Archives for January 15, 2019

You probably already know that contributing to your 401(k) plan will improve your retirement finances. But shoveling as much money as possible into a 401(k) account shouldn’t always be your top priority. There are some circumstances when it makes sense to pay down debt and build up some savings outside of your 401(k) before boosting your 401(k) withholding. Here’s what you should think about before increasing your 401(k) contributions.

Get an Employer Match.

Taking advantage of employer 401(k) contributions is the fastest way to build a nest egg for retirement. The amount you need to save to get the maximum possible 401(k) match varies by employer, but frequently requires saving approximately 6 percent of pay. “Any time there’s an employer match, I think it makes sense to at least contribute enough to receive the full match,” says Theodore J. van Gerven, a certified financial planner for Modern Wealth Builders in Woburn, Massachusetts.

Pay Down High Interest Debt.

If the interest rate you are paying on your debt is higher than the return you expect to earn on your investment, it makes sense to pay down the debt first. “Obviously, if you have high interest rate debt, such as credit card debt, that should take priority over additional 401(k) contributions, above the amount needed to receive any match,” van Gerven says.

Those who have low interest debt, such as you might pay on a mortgage or student loans, may come out ahead by prioritizing saving for retirement. However, some people prefer to eliminate a specific debt before maxing out a retirement account. “Depending on the interest rate and repayment options, it can make sense to pay down student loan debt before increasing 401(k) contributions,” van Gerven says. “In all honesty, it’s not always about maximizing the financial outcome. A lot of times it’s about creating a plan that a person will stick to because it makes them feel better.” 

Create an Emergency Fund.

You need a cash reserve outside of your retirement account to cope with unexpected expenses. You don’t want to have to raid your 401(k) plan, and incur the taxes and fees associated with an early withdrawal, to cope with an emergency expense, such as a car or home repair or medical bill. “Ideally, you want three to six months worth of monthly expenses set aside in emergency savings and $0 in bad debts before putting money towards your 401(k),” says Ryan Stith, a certified financial planner at Pivot Point Wealth Planning in Brandenburg, Kentucky. “Many people who skip the savings and debt part of the equation eventually end up backtracking by stopping contributions to their 401(k), taking out loans against their 401(k), or worse, taking early withdrawals from their 401(k) when emergencies do arise.” 401(k) withdrawals before age 59 1/2 typically trigger a 10 percent early withdrawal penalty, and income tax is also due on the distribution. So, a 35-year-old worker in the 24 percent tax bracket who withdraws $1,000 from his 401(k) plan could trigger $340 in taxes and penalties.

Avoid High-Cost 401(k) Plans.

Some 401(k) plans provide excellent investment options and negotiate for low fees on behalf of employees, while other 401(k) accounts are riddled with poor investment choices and excessive fees. If your 401(k) plan doesn’t have the investments you want or has high fees that are eroding returns, after you get any 401(k) matching funds, you may want to further save for retirement somewhere else. “Think about the quality of the offerings within the 401(k) investment lineup. Actively managed funds sometimes have higher fees than you could get outside the 401(k) plan,” says Tamara Witham, a certified financial planner for GreenLife Advisors in Harrison, New York. “Could you potentially get lower cost passively managed funds, such as ETFs, with an IRA, rather than investing in the 401(k) plan?” 

Balance Other Savings Goals.

Many people have more immediate financial goals than saving for retirement, such as accumulating enough money for a home down payment. There are cases when it makes sense to contribute enough to the 401(k) plan to qualify for employer contributions, and then prioritize your more immediate savings goals. “When working with young professionals, we’re often trying to balance short and long-term goals, such as saving for a down payment on a home versus maximizing employer benefits,” van Gerven says. “If you’re planning to buy a home in the next couple of years, but you’re using your cash flow to max your 401(k) contributions, you’ll obviously have less money to save for a down payment.”

Some parents also want to fund a college education for their children, but many financial planners recommend prioritizing retirement savings over paying for college costs for a child. “You can always take out loans for a child’s education, but you can’t take out loans for retirement,” Witham says.

Consider the Tax Savings.

You can defer paying taxes on as much as $19,000 in a 401(k) plan in 2019, or $25,000 if you are age 50 or older. A 40-year-old worker in the 24 percent tax bracket could reduce his tax bill by $4,560 if he maxes out his 401(k) plan in 2019. The tax savings is even greater for workers who pay a higher tax rate. Remember to factor in tax breaks when deciding whether to fund a retirement account or prioritize other more immediate expenses.

