Most HSA’s require you have a certain balance in the account before you can allocate funds to investments. The amount varies, but is typically around $1,000. Some HSA providers don’t offer the option of investing in low-cost index or mutual funds, so do your research on the available investments before opening an account. The fees vary between HSA’s and some employers will cover the cost. If you leave an employer or they decide to switch to a new HSA provider be sure to check on the fees, it may make sense to open an account with another provider.
What do you think? Is the HSA is the best retirement account available?
A comment that I often hear when talking to friends and family is, “I know I need to do it, but I’m just not sure where to start saving for retirement”. I think the reason that this is such a common refrain is due to the number of options and choices available. Having more options is usually better, but after a certain point it becomes too much. It’s much easier to choose between a vanilla or chocolate cone from your local soft serve, than it is to select from the 40 different flavors at the trendy new ice cream shop downtown. Will you have the pistachio & honey, the coffee chocolate chunk, or one of the other 38 flavors available?
Mmmmm, They all look great, how do you choose?!
So today I want to explain why I think the traditional IRA should be most folk’s first choice for a retirement account, but that you really can’t go too wrong by picking either of your tax advantaged account options. As always, everyone’s situation is different and it can be immensely helpful to talk to a professional before making any investment decisions.
There are two main retirement accounts that area available to everyone who earns an income, the IRA and Roth IRA, but before I dive into this I want to offer one caveat (I know, I know, I haven’t even started and I’m already making an exception). If your employer has a 401(k) plan and offers any match at all, even if it’s only 1%, then contribute at least as much into your 401k to get the full employer match before doing anything else. It’s hard to beat free money, but the stats say that about 20% of folks out there don’t take advantage of it.
The IRA (and Roth) in a nutshell
First, a short primer on the IRA. The IRA (Individual Retirement Account) is a type of savings account that offers you a few tax advantages as long as you leave the money in the account to withdraw after you turn 59 ½. In both a Roth and traditional IRA your money grows tax free. This means you do not have to pay any taxes on dividends, interest, or capital gains while your money remains in the account. For a traditional IRA you can deduct your yearly contributions from your income, lowering your taxable income for that year. Later in retirement when you withdraw from your IRA you will pay income taxes on what you withdraw. For the Roth IRA the reverse is true. Your contributions are included in your income and taxed before going into your account, so when you withdraw your money in retirement it is not taxed again. There are limits on the income you can make and still contribute to a Roth or claim the deduction for a traditional IRA. For the purposes of this post I don’t want to get too bogged down into those numbers, but you can find them all here at the IRS website.
I think this is the point in the decision-making process where most people throw up their hands and give up. Not only are you anxious about making the right financial decision in the first place, but we’ve also brought taxes into the discussion. Yay taxes!
But if you can stay with me for just a bit longer I will explain why this choice is not as complicated as it seems. When you do the math to compare the Roth and traditional IRA, the only thing that makes any difference are your income tax rates when you make your contributions and later in retirement when you make your withdrawals. And if they happen to be the same, then it doesn’t matter which type of account you choose! Most individuals can expect to earn more as they advance in their career, and they can also make an educated guess about their income needs in retirement. So you might think that your tax rate will be higher later on in your career, but maybe lower when you retire. The problem lies in trying to figure out what the tax rates will be on your income on those future dates.
The prevailing wisdom for the last few years has been that federal income taxes will have to go up in the future to pay for increasing entitlement spending, so it makes sense to plan on a higher income tax rate in the future. But we just had the biggest change to the tax code in over 30 years and taxes on corporations and business went down a lot, and for individuals they mostly remained the same or down slightly, with small changes mostly depending where your income falls in the newly created tax brackets.
The Real Benefit of a Roth or Traditional IRA
The biggest benefit is choosing a tax-advantaged account, making steady contributions, and letting it grow. By saving and investing in a tax-advantaged account like an IRA you can expect to gain an extra 0.7% – 2.7% vs investing in a standard brokerage account. For someone contributing the maximum of $5,500 per year, the additional gain adds up to an additional $58k or even $277k after 30 years. That’s a huge benefit that you lose out on if you decide to give up on using these accounts because the choices seem too complicated.
I’ll take the light blue bar, please and thank you.
I was inspired to write this post after readingthis great post on Alpha Architect which is where the 0.7% – 2.7% number comes from. In the post they go deeper into the details and crunching the numbers on the different tax benefits of investing in tax advantaged accounts like IRAs and 401(k) plans. Consider my post a primer and if you want to get more into the details and learn more, please head over to their site and give it a read.
“So, this is great, you’re saying all I need to do is flip a coin and pick one of the two to get my extra returns? All right sign me up.” Great! I’m glad that I’ve been able to get you excited about IRAs. But before you pick one, there’s one more thing I want you to consider before making your choice: Entrepreneurship and Income.
Careers and the changing nature of work
Careers have changed and evolved over time. While many of our parents or grandparents may have worked at one job their entire careers, most of us in the workforce today can reasonably expect to switch jobs multiple times in our career. And many people these days have a side business or “side hustle” that they work at for additional income. Some of these opportunities can grow to the point of becoming a full-time gig and replacing your main job.
