Wes Moss: 3 retirement accounts to take advantage of today

Wes_Moss-for-Web-smaller-fiCertified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest blog will appear here every Monday.

Retirement Savings Accounts – 3 Must Haves!

The key to a successful retirement is saving 15% of your net income for a very long time. Unless you hit it big, a very long time means savings over a 30-to-40 year period. That’s a lot money and sacrifice, so let’s make sure those dollars are in accounts that are the most advantageous to you.

The road to retirement is long, and bumpy; understanding these three important vehicles will make the trip a lot easier – and profitable. Some may be available to you, some may not…but any combination of these will form the foundation of a successful retirement savings plan.

The 401(k) or 403(b)

For most families, a company retirement plan serves a very important role. Common examples are a 401(k), a 403(b) (teachers, nurses, ministers, professors), or a Thrift Savings Plan  (TSP plans are for government employees and members of the armed forces). These accounts allow you to put away up to $16,500 a year straight out of your paycheck, before taxes.  If you are over 50, you can put away up to $22,000 before Uncle Sam gets his increasingly greedy mitts on it.

Some employers actually match a portion of their workers’ 401(k)-type savings. If you are eligible for a company match, take full advantage of the program.  It’s free money!   The number of employers that match 401(k) contributions dwindled in the wake of the financial crisis but, with the economy on the mend, we may see a return of this powerful savings supplement.

ROTH IRA – This is the most amazing retirement invention since shuffleboard!  A Roth IRA allows you to contribute up to $5,000 per year ($6,000 if you are 50 or older), and withdraw that money to fund your retirement without paying any taxes!  Of course there are rules.  For example, you must be 59-½ years old before you start withdrawing your Roth savings (contributions plus growth) – without penalty. But in general, the Roth is the best retirement savings deal in town.

You can set up a Roth IRA at your bank, local credit union, directly with a mutual fund company such as Vanguard, or through low cost online brokerage firms like Charles Schwab.

For the record, you can not “buy a ROTH IRA”, but you can establish a ROTH IRA account, in which you will have full choice on how to invest your ROTH funds.

The Traditional IRA – Another retirement must-have.  The Internal Revenue Service allows you to contribute up to $5,000 per year to a traditional IRA — $6,000 once you reach age 50.  If you are not an active participant in an employer-sponsored plan (like a 401k), you can fully deduct your IRA contribution on your tax return.  For example, let’s say you make $50,000 per year and are in the 25% tax bracket.  Your $5,000 IRA contribution will result in a $1,250 deduction — 25% of the $5,000.  Whether or not you can take a deduction on your contribution gets complicated, so check out this link for IRA Deductibility and Contribution limits

Keep in mind that both traditional IRAs and company retirement plans are similar in that you have tax advantages while accumulating money (before age 59-½), but you are required to pay taxes upon withdrawal.  With the ROTH, you don’t receive an upfront tax deduction, but distributions in retirement are TAX-FREE.

I can’t tell you exactly how to employ these various savings tools, as that mix will depend on your family’s unique circumstances. But I can tell you to start using some combination of them today. I’ve never met anyone who felt that they saved too much in one of these three tax-advantaged accounts!

Wes Moss is a certified financial planner and is the Chief Investment Strategist at Capital Investment Advisors in Atlanta. Moss is also the host of “Money Matters” on AM 750 and now 95.5 FM News Talk WSB on Sundays from 9 a.m.-11 a.m. An author, “Apprentice” alumni, husband and father, Moss is committed to helping Atlanta’s citizens with financial health.

Follow me on Twitter @atlbargains or on Facebook at AJC Atlanta Bargain Hunter

15 comments Add your comment

Sherry

October 4th, 2010
7:40 am

For the Roth, taxes and penalties do not apply to withdrawing your contributions (versus your earnings or conversion amounts). This is a big distinction and worthy of mention. I’m surprised that this fact was omitted. If I contribute to a Roth and expect to retire before 59.5, I can use the contributions to bridge the gap without penalty or further taxes. Or if I find I just need the money later. Perfect!

TaxMan

October 4th, 2010
10:24 am

Personally, it makes a lot of sense to pay taxes today at all-time low rates, let my money grow tax-free and not have to owe anybody anything when I need it in retirement. Also, it is better for my heirs to not leave them a tax liability for the rest of their lives……After taking my free money, I agree with you, Wes, that the Roth is the way to go!

