The Best Strategies to Save for Retirement

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What are the best strategies to use to save for retirement?  In this video and in the summary below, I respond to a few questions sent to me regarding the “right” ways to save for retirement.  Specifically, we discuss these three questions:

  • Presuming that a 401(k) alone won’t be sufficient to fund your retirement, what are the “next best” places to put your retirement money?
  • Pre-tax vs. Roth retirement accounts- what’s the best option to choose?
  • How much do you really need to save for retirement?

(Bill’s Note: The video below was originally recorded as a Facebook Live broadcast on November 26, 2018.)

The Three Tiers of Retirement Savings

Not all retirement savings accounts are created equal.  If your goal is to save aggressively for retirement, you’ll likely need to make some decisions about where you should be putting your money for retirement. 

I like to think about retirement savings accounts in the context of three different “tiers” that you should contribute to, in the following order:

Tier 1: Employer-Sponsored Retirement Accounts

If you have access to a retirement plan through your work, this should almost always be your first priority to save for retirement.  Typically, these accounts are structured as 401(k) accounts (for private sector workers), 403(b) accounts (for non-profit and education workers), or 457 accounts (for government employees).

If you don’t have access to a 401(k), 403(b), or 457 account through your work, you should skip to Tier 2, with one caveat.  If you are self-employed, there are a myriad of other retirement account options you could set up.  We’ll discuss these in more detail another day.

Assuming you do have a 401(k) or similar account at your job, there are several things you should consider:

  • If your employer matches your contributions, you should, at a minimum, contribute enough to receive the full match.  This is the closest thing to “free money” that you’ll ever get, so take advantage of it!
  • One of my favorite strategies to help people find ways to save more for retirement is to increase your 401(k) contributions by 1% every time you get a raise at work. You won’t notice the money you’re “missing” from your paycheck, since your paycheck is going up, anyway!  But you’d be surprised how big an effect thee gradual changes can have.  By the time I left my corporate job at PwC before starting my own business, I was contributing 12% of my paycheck to my 401(k), simply by following this strategy.
  • Most employer-sponsored retirement accounts are pre-tax accounts.  In other words, you don’t pay income tax on the money you contribute to these accounts (and in return, the money will be taxed when you withdraw funds from these accounts during retirement).  But “Roth-style” 401(k) plans have become increasingly common in recent years, which work the exact opposite way- you pay income taxes on your contributions today, but can withdraw the money tax free in retirement. If you have access to a Roth 401(k), you should seriously consider utilizing it.  More on Roth accounts in a bit.
  • Finally, make sure you know the maximum contribution you’re allowed to make to your retirement accounts every year.  For 2019, the max you can contribute is $19,000 per year (assuming you’re under the age of 50).  Typically, the IRS raises this limit each year (it was $18,500 in 2018, for example.)

But, as the three questions at the beginning of this post strongly implied, 401(k) savings alone typically aren’t sufficient to completely fund your retirement.  So, after setting up your 401(k) contributions, what should your next step be?

Tier 2: Individual Tax-Advantaged Accounts

As you have probably noticed, a key component of optimal retirement savings strategies includes managing taxes on your investments and retirement income.  As a result, you should always look for tax advantages in your retirement savings strategies, whether they’re traditional accounts (no taxes now, but you pay taxes during retirement) or Roth accounts (pay income taxes now, grow and withdraw the funds tax free in retirement). 

There are several different options available to you in Tier 2.  And my favorite one might surprise you.

Health Savings Accounts (HSAs)

Outside of a 401(k)/403(b)/457, HSAs are my absolute favorite way to save for retirement.

Why?  Because HSAs are essentially the last complete tax shelter that exists in America.

When choosing between a Traditional or Roth IRA, you pay taxes on your contributions at some point; whether it’s today or during retirement, your money gets taxed eventually.

But as long as you use the funds in your HSA for qualifying medical expenses, the money you contribute and invest in an HSA is never taxed.  Presuming your HSA account allows you to invest the money in your account, this can be an incredible savings vehicle for retirement.

This probably isn’t a shocker for you, but one of the primary challenges in preparing for retirement is making sure you have enough cash on hand to support your medical bills as you get older. With the rising cost of medical care, using an HSA to save for these retirement expenses is an incredibly efficient way to prepare for this.