For those individuals that have lower income in some years because they are working to get their business off the ground, or gaps in employment moving between jobs, the traditional IRA has one clear advantage: convertibility. You can convert the money in your traditional IRA to a Roth IRA and pay the income taxes in that year. If you have a transition year, moving jobs or starting a business, where you are making much less than you normally do you can take advantage of that opportunity and convert some of your IRA contributions to a Roth IRA and pay the lower income tax rate on that conversion. At that point it will continue to grow tax free in your Roth IRA account, and as your income rises back to normal levels you can go back to making contributions to your traditional IRA account.
Pay taxes now or later, just not in between the two
To sum up, consider the traditional IRA as your first choice because of its convertibility during periods of low income. Nobody can tell you for sure what tax rates will be in the future, so don’t stress too much about the difference between the traditional or Roth IRA. The big thing is to take advantage of the opportunity to invest in one of the tax-advantaged accounts available to you because the main benefits for all of them is the tax deferred growth while your money is in the account. And please, please, don’t be part of the 20% that skips out on your 401(k) match.I hope you enjoyed this post and that it helps reduce the intimidation that comes along with researching and making these big financial decisions. If you have questions or you would like some help planning for your retirement or other financial goals, you can learn more by visitinghttp://www.steadyclimbfp.com or sending me an email at chris@steadyclimbfp.com.
If you have a refund check coming your way, consider using it to bolster your personal balance sheet. The average refund is usually around $3,000, and most people receive the money within three weeks of filing their returns (I filed our taxes a few days before the April 17 deadline and received ours in a little over a week, woo!).
So, chances are you have a nice chunk of change in your bank account right now, do you know what you want to do with it? If you don’t have a plan in place, you might end up making a few flashy purchases, spend a bit more money than usual for a few weeks, then regret not putting it towards something more meaningful once that surplus is gone. Here are nine good things you could do with the money.
If your refund was substantial, consider giving yourself an immediate raise by adjusting your tax withholding to increase your take-home pay. You’ll see more dollars show up in your paycheck and lessen the amount of that interest free loan you give to Uncle Sam.
PAY OFF CREDIT-CARD DEBT
Using your refund to pay off a balance with an 18% interest rate is like earning an 18% return on your investments. I’ll take that all day, every day.
REBUILD YOUR EMERGENCY FUND
It’s a good idea to keep three to six months’ worth of expenses in an emergency fund, so you don’t end up in debt or have to raid your retirement funds if you have unexpected expenses. If you’ve had to tap the fund over the past few years, you can use your refund to help build the account back up. Keep the money easily accessible in a savings account or money-market account that earns some interest.
BOOST RETIREMENT SAVINGS
You can contribute up to $5,500 to a Roth IRA for 2018 (or $6,500 if 50 or older) — and withdraw the money tax-free in retirement. You can contribute the full $5,500 as long as your income falls below $118,000 if you’re single, and $186,000 if married filing a joint tax return. You can make a partial contribution if you earn less than $133,000 if single or $196,000 if married filing jointly. If you work and your spouse does not, you can also contribute to a Roth IRA in his or her name if your joint income is within those limits. Even if you earn too much for a Roth, you can contribute to a nondeductible traditional IRA, then convert it to a Roth.
BUILD YOUR COLLEGE SAVINGS
It’s always hard to juggle saving for college and retirement. Here’s an opportunity to use your extra money to contribute to a 529 account. You’ll be able to use the money tax-free for college bills, and you could get a state income-tax deduction for your contribution.
HELP YOUR KID SAVE
You can use the extra money to contribute to a Roth IRA for your child. Your kid is eligible as long as he or she has earned income — from mowing yards or babysitting, for example. Your child can contribute up to $5,500 or the amount of his or her earned income for the year, whichever is lower, and you can give him the cash to do it.
MAKE HOME IMPROVEMENTS
Your refund won’t be enough to redo your kitchen or bathroom, but it can pay for some smaller home improvements. Use the extra cash to add a backsplash, paint a room or cabinets, replace your bathroom sink, swap out your faucets, organize a closet, install a programmable thermostat or spruce up your yard.
SAVE FOR SOMETHING SPECIAL
Set aside some money for vacation rather than using your credit card and paying interest long after you have returned. Or you can use some of your refund to start saving for holiday gift-giving or help with other short-term goals, such as for a down payment on a new car.
MAKE AN EXTRA PAYMENT TOWARDS YOUR HOME LOAN
If you are on track with your other savings and investing goals for the year, consider making an extra payment towards your mortgage principal. Making an additional principal payment on your mortgage earns you an instant return the same way paying off your credit card balance does. Your personal balance sheet consists of all your assets and liabilities, it’s important to grow your assets (investments) for use in retirement, but don’t neglect the other side of the ledger either.
GIVE TO CHARITY
If you have your financial bases covered, consider using your refund to make a charitable contribution to help others in need. You’ll feel good — and you’ll be rewarded for your good deed when you file your tax return next year (charitable contributions are deductible if you itemize).
You also can use your refund to help accumulate enough money to open up a donor-advised fund. Most funds require a minimum of $5,000 to $10,000. You can claim a tax deduction in the year you make a contribution to the fund, but you have an almost unlimited amount of time to decide which charities to support.
