Editor’s Note: This is part 3 of a four-part series called “Financial Advice I’d Give My Younger Self,” as a wealth strategist looks back at what he knows now and wishes he knew then. For more information read: Part 1: The best ways to pay for college and part 2: From premarital to pregnancy. Part 4 on Caring for Aging Parents is coming soon.
It’s hard to imagine retirement when you’re just starting out. I remember early in my career, before I got into wealth management, my financial advisor insisted on creating a financial plan for me and my husband that laid out our retirement goals. I was resistant because I felt that with so many unknowns and such a long time horizon, any projected numbers would be imprecise by definition.
His answer: “Of course the numbers won’t be right!” What we look for are directional trends. Without a plan, what basis do we have for financial discussions?’
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I realized that when I was so fixated on my monthly cash flow and savings, I didn’t have a long-term vision. I had to shift my perspective for at least another 30 years. Which brings me to the first retirement lesson I share with my age:
1. Never think you’re too young to need a financial plan
Any discussion about retirement should be done with a long-term view that sets long-term goals, where you set long-term goals with intermediate mini-goals. Without a financial plan, even with a broad stroke, we make important financial decisions based on qualitative “gut” rather than quantitative analysis.
My advice: Work with a financial planner to put together a retirement plan, even if it’s full of estimates and assumptions. This will help you determine where you are now and where you want to end up. It becomes your financial compass.
2. Cash in on the compounding impact of early investing
I can’t stress enough the power of early investing and the value of compounding. This may sound obvious, but you’d be surprised how many people don’t do it. The most common barriers I hear are, “I don’t know anything about the markets,” “I don’t have time,” or “I’d have to pay taxes anyway.” Yes, these are all legitimate concerns, but they are not legitimate reasons to raise the opportunity cost of doing nothing.
Let’s take a very simple example: Let’s say you have $100 each month that you can save in an interest-bearing account or invest in a balanced equity portfolio. At current interest rates and assuming modest portfolio growth, $100 per month over 30 years could yield $41,963 in a savings account or $83,226 in a balanced equity investment portfolio.*.
Of course, there are always risks associated with investments and the returns may not be what you expect or there may be a market downturn. That’s why it’s important to learn early by investing. The answer to the unknown is that you don’t try to avoid it at all, or you avoid it. Rather, the answer should be to reach your comfort zone by educating yourself and working with professionals who can guide you.
3. Contribute as much as you can to a Roth IRA
Named after Senator William Roth, who sponsored the program’s creation in 1997, the Roth IRA is a retirement savings strategy that is often overlooked by those who qualify. Unlike traditional IRAs, where contributions to the account are tax-deductible, Roth IRAs are contributions. not tax is deducted. This is the key difference that allows you to reap the tax benefits of a Roth IRA, as withdrawals from a traditional IRA are taxed, while withdrawals from a Roth IRA can be tax-free.
Essentially, you’re opting for a tax break on the back end of your withdrawals during your retirement years. The important lesson here is that you can only contribute to a Roth IRA if your income level is below a certain threshold. In 2022, that limit will be $144,000 for a single filer or $214,000 for married couples (the contributions will phase out with lower income limits). Therefore, it is a type of tax-advantaged savings vehicle that you can use early in your career, assuming that your income level is likely to exceed the threshold in your lifetime.
A common objection I hear is that you’d rather contribute to a traditional IRA and deduct income taxes today instead of waiting for the tax benefits years from now. Currently, I can understand and appreciate the value of saving tax dollars, but keep in mind that the tax rate is often lower for those in these lower income brackets, so forgoing the income tax deduction today may be worthwhile considering the years it may accrue in the long run. compound growth, which is ultimately tax-free, and you may not be eligible for this program during your lifetime when your income is high.
You can also contribute both of them types of accounts! Although the IRS annual contribution limits for IRAs are cumulative (for both traditional and Roth IRAs). You can make a total of $6,000 a year (or $7,000 if you’re over 50). So, if you have the liquidity, you can set aside $6,000 and put some into a traditional IRA (and get a tax deduction for that contribution) and the rest into a Roth IRA (and get a lifetime income tax break).