Of course, there are a few qualifiers here:

  • You’re only eligible to open and fund an HSA if you have a high-deductible health plan. And if you do, you need to make sure you have a sufficient emergency fund to meet your deductible if you want to use your HSA for long-term investing.
  • The maximum contributions you can make to an HSA are relatively low.
HSA Contribution Limits for 2018 and 2019

HSAs are commonly overlooked as a retirement savings vehicle… but they really shouldn’t be.

NOTE: HSAs and Flexible Spending Accounts (FSAs) are not the same thing.  You should not be using FSAs to save for retirement, because you need to use the money in FSAs each year or it goes away.  Conversely, you are allowed to accumulate money in an HSA.

Traditional/ Roth IRAs

In 2019, you can contribute $6,000 to either a traditional or Roth IRA (up from $5,500 in 2018). Although, it’s worth noting that you have until April 15, 2019 to make that $5,500 contribution to your IRA for the 2018 tax year!

There are several questions you need to answer to determine which is the right type of account to use. Here’s how to decide which one to contribute to:

Can you deduct a traditional IRA contribution?  We’ve already established that “traditional” retirement accounts allow you to deduct your contributions from your taxable income this year.  But here’s the catch: if you have a 401(k) or similar account at work, you likely can’t deduct your IRA contribution on top of that.  The rules are somewhat complicated, and you should seek professional advice to verify your ability to deduct your IRA contributions.  But, this should be the first question you answer before making your decision.

Are you eligible to contribute to a Roth IRA? “Making too much money” is generally a good problem to have.  But, it can make you ineligible to directly contribute to a Roth IRA.  The table below shows the income restrictions on making direct Roth IRA contributions. 

Roth IRA Income Contribution Limits: 2019

Two caveats about this:

  1. These income restrictions do not apply to Roth 401(k) plans.  So, if your employer offers one, it is worth considering regardless of your income levels.
  2. You technically can still get money into a Roth IRA utilizing a Roth IRA conversion strategy. This is a very complicated process and it’s important to make sure you do it the proper way to avoid trouble with the IRS, so you should seek professional help before attempting this on your own.

When will your tax rate be higher: now, or during retirement?  This is the fundamental driver of the Traditional-or-Roth IRA decision.  Simply put, you want to pay taxes when you’re in a lower tax bracket.

If you expect your tax rate to be higher in retirement than it is now, you should pay taxes on your income now and withdraw it tax free in retirement by using a Roth IRA.  If, on the other hand, you expect your income (and income tax rate) to be significantly lower when you retire, a Traditional IRA is probably the right choice for you.

However, this is more complicated than it appears at first glance.  Remember, we’re not looking to compare your tax rate today with what your tax rate today is for your expected retirement income level.  You need to think about how tax rates will change between now and when you retire to make this decision.  Which, given that your retirement date is likely decades from now, is notan easy task.

My personal belief? Particularly after the passage of the Tax Cuts and Jobs Act in late 2017, today’s income tax rates are at all-time lows.  Which makes me inclined to believe that tax rates are likely to be higher when we retire, making Roth IRAs a great option for young people today.  That’s just my opinion, of course; I don’t have any more of a crystal ball to predict the future than you do.  But, particularly if you’re close to exceeding the income limits, you should seriously consider a Roth IRA.

How much flexibility do you need?   One final thing to consider: Roth IRAs are much more flexible than traditional IRAs.  While I don’t typically recommend that you withdraw money from your retirement accounts before retirement, you should know that you can withdraw your contributions to your Roth IRA at any time, without penalty. (As long as your investments haven’t gone down significantly in value of course- you can’t withdraw something that isn’t there!)  You can’t withdraw the investment earnings in your Roth IRA without paying a significant penalty, but you canwithdraw your contributions. 

Make Non-Deductible Contributions to Traditional IRAs

Even if you can’t deduct your traditional IRA contributions, it’s a strategy worth considering.

Even though you won’t be able to deduct a $6,000 (2019 maximum) contribution to a Traditional IRA now, and you’ll pay taxes when you withdraw the money in retirement, there’s still one tax benefit you can take advantage of:  between now and when you retire, you won’t be taxed each year on the investment earnings in your account. 

You might be losing the “primary” benefit of a traditional IRA if you can’t deduct the contributions, but at least you’ll save on taxes every year between now and when you retire by sheltering your investments in this type of account.

Tier 3: Regular Investment Accounts

You should be investing your retirement savings into something.  Which means that once you’ve run out of retirement account options, your final option is to invest in a regular brokerage account.

