Here’s the routine for many employees: Human Resources sends out an email saying the company’s retirement plan representative will be in town next week to review your investments. You sign up, go in, look at your massive (or not) portfolio on the representative’s computer screen, and gently get told that you should add more to your 401(k).
Maybe you should not. Instead, many advisers recommend that you fund your employer’s retirement account to the point where you earn the company match, then stop, and invest the additional money outside the company plan in order to lower future taxes and increase your options. Remember, 401(k) withdrawals at retirement are fully taxed, and that could easily mean a tax bite of 15 percent or more. However, money withdrawn from a Roth IRA at retirement can be tax-free. Withdrawals from brokerage accounts are currently taxed at only 15 percent for most people. If your nest egg at retirement is $300,000, and one-third has been saved outside your 401(k), the tax savings could be $10,000 or more.
Hold on, you say. What about the tax deduction that comes from contributing to my company’s retirement plan? Indeed, your 401(k) contributions do receive an up-front deduction. Money going into Roth or brokerage accounts does not. However, you are hoping the big gains in your 401(k) come from compound interest that your investments produce over many years. Unfortunately, the IRS provides no reward for picking good stocks and bonds; all growth in your company plan is fully taxed.
“Tax rates are historically low now, and future tax rates are unpredictable,” points out Roger Nurrenbern, a financial adviser in Evansville for Edward Jones. “A blended route might be best for many people. By investing in your 401(k), then beyond the match in a Roth IRA, you have the option down the road of pulling either taxable income or tax-free income. Also, many people overlook investing in a regular taxable account. The disadvantage there is paying taxes on dividends and interest along the way, but those accounts provide flexibility and easy access to money without penalties.”
In other words, workers have more choices than they are sometimes led to believe. And when it comes to saving for something as important as retirement, choices are good.
Roger Nurrenbern may be reached at 812-464-2788 or find him on www.edwardjones.com.