Wes Moss

October 4th, 2010
10:30 am

Since direct ROTH contributions are technically “after-tax” to begin with, your direct contributions to a ROTH may be taken out tax-free at any time. This is yet another advantage of the ROTH; more of which can be found in the ROTH section of the IRS website. http://www.irs.gov/retirement/article/0,,id=137307,00.html

KPowers

October 4th, 2010
10:48 am

I feel ya with the lack of employers doing a 401(k) match! It makes putting that extra money into a retirement plan pretty disheartening… Am I better off just using a Roth for my retirement savings?

Wes Moss

October 4th, 2010
11:02 am

In response to TaxMan…there’s no question that ROTH contributions make sense if you are able to do so – however, we all need to be careful about ROTH ‘conversions’…I’ve done dozens of IRA to ROTH IRA conversion calculations and MOST of the time, especially for those ages 50 and UP, it doesn’t make sense. WHY? Because the IRA conversion question comes down to the “Taxes today, versus Taxes tomorrow” debate.

For instance, once in retirement, most retirees are in a much lower income tax bracket than when they were working… So, during your peak earning and working years (let’s say today at age 55), you may pay taxes on a ROTH conversion at a 30%+ rate, while your income in retirement may only put you at the 15% rate… So why pay taxes today at 30%, when your tax rate may drop to 15% in the future?

Here’s a great calculator to help you make the determination – along with talking to your CPA.

http://www.schwab.com/public/schwab/planning/retirement/iras/roth_ira/roth_ira_conversion/considerations/roth_conversion_calculator?cmsid=P-3246561&lvl1=planning&lvl2=retirement

Vinny

October 4th, 2010
12:00 pm

Wes, Can anyone open a Roth account? What is the penalty if I need to withdraw the money before age 59 1/2?

Bravesntheseries

October 4th, 2010
12:07 pm

Roth IRAs are definitely the way to go… I have access to my money and the Government can’t tax my earnings in retirement!

Wes Moss

October 4th, 2010
12:10 pm

Anyone looking for IRA/ROTH contribution limits and/or income guidelines check out http://www.irs.gov/retirement/participant/article/0,,id=188232,00.html

Bdawg

October 4th, 2010
12:50 pm

You can set up early withdrawals before 59 1/2 without the 10% penalty using Section 72t

harry

October 4th, 2010
1:40 pm

I was informed by my CPA that being older than 55 made no sense to do the converting of a Roth to an IRA.
I also don’t believe that leaving your heirs IRA’s is a bad thing. If you leave them a Roth they could withdraw and spend the whole thing immediately. With an IRA they will be required to pull out only a small amount based on their life expectency tables with the IRS, controled spending of monies not a tax burden.
Good article

Richard

October 4th, 2010
2:12 pm

I would definitely agree with Wes on this one. The Roth Conversion goes against the logic of the 401K in the first place. 401K logic would lead you to save money in your working years when your taxes are higher and take it out in retirement when your tax rates are lower. The Roth Conversion uses the reverse logic and causes taxes today for a future tax free income stream in retirement.

Now critics will say that…well, tax rates will be higher down the road because of all this government spending…and I certainly agree with that, but there is also no guarantee that Roth distributions will be tax free in the future. As long as the government is promoting class warfare, I can see a time when the populist thing to do will be to tax all these “rich” people that have roth accounts.

harry

October 4th, 2010
4:54 pm

I agree with Richard
Also while you are working you are in your highest tax bracket, when you retire what will your tax bracket be? Won’t your taxes be lower when you don’t have any income?

Thanks Bobby

October 4th, 2010
5:26 pm

Wes,
Great column, I enjoy reading it every Monday.
I am currently maxing out my 401K and my employer has been matching since I began (which has been great even in these tough economic times), but with that being said am I able to also contribute to both a regular IRA and a Roth IRA.
Thanks for your objective advice.

Phil

October 5th, 2010
6:30 am

Nice article Wess! For those families with AGI > $250,000 and individuals > $200,000 also consider a Roth Conversion to protect your wealth from future higher taxes. In 2010 taxes on a Roth Conversion can be paid (split) 1/2 of tax owed in 2011 and 1/2 of tax owed in 2012. Pay the income tax from taxable accounts, not from tax-free or tax-deferred accounts and maybe you can find some investments with capital losses that you can use to offset the conversion amounts. Work with your tax professional or CFP to determine whether you should do a Roth Conversion.

sharon

October 6th, 2010
1:10 pm

what about investing in american eagle gold and silver coins. gold and silver just keeps going up up up! somehow this seems the most intelligent thing i have looked into for investment purposes. what do you think?