This article is for educational and entertainment purposes only. Please seek professional advice for individual situations. Do not buy or sell securities based on what you read here.
Americans are really bad at saving for retirement. In 2019, the average retirement savings in an American household was $65,000. That's it. That's all. It gets worse when you look at younger cohorts: the average under 35 retirement savings drops all the way to $13,000. Only 55% on non-retirees have a 401(k) or 403(b) plan. The highest median retirement savings belongs to the 55-64 age group, where they clock in at around $134,000. However, considering that the average household income in the U.S in 2020 was $67,521, even the highest retirement savings group only has enough to last a little under two years at their current lifestyle.
Despite all of this, Congress is now looking to make it more difficult to save for retirement. The new tax plan designed to pay for the "Build Back Better" infrastructure program includes some confusing new rules around certain retirement accounts. Today, I'm going to cover what those changes are, the different types of retirement accounts and how you can take advantage to make sure you're on track for retirement.
The Rules Have Changed
Back in our parents' day, there was a retirement vehicle referred to as a "pension." Effectively, you would put in your time at a company and, in return, the company would take care of you in retirement. Each company has their own formula, but they would set aside a certain percentage based on your salary and length of service, and that pension would serve as a regular paycheck to you in retirement, adding to the Social Security benefits you receive so you could live a comfortable retirement in your twilight years. Everything changed in 1978 when Congress approved the appropriately named "The Revenue Act of 1978," which created the 401(k) retirement plan.
While this sounds cool, it actually changed the retirement game completely, now stripping the burden of retirement out of the company's hands and lays it completely at the feet of the employee. "Want to retire?" screams the company to blue-collar factory worker, "then you'd better be incredibly disciplined forever." It removed the risk and financial worry from corporations, which isn't great. In fact, this dramatically lowered the average retirement savings in the United States and has caused the average retirement age to drift later to account for the financial gap. It also gave rise to "The 4% Rule." Effectively, the rule states that if you took 4% out of your portfolio to live on each year, it should replace itself thanks to returns, meaning you're living on house money. Prior to the elimination of most pension programs, no one gave a shit about this because they had a guaranteed flow of income.
However, in 1998, something amazing happened: Congress did something good. They passed legislation that allowed for the creation of the Roth IRA, so named after the late
Senator William Roth. The Roth IRA was created to give Americans a new type of retirement savings plan that you could contribute to after taxes, but could be withdrawn tax free after the age of 59 and a half. There are also no required minimum distributions, meaning you could theoretically die with a full account and just roll that shit to your children. At least, for now you can.
Proposed Changes to the Roth IRA
With the new tax plan proposed by Congressional Democrats last month, several provisions provide a rather knee-jerk reaction to the recent ProPublica report about Peter Theil's Roth IRA. You can read a deeper dive into this story here, but effectively it was discovered earlier this year that Theil has over $5 billion in a Roth IRA thanks to a series of sweetheart deals paid for my Roth funds, making them tax free once he hits 59.5 years old. In order to combat this, Congress is now proposing the institution of RMD's for accounts with over $10 million, effectively penalizing those that have saved consistently and got really lucky.
Congress is also looking to put a stop to what's referred to as "the backdoor IRA." Currently, a Roth IRA has an income limit if you're already participating in a 401(k) or 403(b) program. If you are a single person making over $140,000 per year, or a couple making over $208,000 per year, then you cannot contribute to a Roth IRA. In that instance, you could get around this limit by opening a traditional IRA and contributing to it with post-tax dollars. You'd then convert this IRA into a Roth using basically the power of administrative paperwork, and boom, you're into Roth world. There may be some tax implications if you use pre-tax dollars to open a traditional IRA prior to Roth conversion, but this is a simple and effective tactic that the wealthy have been using for years. In the newly proposed tax plan, Congress is looking to eliminate this loophole starting in mid-2022 for anyone making over $400,000 per year (single or joint filers). Again, this is looking to stop the rise of "mega-IRA's" that were discovered in ProPublica's IRS bombshell earlier this year.
How Can I Make This Work For Me?