I did this a few years ago in my career and I’m glad I did because now I have both a traditional IRA and a Roth IRA. Not only did I diversify my investments, I also diversified into tax-advantaged accounts. When deciding which type of IRA and how much to contribute, keep in mind the rules for early withdrawal (for example, before age 59½, within the first five years for a Roth IRA), as this may result in taxes and penalties depending on individual circumstances. .
If you’re lucky enough to work with an employer that offers a retirement savings plan, or better yet, one that matches your contributions, take full advantage of it. My first company had an employer matching program and I made sure I contributed enough to my 401(k) plan every month so I could qualify. Think of it as extra compensation your employer gives you.
The company match is tax-free for you when your employer makes a contribution. It is taxed only when it is withdrawn from the pension account. Until then, the money can earn years of deferred tax and interest. Again, the impact of this investment composition is significant over time.
Another thing to remember is to review the contribution amount every year. Most people set their contribution rates and forget about them, but since IRS contribution limits for 401(k)s and other savings plans can change, and so can your income, it’s important to check the numbers every year to make sure they still work. they should be. For example, many people set their monthly contribution at a certain percentage of their salary. When contribution limits increase, you may want to adjust your interest contribution based on changes in your salary.
Finally, many employers now offer a Roth 401(k) option in their company retirement plans. Roth 401(k) taxation is similar to Roth IRA taxation as discussed earlier. For young and even some experienced professionals, this option can be beneficial in the long run. Although there is no current income tax benefit for Roth 401(k) contributions, there may be significant tax benefits in your retirement years.
5. Consider an HSA – a “stealth” retirement savings strategy
Another popular employer-provided retirement vehicle is a health savings account (HSA), a type of savings account recommended for people with high-deductible health plans. HSA contributions are tax deductible. Money grows tax-free in an HSA. In addition, there is no tax on the distribution of qualified medical expenses. Basically, you can save with pre-tax dollars, invest with tax-free growth, and use it to pay for medical expenses later in life with no taxes.** I think there is an HSA system. A 401(k) has value for your medical expenses, only better because there are no taxes on qualified medical expense withdrawals.
Another flexibility is that you can withdraw from your HSA after you turn 65 any reason (non-medical only) without penalty. If it’s for non-medical expenses, you’ll have to pay taxes on that withdrawal, but it’s the same tax treatment as a 401(k) or traditional IRA. You would still benefit from tax-free growth.
Note that this is different from a flexible spending account (FSA), a type of savings account that you contribute to during the year and can use that money for certain medical expenses at the end of the year. Money invested and ultimately spent on medical expenses will not be part of taxable income. However, any money that is not used by the end of the year and is not eligible for any rollover will be forfeited. Therefore, while an FSA is a good income management tool for annual medical expenses, it is not a long-term retirement vehicle like an HSA.
6. Maintain a steady hand and recalibrate as necessary
The road to retirement can be long, with many bumps in between. When following your financial plan, I would encourage you to resist the urge to make rash decisions based on headline news or impulsive needs. Slow and steady wins the race.
This doesn’t mean you set your plan and forget about it. I recommend that you review and revise your financial plan at least once a year to account for any changes and to experience a life event such as marriage or the birth of a child.
Your financial plan may be your compass, but that doesn’t mean the journey will always be straight. Periodic revisions are necessary to ensure your plan is fresh and up-to-date.
I hope this was helpful, and stay tuned for next month’s column: Financial Advice I Would Give My Age: Planning for Aging Parents.
*Assumes the savings account earns 1% annually and the investment portfolio earns 5% annually, with no sales or withdrawals and no upfront taxes.
**Please note that tax rules may vary at the state level.
Wilmington Trust is a registered service mark used in connection with various trust and non-trust services provided by certain subsidiaries of M&T Bank Corporation. Please note that tax, estate planning, investment and financial strategies require consideration of the suitability of the individual, business or investor, and there is no guarantee that any strategy will be successful. Wilmington Trust is not authorized to provide, and does not provide, legal, accounting or tax advice. Our advice and recommendations to you are illustrative only and are subject to the opinions and advice of your attorney, tax advisor or other professional advisor. Investing involves risks and you may experience profits or losses. There is no guarantee that any investment strategy will be successful. This article was written by and represents the opinion of our consultant, not Kiplinger’s editorial team. You can check the adviser’s records with the SEC (opens in new tab) or with FINRA (opens in new tab).