There are no tax benefits to holding this type of account.  The money you put into this account is after-tax money, your investment earnings will be taxed every year, and you’ll be taxed when you sell your investments.  But, the primary challenge in saving for retirement is making sure your money grows at a faster rate than inflation.  By investing your money as opposed to keeping it in a savings account, you give yourself the best possible shot to make sure that happens, even if there aren’t specific tax benefits for doing so.

What Shouldn’t You Use to Save for Retirement?

In a nutshell: you shouldn’t use permanent life insurance or annuity products to save for retirement. 

I’ve written at length before about why I hate permanent life insurance as an investment vehicle for retirement.  It might come with tax benefits, but the costs of these products far outweigh the benefits for the vast majority of people. 

And for young people, annuities are even worse. Until you’re at least 50 years old, you shouldn’t even consider purchasing an annuity.  And even then, there are still probably better options for you.

I’ll probably do a whole separate article about why I dislike these products.  But until then, if you’re contemplating using life insurance or annuities as a retirement-savings vehicle, you should seek advice from a third party who doesn’t sell these products for a livingto make sure it’s the right fit for you.

How Much Do I Need to Save For Retirement?

Unfortunately, there’s no generic answer I can give to this question.  Everybody’s retirement savings needs are different, so you should work with a financial planner to develop a retirement plan specific to you and your vision for your life to answer this question.

Simply put, the way you want to live in retirement significantly impacts the math on how much you need to save.  Consider two different families:  one of whom wants to purchase a vacation house on the beach when they retire, and the other wants to sell their primary house, downsize to an apartment, and buy an RV to travel the country.

Which person will need more money to support their vision for their life in retirement?  All other things equal, the first one.

You need to develop your own retirement savings plan to determine how much you need to save.  If you want to learn more and get this process started, I encourage you to book a free breakthrough session with me so we can discuss more and start developing your plan of action. 

KEEP More of Your 2018 Money, plus What We’ve Got for You in 2019

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In this short video, I’ll tell you what we have in store for you to close 2018 (including how to KEEP more of your 2018 money) and I have a BIG announcement for you at the end of the video!

 Watch the Video ⬇️ 

In the video above, I talk about three simple and practical ways we can work together without (or before) comprehensive financial planning services: through Focused Project Planning services.

Timestamps for your convenience:

1:06 – “Lighter” ways to work together: Focused Project Plans
1:20 – Student Loan Analysis and Payment Planning
1:39 – Health Insurance Plan Selection & Open Enrollment
1:56 – End of Year Tax Loss Harvesting (<< BIGGEST opportunity at this time of year, especially in our current stock market conditions.  There could be a great opportunity to keep more of your 2018 money by saving on taxes!)

⬆️ If you’re interested in working together through Focused Project Planning, please schedule a call with me!

I also made a special announcement in the video (at 4:36)…

could be one of 10 people
in my Personal Savings Pilot Program 
beginning together on Tuesday, January 1st! 

My program goal is to double your monthly savings amount
without feeling like you’re sacrificing your quality of life.

If you’re ready to challenge yourself
to putting your money where your mouth is…

Click below to apply for your chance 
to be one of just ten people in this program!

Are Health Savings Accounts A Good Deal?

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Are Health Savings Accounts (HSAs) a Good Deal?

Health insurance is back in the news again. While the American Health Care Act proposed by Congressional Republicans probably faces serious legislative hurdles, it seems likely that health care is in for some major changes over the coming years.

As usual, the politics of the issue are outside the scope of this blog.  Instead, I want to take a closer look at Health Savings Accounts (HSAs), which Obamacare made much more commonplace.  And, any Republican change to the law is likely to increase the prevalence of HSAs going forward.

What is a Health Savings Account?

Health Savings Accounts are savings and investments accounts designed to pay for medical expenses.  Sometimes, employers may choose to make contributions for you as they would in your 401(k).  But more commonly, it’s on you to actively contribute to these accounts.

In order to qualify for an HSA, you need to be enrolled in a High Deductible Health Plan.  These plans have lower premiums, but require you to pay a higher amount of your health expenses than a traditional plan. A discussion of the different types of health care plans probably warrants an entire separate article, but you should confirm you are in a High Deductible Health Plan before attempting to open an HSA.

Using an HSA, you will save each month and use that money to pay for your health care costs, up to your annual limit, when you get sick.