The good news for you in this instance is that you probably are not making $400,000 per year. If you are, then you don't need me and enjoy your diamond encrusted Aston Martin. For the rest of us, we have a TON of options in retirement, but it can occasionally get confusing as to which one to do first, and how best to take advantage. Let's break it down in order, along with some helpful reminders to make this your one-stop-shop for retirement:
1. Contribute to Your 401(k) Employer Match Limit
As mentioned above, the 401(k) is here to help you plan for retirement. Though it may not be as sweet as a pension, it's still a powerful tool that takes your pre-tax dollars and puts them to work in a retirement account. A 401(k) is typically pretty limited on investment options, which isn't necessarily a bad thing. You don't want to trade in and out in this account. You want it to be the bedrock of your retirement, giving you a stable foundation on which to grow your retirement savings. For this, I would recommend a target date fund or an index fund so you can put it on autopilot and watch compound interest do its thing.
Quick note on employer matches: many employers offer a "match" to an employee that contributes to their retirement account. This means, for example, if you contribute 3% of each paycheck to your account, so will your employer. This is literally free money. That's why I recommend this avenue first. It's an automatic doubling of your money, and it's hard to beat that return. Please check with your human resources department for all match information specific to your company, as each company is different.
2. Open a Roth IRA, Then Max It
As noted earlier, a Roth IRA is so good that it should be illegal. Money goes in post-tax and comes out untaxed. It's really hard to beat that. Roth IRA's are also typically not subject to the same investment option limitations that 401(k)'s are, so this is where you can start to pick individual stocks if you feel comfortable with that. If not, there are thousands of low-cost index funds that you can set and forget all the way up to each year's $6,000 contribution limit.
3. Open an HSA and Then Max That, Too
This is one you likely won't find in too many other guides. A Health Savings Account is a criminally underutilized investment vehicle, because those that have it typically don't know it can be used as an investment vehicle. This account exists to pay medical bills, but that's certainly not its only function. It's actually the most powerful retirement account around because it's "triple tax-advantaged." That means the money contributed to this account comes out of your paycheck pre-tax, grows tax free, and is tax free when you withdraw it in retirement. The downside? Again, it's meant for medical bills so it's likely you could spend through the account fairly quickly. The contribution limit for this account is also very low at only $3,600 per year for an individual, or $7,200 per year if you have a family healthcare coverage plan.
4. Fill Out The Rest of Your 401(k)
A 401(k) has an annual contribution limit of $19,000, meaning your contributions up to your employer match are likely not enough to hit the limit. After you've followed the first few steps and contributed to your other accounts, fill that thing up! Sticking away $19,000 per year in an account that actually lowers your taxable income is magical, and the compounding interest that accrues over time doesn't hurt much either.
5. Open a Traditional IRA for Continued Tax Advantages
The third and final tax deduction I'll cover here is the traditional IRA. Like a 401(k), the money goes in pre-tax and comes out taxed, and there is a $6,000 contribution limit each year ($7,000 if you're over the age of 50). There are also RMD's on the account after the age of 72, so keep that in mind.
6. Open a Taxable Brokerage Account
OK now you can open that Robinhood account and start YOLO'ing into GameStop call options. Except please don't do that. Taxable brokerage accounts have zero tax breaks. None. It is pure dollars in and out, with no fancy rules or litigation behind them other than the laws of capital gains. As a quick overview, if you buy and sell a security within 12 months, then it's subject to short-term capital gains. If you hold that security longer than 12 months, you will be subject to long-term capital gains. The reason I'm staying unspecific on the exact rates is because it's different for everyone, taking into account annual income and tax filing status. Please consult a tax professional for your individual situation. Want to get up to $200 in FREE shares? Sign up for a new account with my link and our partners from Robinhood will gift you a free stock, all the way up to $200!
7. Open a Cryptocurrency Account
Please keep in mind that the crypto space is in its infancy, and could go away tomorrow with the right set of laws. Cryptocurrency has begun to roll like a snowball down a hill, picking up momentum as it goes. El Salvador recently became the first country to recognize Bitcoin as a national currency, and even naysayers like Jamie Dimon are offering their clients a chance to invest in the space. I'd recommend a minor allocation to crypto as an asymmetric bet on the space. Want a jump start on your account? Get $25 in FREE crypto when you sign up for a new account at Crypto.com with my link!
The Bottom Line
Look, retirement is a difficult concept for 99% of us. It's confusing with all of the options we have available, trying to figure out what money to put where. Our inner college student kicks in as well when we say "retirement is so far away, why do I need to start now?" and we don't take advantage of that compounding interest. Retirement will be here sooner than you think, and based on the numbers I outlined in the introduction, I wouldn't rely on a huge inheritance coming your way anytime soon.
Have you started planning for retirement? Do you use an account that I didn't list above? Let me know in the comments below! And don't forget to sign up for my email list so you can get these in your inbox as soon as they post!
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