Financial planner Jonathan Knapp says it’s not uncommon for recent empty nesters to realize they’re not on track for a secure retirement after years of funding the lifestyles of their departed kids.

Bolstering a bare or depleted nest egg tops Knapp’s list of things to do for parents once all their children have moved out and can support themselves.

“If your retirement savings are not on track, this is the time to turbocharge your 401(k),” says Knapp, director of financial planning at Creative Planning in Kansas City, Kansas.

He adds: “The majority of families have not put away enough. People tend to under save when the kids are at home. Now’s the time to play catch-up.”

No doubt, kids are expensive: clothes, competitive club sports, car insurance, college. It adds up.

Each child reduces the household wealth of Americans between the ages of 30 and 59 by about 3 or 4 percent, according to data from the Center for Retirement Research at Boston College.

But there’s time for empty nesters to get their retirement savings back on track. The math is pretty basic: Divert into your retirement savings a large portion of the extra cash freed up now that your kids are off your payroll.

Here’s a game plan to play catch-up:

1. Bump up your savings

If your 401(k) balance is skimpier than it should be at your age, now’s the time to “bump up” the percentage of your pay that is invested in your retirement savings account, says Mark Lamkin, CEO and chief market strategist at Lamkin Wealth Management in Louisville, Kentucky. The maximum amount you can set aside in your 401(k) in 2019 under IRS rules is $19,000 and workers 50 and older can save $6,000 more in so-called catch-up contributions. The limit on annual IRA contributions is $6,000, with allowable catch-up contributions of $1,000 if you are 50 or older. To work toward maxing out, Lamkin advises people to gradually increase your paycheck deductions, if possible, to the percentage that boosts your annual savings to the IRS limit.

2. Make sure you get ‘match’

Don’t pass up free money from your employer, advises Tony Ogorek, founder and CEO of Ogorek Wealth Management in Buffalo, New York. That means at least saving enough on your own in your 401(k) to take advantage of your employer’s full matching contribution. The most common company match, and offered by 70 percent of 401(k) plans in 2017, according to Vanguard Group, is 50 cents per dollar on 6 percent of pay. That means someone earning an annual salary of $75,000 who saves 6 percent of his or her pay would receive a match of $2,250, bringing total savings $6,750. “You must at least fund up to that (matching) level,” says Ogorek. “If your employer is matching 50 cents on the dollar you are making a risk-free, 50-percent return on your money.”

3. If possible, ‘max’ out

The more you save, the quicker you can replenish and rebuild your nest egg, says Diahann Lassus, president of Lassus Wherley, a wealth management firm with offices in New Providence, New Jersey, and Bonita Springs, Florida. A married couple over age 50, for example, can sock away $50,000 in pretax dollars in their 401(k)s. And that sum doesn’t include matching dollars from their employers. That same couple can boost their combined account balance by a quarter of a million dollars in five years by simply maxing out, before company matches or any appreciation on the investments.

4. Play catch-up

If you’re over 50, the IRS lets you save an additional $6,000 in your 401(k) with before-tax dollars in what is dubbed “catch-up” contributions. And saving more will help you reach your goal of having enough cash to retire. “This is another opportunity to redirect freed up cash toward yourself rather than your kids,” says Ogorek.

5. Keep spending in check

Sure, you’ll likely have more money leftover at the end of the month now that you’re no longer supporting kids. But if you blow all the cash on vacations or the new convertible you’ve been dreaming of or lavish dinners, you’re just going to dig yourself into a deeper financial hole, according to researchers at the Center for Retirement Research.

“Much of the debate on whether or not we face a retirement crisis comes down to what parents do when the kids leave,” a CCR research report concluded. If parents spend the extra money instead of saving it, they will get to retirement with less money and a higher standard of living to maintain.

Unfortunately, many people “take advantage of the fact that kids are not there to live it up a bit,” says Geoffrey Sanzenbacher, associate research director at the Center for Retirement Research. “Instead of going out for pizza, they go out for steak.”

