We all know the importance of saving for retirement— as much as you can, as early as you can. But where is the best place to do so? Saving through tax-deferred vehicles provides you a better opportunity for accumulating more wealth than saving in a nonqualified (non-retirement) savings or investment account. Since it’s tax time, keep in mind that any interest, dividends or capital gains realized in a nonqualified account gets reported on a 1099 and taxed on your income tax return. You pay federal and state income tax on that income, effectively reducing what you earned on that account.
Money accumulated in a tax-deferred account is left intact to grow and compound unfettered by income taxes. An account earning 8% one year gets to keep the whole 8%. The snowball effect can be powerful over time. Granted, you pay tax later, when you take withdrawals from a qualified plan or traditional IRA, even so, you will likely net more money and that’s what really matters. Additionally, you can reallocate a tax-deferred account whenever you need to without any capital gain tax concerns. This is important from a financial well-being standpoint to minimize risk if your allocation gets out of balance when the stock market has a run up.
The IRS raised the limits on most retirement plan contributions for 2019, allowing you to contribute more.
| 2019 Retirement Plan Limits | |
|---|---|
| Elective salary deferrals on 401(k), Roth 401(k), 403(b), 457, SARSEP plans | $19,000 |
| Age 50+ catchup contribution | $6,000 |
| Overall individual limit for elective salary deferrals on all plans (except 457(b) plans) combined (under age 50) | $19,000 |
| Overall individual limit for elective salary deferrals on all plans (except 457(b) plans) combined (age 50+) | $25,000 |
| Annual overall plan additions limit (employee & employer contributions plus forfeitures, excluding catchup contributions) | $56,000 |
| Max compensation that can be counted for contributions | $280,000 |
| SIMPLE plan deferral | $13,000 |
| Age 50+ catchup contribution | $3,000 |
Note that it may be possible to participate in more than one retirement plan, but you may be subject to some limitations depending on the situation. Also, a self-employed individual has many retirement plan options. The best option depends on various criteria.
An IRA can be a useful tool as well, especially if you don’t have access to a company retirement plan. Even if you do, contributions to an IRA for yourself or your spouse (even if not working) can supplement those plan contributions and the earnings can grow tax-deferred for additional retirement accumulations. You’re eligible for a traditional IRA contribution as long as you have enough earned income. The contribution may even be deductible, but if it’s not, it’s still valuable to have another pot growing tax-deferred and without all the costs of a deferred annuity. Plus, any non-deductible contributions count as basis, reducing taxation of future distributions.
If you have earned income and your AGI is below the limits, you can make a contribution to a ROTH IRA. Though the contribution wouldn’t be deductible, qualified distributions would be tax-free. That means all those compounded earnings can escape taxation. If an emergency arises, you can always withdraw up to your total contributions tax-free and penalty-free.
Be sure to tell your tax advisor if you make any IRA or Roth IRA contributions so they can be tracked and properly treated on your tax return.
| 2019 IRA Limits | |
|---|---|
| IRA and/or Roth IRA contribution limit, lesser of earned income, or | $6,000 |
| Spousal IRA and/or Roth IRA, lesser of spouse's earned income to extent not already taken into account, or | $6,000 |
| Age 50+ catchup contribution | $1,000 |
| Roth IRA contribution eligibility modified AGI phase-out | |
| Single | $122k-$137k |
| Married filing jointly | $193k-$203k |
Health Savings Accounts
Though we like using retirement plans and IRAs for retirement savings, we like health savings accounts (HSAs) even more. An HSA is a tax-advantaged savings/investment account to help cover medical expenses either now or in retirement. You must participate in a high-deductible health plan in order to be eligible to participate in an HSA.
Even better than a retirement plan, an HSA is triple tax-advantaged – your contributions are deductible, employer contributions are tax-free and distributions used for qualified medical expenses are tax-free. Nice! And, it can serve as another retirement savings vehicle. If you can afford to, you could pay current medical expenses out of cash flow and allow the HSA balance to accumulate to cover health care expenses in retirement. Most plans even allow you to invest the money for maximum growth potential. Should you need a bigger distribution at some later point, you can reimburse yourself at any time for any unreimbursed expenses as long as you save all the receipts.
| 2019 HSA Contribution Limits | |
|---|---|
| Single | $3,500 |
| Family | $7,000 |
| Catch-up Contributions (age 55+) | $1,000 |
The higher the lifestyle you want in retirement, the more money you need to have saved to support it, especially when you factor in the impact of taxes and inflation over all those years. Maximizing retirement savings strategies helps put you on the path to better long-term financial well-being. Though it’s never too late to do the most you can do, earlier gives you a better chance of meeting your goals.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.