Why Saving Matters
We all know that women live longer than men. If you’re a woman, the World Health Organization reports that you will live, on average, six to eight years longer than men. In the United States women live, on average, to age 81, while men live to an average age of 76. If you’ve ever visited a retirement community, you quickly see that women outnumber men. This is why retirement saving and planning is so important to achieve financial independence for women.
Start Saving Early
“Save early, save often”, so the saying goes. The implication is that you start saving as early as you can, and that you should save as much as possible. Why? Because of the “magic” of compounding. Compounding is what allows even small amounts of money that you save to grow into a large sum, given enough time. The money you save earns a return. Over time, your account will generate earnings on your old and new contributions, as well as on past earnings you’ve accumulated (“earnings on earnings”). As your savings grow, you generate earnings on a bigger and bigger pool of money.
By way of example, let’s say you want to save $1 million for retirement at 65, and assume you’ll earn 7% per year on your investments. If you start saving at age 20, you’ll only need to save about $264 a month. But if you wait until age 45 to start saving, you’ll need to set aside over $1,900 a month to reach that $1 million nest egg by age 65.
IRAs and Roth IRAs
An Individual Retirement Account – or IRA – is a personal retirement account that allows you to contribute pre-tax dollars to an account that can grow tax-deferred. You won’t pay any tax on growth in the account. When you take a withdrawal for retirement income, the entire distribution will be taxed as ordinary income. There are contribution limits, and if your income is too high you may not be able to deduct your contribution for income tax purposes. At age 72, you’ll have to begin taking required minimum distributions (or RMDs), because the IRS eventually wants to collect the taxes they allowed you to defer.
A Roth IRA is similar to a traditional IRA, with the biggest distinction between the two being how they’re taxed. Your contributions to a Roth IRA are not made with pre-tax dollars, but rather with after-tax dollars. As with the traditional IRA, you won’t pay any tax on the growth in your account. But once you begin withdrawing funds, the distribution from the Roth account is tax-free. And, unlike traditional IRAs, Roth IRAs do not have required minimum distributions.
So, which is better – the traditional IRA or the Roth IRA? Well, the decision is really a bet on your current tax rate versus your anticipated future tax rate. If you’re young, and you’ve just started out in your working career, it’s reasonable to assume that your income (and your tax rate) will go up in the future. So, you’d be better off paying taxes today, at a relatively lower rate, than in the future, at a higher rate. In this scenario, the Roth account, which offers you no tax deduction for account contributions today, but which allows future withdrawals to be taken tax-free, is more attractive.
Want to learn more about how you can boost your retirement savings? Contact our team at Springwater Wealth today to learn how we can help.
The Spousal IRA
If you’re married but haven’t earned employment income in a given year – perhaps because you’ve taken primary responsibility for raising your kids – you’re not out of luck. If you file taxes jointly with your working spouse, you can still contribute to a traditional or Roth IRA. The key is that your working spouse must earn at least as much as is contributed to both your IRAs. The same contribution limits and income restrictions apply.
Note that contributing to a traditional or Roth IRA also doesn’t stop you from participating in a retirement plan at work, if your employer sponsors one. By saving in both an IRA and a workplace retirement plan, you can boost your retirement savings and make progress toward financial independence.
Participate in the Retirement Plan at Work
Studies of the American labor force show that barely half of adult workers participate in a retirement plan. The percentage is lower for younger workers, and higher for older workers. While it may seem logical that the participation rate for younger workers is low – because their income is generally lower, and they’re not (yet) focused on retirement – they’re also missing out on the undeniable benefits of compounding. So, even if you’re young, you should participate in your employer’s retirement savings plan with as much as you can afford to save.
The majority of large companies that offer a retirement plan include both traditional and Roth options, so that you can make either pre- or after-tax salary deferral contributions. If your employer’s plan doesn’t offer a Roth option, it’s worth the time and effort to ask your H/R department to consider adding one.
How to Pay Yourself First
One of the most attractive features of employer-sponsored retirement plans – like 401(k) and 403(b) plans – is that they are payroll deduction plans. This simply means that the amount of your pay that you elect to contribute to the plan is deducted from your paycheck each pay period (weekly, bi-weekly, monthly, etc.). Why is this attractive? Because you can’t spend what you don’t have! Retirement plan participants overwhelmingly acknowledge that they wouldn’t be able to save as much as they do if they tried to do so with after-tax dollars. By having your contribution to the plan go directly from your account, you’ve paid yourself first – before your mortgage lender or landlord, before the cellphone and utility bills, and so on.
An Employer Match is Free Money
Contributing to your employer-sponsored retirement plan is a great way to boost your retirement savings and help you achieve financial independence. But an equally great reason to participate in your workplace plan is that doing so may entitle you to free retirement money. How? Well, the majority of companies offer some sort of “matching” contribution to employees. A typical matching contribution is 50 cents on the dollar, up to 6% of the employee’s pay. This means that for every $1 you contribute to your account, your employer will contribute 50 cents. Some employers will match dollar for dollar up to a maximum of, say, 3% of pay. Regardless of the matching formula used, it’s free money toward your retirement. So, if your employer-sponsored plan offers a match, participating in the plan to take advantage of the match is an easy, risk-free way to boost your retirement savings.
Can I Participate in Two Plans at Once?
Many universities and colleges, as well as school districts and other public sector employers, offer both 403(b) and 457 retirement plans. For our discussion here, let’s assume that these two types of plans are largely similar to the more well-known 401(k) plan. They allow for traditional pre-tax or Roth after-tax salary deferral contributions. There are annual contribution limits. And at retirement, your plan account balance can be “rolled over” to an IRA.
But, if your employer offers both a 403(b) and a 457 plan, it may be possible to contribute to both at the same time. Put another way, you can potentially make a maximum contribution to each.
Let’s look at an example. For the 2020 tax year, the maximum permitted contribution to a 401(k), 403(b) or 457 plan for those under age 50 is $19,500. So, if you work for a company in the private sector that offers a 401(k) plan, you can defer up to $19,500 of your pay in 2020. But, if you work for a public sector employer that offers both a 403(b) and a 457 plan, you could conceivably defer that amount into each plan, or a total of $39,000!
In contrast, someone who works for multiple private sector employers can only contribute a total of $19,500.
Deferring the maximum possible into your employer’s plan is a great way to boost your retirement savings.