Sanzenbacher says the center’s research shows that families do increase their retirement savings after the kids are gone, but only by a small amount. In theory, a household of two adults and two kids making $100,000 and contributing 6 percent to their 401(k) should be able to increase their savings rate from 6 percent to 18 percent of earnings – or a 12 percentage point bump in savings. Yet the reality is that families only increased their savings by 0.7 percent.

“That sets them up for disappointment in retirement,” says Sanzenbacher.

WITH YEAR-END statements, W-2s and 1099 forms arriving, it’s time to look for ways to trim capital gains tax liability, especially given the many changes that kicked in for 2018 due to the tax law passed just over a year ago.

As always, the end of the tax year – Dec. 31 – closed the door on many opportunities to save on your tax bill, like selling losing investments to book capital gains tax losses. But experts say a few tax tips are still possible for investors, mainly by contributing to retirement accounts.

“The year is over and, for the most part, the time has passed to make tax-smart moves for 2018,” says Steven J. Weil, president and tax manager of RMS Accounting in Fort Lauderdale, Florida. “The things you can still do include fully funding an IRA, if you qualify, maximizing contributions to a pension plan, and being sure you don’t miss out on any of the changes found in the new tax law that could benefit you.”

The biggest change for 2018 was a near doubling of the standard deduction to taxable income taken by people who do not itemize deductions. For 2018, it is $12,000 for single filers, up from $6,360 in 2017, and $24,000 for couples filing a joint return, up from $12,700.

Also, the individual tax rates for ordinary income were cut. For couples filing a joint return, for example, income from $77,401 to $165,000 will now be taxed at a 22 percent marginal rate. Most those taxpayers were in the 28 percent, 33 percent and 35 percent tax brackets the year before. (Income ranges, as well as rates, changed for each tax bracket.)

Dividends and long-term capital gains continue to be taxed at a maximum of 15 percent for most investors.

The first step for many investors is to decide whether to take the standard deduction or to itemize. Whether you use an online tax-preparation program, a downloaded one or old-fashioned paper forms, you’ll need to list your deductions to determine if itemizing will pay.

Most basic tax rules and strategies remained unchanged with the 2017 law. Investment losses are still subtracted from gains to reduce long- and short-term capital gains, for instance, though sales had to be by Dec. 31.

The most significant last-minute move for cutting the tax bill survived. That is to maximize contributions to individual retirement accounts, traditional or Roth, before filing, says, Nicole N. Middendorf, CEO at Prosperwell, a wealth advisor in Plymouth, Minnesota. Contributions for 2018 must be made by this April 15, even if you get an extension to file your return. The account can be opened up to the filing deadline.

As a general rule, investors are smart to make traditional and Roth IRA contributions as early as possible to provide more time for investment growth, says Jai Kumar, marketing manager at Rapid Filing Services, a tax filing site based in New York City. This tax tip may be especially smart this year, as stocks are well below their highs, some experts note.

“You can contribute to the IRA through Tax Day and still get benefit of the deduction in 2018, and the sooner you start, the better, actually, instead of doing throughout the year,” Kumar says. “It is recommended to max it out as soon as possible.”

These contributions reduce taxable income and are available regardless of whether the taxpayer itemizes or takes the standard deduction. But not everyone can deduct up to the maximum contribution.

The maximum IRA contribution for 2018 is $5,500, of $6,500 for people 50 and older. That applies to all IRAs taken together, including a mix of traditional and Roth accounts. There is no tax deduction for a Roth IRA contribution, though it still may be worth doing because Roth withdrawals are tax free while money taken from a traditional IRA is taxed as income.

Rules for tax deductions to traditional IRAs vary with income and circumstances. If the individual, or neither spouse filing jointly, has no retirement plan at work, the entire contribution is subtracted from income, reducing the income tax. A couple over 50 contributing $13,000, could thus save $2,860 in income tax, assuming a 22 percent tax bracket. A workplace retirement plan includes a 401(k) or similar plan as well as a traditional pension.

It gets trickier if there is a workplace plan. Single filers with modified adjusted gross income of $63,000 or less can deduct a full contribution. For joint filers, the figure is $101,000. Above those levels, deductions phase out until they reach zero for singles reporting $73,000 and joint filers $121,000.

Investors who are self-employed or have moonlighting business have an additional opportunity, Middendorf says.

“If you have a business on the side, use the SEP IRA for additional deductions,” she says. “You can put away up to 25 percent of your net income.”