One other important qualification note: in order to have an HSA, you can’t be listed as a dependent on someone else’s tax return.  In other words, if you are living with your parents house or someone else provides you with financial support, you may need to confirm with them whether or not they claim you as a dependent.

How Do Health Savings Accounts Work?

You can set up your direct deposit to contribute a portion of your income directly into your HSA. But, there’s a maximum for how much you can contribute annually.  If you’re single, you can contribute up to $3,400 in 2017.  If you’re married, the contribution limit is $6,750 per family.

Once the money is in your account, you can either keep it as cash, or invest the money in the stock market.  Investing this money is great if you’re planning on using your HSA to cover healthcare expenses in your retirement.  But, if you’re looking for a way to save for short term medical expenses, it’s best to keep your account in cash.  The more risk you take with the money in your HSA, the higher the likelihood that your account could go down in value.

A common misconception about HSAs has to do with how long you can use the money you contribute.  I often hear people cite rumors that you have to use the money you put into an HSA by the end of the year, or it expires.  Simply put, this is not true.  Money you contribute this year carries forward to the following year, and so on.  This can make HSAs a great vehicle to save for your healthcare expenses in the future, even if you’re perfectly healthy today.

And, when you change jobs, you still have access to the account.  Just like a 401(k), when you leave you can either keep your account with your old employer and spend it as needed, or you can open a separate HSA and transfer the money.

But why not just keep your money in a regular savings account?  What’s the purpose of having a separate health care savings account at all? Aside from the fact I typically recommend you have separate savings accounts for each of your savings goals, there’s one key benefit to HSAs that we haven’t addressed yet…

HSAs Come With Big Time Tax Benefits

Simply put, HSAs are one of the most tax efficient savings vehicle out there.  What they lack in flexibility (i.e., you need to use the money in the account on healthcare expenses), they make up for in tax benefits.

Money you contribute to an HSA isn’t taxed when you contribute it.  In other words, every dollar you put into your HSA (up to the annual limit) directly decreases your taxable income for the year.  In this way, these accounts work in a similar way to your 401(k).

But, that’s just the beginning.  Not only are the contributions not taxed, but neither the growth of the investments in your account or your withdrawals are taxed. The only catch is that there’s a tax penalty if you don’t use the money you withdraw on medical expenses.

To recap: money contributed to an HSA isn’t taxed when it goes into the account.  Growth isn’t taxed.  And withdrawals aren’t taxed (if spent appropriately).

Simply put, saving in an HSA is one of the best tax incentives out there.

A New Way To Save For Retirement

One of the most common questions I get from millennials has to do with how to appropriately account for health care expenses when they save for retirement.  With the future of Medicare and Social Security in doubt, our generation needs to do a better job saving for these types of expenses than our parents or grandparents did.

An HSA can be a fantastic way to save for these type of expenses.  If you are relatively healthy now and have low medical costs, consider using your HSA as a retirement savings vehicle to cover your medical costs as you get older.

In other words, treat your HSA the same way you treat your 401(k).  Regularly contribute money each month, and invest that money in a portfolio that aligns with your tolerance for risk and long term growth objectives.  As you get older, shift the investments into a more conservative portfolio.  If you do this correctly, by the time you retire, you’ll have a great source of money to cover retirement medical costs.

But, There’s a Catch

The strategy above is a great one, but only for specific people.  If you are relatively healthy now, HSAs can be a great way to save for retirement expenses.  But, if you have a lot of medical expenses now, this probably isn’t the right strategy for you.

The problem with HSAs for people who have high medical costs goes back to the beginning of this article- in order to have an HSA, you need to have a High Deductible Health Plan.  These plans can sometimes require that you pay $10,000 or more of your medical costs per year before your insurance kicks in to cover your expenses.  If you’re likely to spend a lot on heath care, it might be better for you to opt for a lower deductible health plan and skip the HSA altogether.  Or alternatively, to use the money in your HSA for your current medical expenses, rather than saving it for the future.

In other words, I think HSAs are a great option for most people, but if you have a lot of medical expenses, it may not be the best one for you.  If you’re in this boat, I recommend sitting down and comparing the tradeoff between paying a higher premium for more comprehensive health insurance vs. paying a lower premium with a higher deductible.  Let this analysis drive your decision.

I help my clients make these decisions all the time.  If you need help, give me a call.