Guest Opinion: Retirement savings 101

The views expressed in Guest Opinions represent only those of the author and are in no way endorsed by Richmond BizSense or any BizSense staff member.

Q: My goal is to save 15% of my salary. I have a 401(k) plan at work. I also have a personal Roth IRA and taxable brokerage account. How should I prioritize my savings?

Sincerely,
Building a Nest Egg

Dear Building a Nest Egg,

Your savings goals are admirable! Make sure you get any free or matching money, and then focus on tax efficiency.

Before you focus on retirement savings, I always like to make sure an emergency reserve account is funded. We all know people who have unexpectedly lost their jobs. So I recommend you put three to six months of living expenses into an account you could access quickly in the event of an emergency.

Your next priority should be retirement. If your employer offers a 401(k) match, start your savings here. At minimum, many employers match the first 3% of your savings. This is free money that you cant afford to pass up.

For those that income qualifies, typically the next best place to begin is by adding $5,000 in a Roth IRA. Income phaseouts for Roths begin at $105,000 (modified adjusted gross income, or MAGI) for single filers and $166,000 (MAGI) for joint filers. A Roth provides flexibility because you can access the principal at any time without penalty. Like a traditional IRA, a Roth allows your money to grow tax deferred. But unlike a traditional IRA where you will pay ordinary income tax when you begin distribution, Roth money comes out tax free. And with the income tax debate currently controlled by legislators advocating even higher rates, I don’t think you will regret having some tax free money.

Stash any remaining money and invest it in your taxable brokerage account. Following these steps will ensure your retirement egg is golden.

Q: I am a self-employed consultant with no employees. Do you suggest an individual 401(k) or a SEP IRA for my retirement savings?

Sincerely,
Weighing My Options

Dear Weighing My Options,

The simplified employee pension (SEP) plan and individual 401(k) plan both are advantageous for self-employed business owners. But I typically recommend the individual 401(k). Its more flexible and carries a more powerful tax savings punch.

With both plans you can vary your contributions from year to year. But only the individual 401(k) (also known as a “solo 401(k) “) offers you the option to defer the first $16,500 of income. Despite the name, if your spouse also earns an income, double that savings to $33,000. And if youre 50 or older, add an extra $5,000. Unlike the SEP, which only allows taxdeductible savings, an individual 401(k) allows you to save this money in a traditional pre-tax or Roth after-tax account that comes out tax free in retirement.

Both the SEP and the solo 401(k) allow for contributions up to 20% of qualified income (for sole proprietors) or 25% of W-2 income (for corporations). Thats a total reduction of taxable earnings of $49,000 for those younger than 50.

The difference is apparent when you look at a 40yearold who has $100,000 of W-2 income. The SEP allows a deductible $25,000 contribution, whereas the individual 401(k) permits a much larger contribution of $41,500 ($25,000 + $16,500).

A SEP does not require the same annual reporting. But these days custodians like Charles Schwab provide this service without a fee. Additionally, the 401(k) has a loan provision, allowing employers to borrow from their accounts if necessary.

The views expressed in Guest Opinions represent only those of the author and are in no way endorsed by Richmond BizSense or any BizSense staff member.

Q: My goal is to save 15% of my salary. I have a 401(k) plan at work. I also have a personal Roth IRA and taxable brokerage account. How should I prioritize my savings?

Sincerely,
Building a Nest Egg

Dear Building a Nest Egg,

Your savings goals are admirable! Make sure you get any free or matching money, and then focus on tax efficiency.

Before you focus on retirement savings, I always like to make sure an emergency reserve account is funded. We all know people who have unexpectedly lost their jobs. So I recommend you put three to six months of living expenses into an account you could access quickly in the event of an emergency.

Your next priority should be retirement. If your employer offers a 401(k) match, start your savings here. At minimum, many employers match the first 3% of your savings. This is free money that you cant afford to pass up.

For those that income qualifies, typically the next best place to begin is by adding $5,000 in a Roth IRA. Income phaseouts for Roths begin at $105,000 (modified adjusted gross income, or MAGI) for single filers and $166,000 (MAGI) for joint filers. A Roth provides flexibility because you can access the principal at any time without penalty. Like a traditional IRA, a Roth allows your money to grow tax deferred. But unlike a traditional IRA where you will pay ordinary income tax when you begin distribution, Roth money comes out tax free. And with the income tax debate currently controlled by legislators advocating even higher rates, I don’t think you will regret having some tax free money.

Stash any remaining money and invest it in your taxable brokerage account. Following these steps will ensure your retirement egg is golden.

Q: I am a self-employed consultant with no employees. Do you suggest an individual 401(k) or a SEP IRA for my retirement savings?

Sincerely,
Weighing My Options

Dear Weighing My Options,

The simplified employee pension (SEP) plan and individual 401(k) plan both are advantageous for self-employed business owners. But I typically recommend the individual 401(k). Its more flexible and carries a more powerful tax savings punch.

With both plans you can vary your contributions from year to year. But only the individual 401(k) (also known as a “solo 401(k) “) offers you the option to defer the first $16,500 of income. Despite the name, if your spouse also earns an income, double that savings to $33,000. And if youre 50 or older, add an extra $5,000. Unlike the SEP, which only allows taxdeductible savings, an individual 401(k) allows you to save this money in a traditional pre-tax or Roth after-tax account that comes out tax free in retirement.

Both the SEP and the solo 401(k) allow for contributions up to 20% of qualified income (for sole proprietors) or 25% of W-2 income (for corporations). Thats a total reduction of taxable earnings of $49,000 for those younger than 50.

The difference is apparent when you look at a 40yearold who has $100,000 of W-2 income. The SEP allows a deductible $25,000 contribution, whereas the individual 401(k) permits a much larger contribution of $41,500 ($25,000 + $16,500).

A SEP does not require the same annual reporting. But these days custodians like Charles Schwab provide this service without a fee. Additionally, the 401(k) has a loan provision, allowing employers to borrow from their accounts if necessary.

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Jeff
Jeff
12 years ago

I am not sure why the advice here, as in most financial advice columns, to put the 3-6 month “emergency funds” into a taxable savings or other liquid taxable account. Since you are able to withdraw your contributions from a Roth without penalty, and the returns are tax free, this should be the FIRST place you put savings. Just be sure that you have a couple months in highly liquid investments and some more in something like a high yield ETF, that is not terribly volatile. Second is to contribute to a taxable emergency fund, until you have enough in… Read more »

Matthew Illian
Matthew Illian
12 years ago

Jeff, your method works as well. In this example, Weighing My Options would like to save more than the $5,000 limit and must decide where to put this additional money. We believe that a Roth better serves as an investment vehicle for your most aggressive investments. Since Roth money will one day be taken out tax free, it is best to add those investments with the most potential for growth. For example, we have been adding Emerging market ETFs, Technology ETFs and small cap funds to our Roth IRAs. We do not waste any of this tax efficient space on… Read more »