Who wants to be a Millionaire?
For pre-retirees who haven’t quite accumulated the coveted seven figure portfolio, there is hope. An advisor can help you develop a retirement savings plan, including how much to save and what type of investment vehicle(s) to save in.
Of course, there isn’t a one size fits all solution, but the following savings hierarchy is intended to serve as a general guideline for accumulating wealth.
Step 1) Contribute to a 401(k) or employer sponsored plan up to the company match. The “match” is money contributed by your employer. This is a no-brainer regardless of the variables mentioned above. At a minimum, take the free money! Depending on your income and your tax situation, you may want to consider making Roth 401(k) contributions IF your company plan offers this option. Unfortunately, some plans do not offer a company match, but the pre-tax payroll deductions along with the tax-deferred growth of these plans still make them worthwhile.
Step 2) Contribute to a Roth IRA if you qualify based on your adjusted gross income. Although these contributions are non-deductible, Roth IRAs grow tax-deferred like a traditional IRA. The big difference is that when qualified distributions are made, they are tax free. If married, don’t forget to make a spousal Roth contribution. The limit for 2017 is $5,500 with a $1,000 catch-up contribution for participants older than age 50.
Step 3) Max out contributions to your 401(k) or employer sponsored plan. Even if your company plan does offer a Roth option, take advantage of pre-tax payroll deductions and tax deferred compounding by maximizing your contribution. For 2017, the 401(k) contribution limit is $18,000 with an additional $6,000 for investors over age 50.
Step 4) Open a taxable account. Though they don’t offer any immediate tax benefits, taxable or non-qualified accounts are the most flexible. You can take withdrawals whenever you want, as they are fully liquid. Realized capital gains on securities held longer than 12 months are taxed at long-term capital gains rates as opposed to ordinary income rates.
Self-employed investors and small business owners should consider contributing to a SEP IRA, SIMPLE IRA or Solo 401(k). Factors such as type of business, number of employees, and tax situation will determine whether to prioritize funding one of these retirement vehicles instead of a Roth IRA. While it may be advantageous to fund a Roth IRA, small business owners should seriously consider funding one of the aforementioned account types in order to accumulate significant wealth.
Please note that the steps above are intended to serve as a savings hierarchy framework. Savings plans will vary based on the circumstances of each individual investor.
By Gregory Yocum, CFP®, AIF®