The maximum SEP contribution for 2018 is $55,000, so long as it is no more than 25 percent of net income (or 20 percent for self-employed people.) Again, the deadline is April 15, or up to Oct. 15 if you file for an extension.

Self-employed taxpayers with no employees other than a spouse can contribute to an individual or solo 401(k) up to the filing deadline, so long as the account was set up by Dec. 31 (IRAs and SEPs can be set up after the 1st of the year).

You can put in $18,500, or $24,500 if over 50, as an “employee.” In addition, as the “employer” you can contribute up to 20 percent of your net income from self-employment. Both types of contributions are removed from your taxable income, so the potential saving from this tax tip can be quite large.

For most, those retirement account contributions are the last chance to save significantly on your tax bill for 2018. Experts urge investors to get a jump on 2019 taxes by making the moves that must be done by the end of the year. That includes tax-loss sales and maximizing 401(k) retirement account contributions as well as old standards like deferring a bonus to the next year or taking deductible expenses as early as possible.

It’s always great when that payday direct deposit hits, but exactly where that money hits could make a major difference in your financial future. If you haven’t yet set up a savings account to stash some of your earnings, you could be missing out on an opportunity to add a little extra to your bottom line.

Whether you’re new to opening a savings account or you have concerns about an existing account, we’ve turned to an expert for help. Grab that spare change, and let’s determine how a savings account can be right for you.

What’s a savings account?

As Priya Malani, co-founder of Stash Wealth, explained, a savings account is an account separate from your standard checking account. You typically draw from a checking account to make basic, everyday purchases, but a savings account is intended to hold money aside. The account, which you can deposit or transfer money to, is in addition to a checking account. By having at least two accounts—a checking account that holds your everyday cashflow, and a savings account that ostensibly holds money for future use—you’re more likely to reach a money-saving goal.

Some banks may require a minimum deposit to open an account; others may require you to maintain a certain balance to keep the account open. Both online-only and traditional bank branches offer savings accounts, but Malani recommends doing your research when it comes to online-only banks, noting that you can generally take advantage of online banks’ better interest rates (more on that below). But, before opening any account, always review the terms and conditions.

Why you should have more than one savings account

It may seem like a good idea to have one basic savings account for all of your extra money, but Malani warns against that. “If you have a general savings account, it’s very easy and tempting to tap it for bills, life, boozy brunch, that extra splurge, whatever.” To make sure your savings account actually keeps its savings, she recommends having more than one account and designating each for a specific purpose.

For example, you could create an account for an emergency fund or an account to hold money for recurring costs like holiday gifts or charitable donations. For shorter-term savings needs, like an upcoming vacation, you can open a specific savings account for that goal that you can later close out without penalty. (Discuss account closure fees with your bank ahead of time to avoid any surprises.)

Malani has a great tip: “Each account should be nicknamed according to what you’re saving for. Studies show that by nicknaming your savings account—something that online banks make it easy to do—you’re less likely to use it for something other than its intended purpose.”

What to know about interest rates

An interest rate is a small percentage of money you earn by depositing your money in the bank.

Online-only banks like Ally or Marcus are often able to offer higher interest rates, Malani explained. “An online-only bank has less overhead. They don’t have to pay for any real estate, and they save on salaries because they don’t have to pay people to staff their bank branches. They pass their savings on to you in the form of a higher interest rate on your savings account.”

She noted that some online-only banks are currently paying up to 200 times more yearly interest (or what’s called APY: annual percentage yield) than a physical bank. This means, for example, if you placed $10,000 in savings at a bank with a .02% APY you’d earn $2 in interest, but a bank offering 2% (like Ally currently does) would earn you $200 in interest over the year.

Manage your expectations

Although selecting a savings account with a higher APY might sound like a way to make quick, easy money, Malani suggests managing your expectations. “When interest rates are really low (like they are now), [your savings] may not be ‘racking up money’ for you,” she said. “Investing takes time to work, it’s not like gambling, where you can double your money overnight.”

Ultimately, deciding on a savings account is a great way of taking the next step toward achieving your financial goals. No matter what bank you choose or what purpose your account will serve, Malani said it’s important to just get started. “Don’t let the options confuse or paralyze you,” she said. “Pick a bank and start stashing.”