How much money do you need to retire?
In general, it’s good to target about 10 to 12 times your annual income in retirement savings to live a lifestyle that was similar to the one you lived prior to retirement. Here’s how the formula works. In retirement, a good rule of thumb is you can withdraw about 4% of your portfolio each year. Thus, if you used to make $100,000 of household income and have saved 12 times that amount, or $1,200,000, a 4% withdrawal rate is about $48,000 a year. Add in about $20,000 for Social Security (a reasonable estimate for household income of $100,000) and you should be at about $68,000 or pretty close to 70% of your pre-retirement income, which for most folks should be pretty comfortable.
How much should you save each year if you want to retire?
A good goal is to save somewhere between 12% and 15% of your gross pay. By way of example, if you and your spouse have household income of $100,000 (let’s say you both earn $50,000 a year to make it simple), you’d want to be saving about $12,000 a year in your 401(k) or other retirement plans. Many folks split the savings obligation based on their proportional incomes. Remember to factor in any match that your employer provides. For instance, if you receive a 3% total match, or about $3,000, then you could save $9,000 or 9% and still be in pretty good shape. Try to hit 12% a year, and if you can, stretch to 15% in years when you may have more income.
What’s the maximum you can save in a 401(k)
If you are under age 50, the maximum for 2019 is $19,000 per year. If you are age 50 or older, the maximum is $25,000 per year. This is an individual limit, so if you are married, you could each contribute this much to your respective plans. But you always have to check with your employer to ensure your retirement plan allows you to contribute the maximum. Some plans, for various reasons, may not let all employees contribute the maximum.
Should you use a Roth 401(k) option
Many people wonder if they should use a Roth 401(k) or Traditional 401(k) feature. The difference is in how the money is taxed. If you put money in a Roth, you receive no current income tax deduction, so it makes it harder to save since you have to pay tax on that money. But then the money grows tax-free into the future, so any gains going forward are not subject to tax. With a traditional plan, you receive an income tax deduction when you contribute the money, so it makes it easier to save. Then the money grows tax deferred until you take it out. But when you take it out you pay ordinary income tax on it.
Which is better?
It really comes down to your tax rate in retirement. If you think your tax rate in retirement will be higher than the tax rate while working, it’s good to use a Roth. If you think it will be lower, you’d be better off with a traditional IRA. You might be thinking, how would I know what my tax rate will be? That’s a good question. Since it’s hard to predict future tax rates, it can be a good idea to just split your savings and put some in the traditional 401(k) each year and some in the Roth. That way you are covering both options.
Do you need to save outside of your 401(k) for retirement?
For most people, the 401(k) contribution limits of $19,000 if you are under age 50 and $25,000 if you are over age 50 are large enough to cover most of what you’ll need to save for retirement. In general, you want to be saving a minimum of 12% of pay each year. So, if you can contribute up to $19,000, then that covers people who earn up to about $158,000 a year ($19,000 is 12% of $158,000). If you are over age 50 and can do $25,000, that covers people earning up to about $208,000 a year. If your pay is above those levels, then often you will need to both maximize your 401k and also save outside of that to reach the goal of 12% of pay in annual savings.
Should you rollover your 401(k) from a prior job?
In most cases, it’s a good idea to consider rolling over your money from a prior employer. You can usually roll it over to your own IRA on a tax-deferred basis. This allows you to oversee and control it on your own. You may also be able to lower the investment costs associated with the money because company sponsored retirement plans often incur higher administrative charges to account for and supervise all of their employees’ balances. If you roll it over, you can often avoid those costs. Plus, if you have multiple old 401(k) plans, it’s likely you aren’t paying close attention to them, so consolidating them in one IRA that you control can lead to better outcomes because it’s easier for you to manage.
Getting ready to retire, here’s how to take control of your savings and rollover your 401(k) to an IRA?
If you are thinking of retiring, you may want to take control of your money and roll it over to your own IRA. You can generally do this at the time you retire, or sometimes, if you are over age 60 and your company plan allows you to, you can rollover the balance prior to retiring but still contribute to your workplace plan until you actually do retire.
Why roll it over?
Well, retirement plan investments are often designed for long-term accumulation goals, but when you retire, you will need to start taking money every month to support your lifestyle. This may require you to invest in different types of strategies so that you can be sure you are generating some income to distribute, but also protecting your funds in the event of a market downturn.Bear markets are a bigger risk to retired investors because they have to take constant distributions, and if you rollover your money to your own IRA, you will have a much broader array of investment options to choose from. Generally, within a 401(k), you are limited to an investment menu selected by your employer, and most of those options are designed for long-term accumulation, not necessarily the challenges of investing during retirement.
Should you convert to a Roth IRA at retirement?
Once you retire and rollover your money to your own IRA, it is possible to convert a part of that IRA to a Roth IRA. The main reason to convert is to reduce the impact that required minimum distributions (RMDs) from your traditional IRA will have on your taxes. As you may know, once you reach age 70.5, you have to start taking money from your traditional or rollover IRA. The bigger the balance is in the IRA, the higher the distributions will be and the higher your taxes will be. So, one approach is to convert some of your traditional IRA money to Roth IRA money prior to taking your RMDs. This helps reduce the size of your traditional IRA. Now, you will have to pay tax on the money you convert, but if the amount you convert in any given year does not push you into a higher tax bracket, then it can make sense to convert. You remove the money at a modest tax rate, then it grows tax-free going forward in your Roth IRA. And you have reduced what is in your traditional IRA and likely reduced the amount you’ll have to distribute later and the taxes you’ll have to pay.
How do you handle Required Minimum Distributions from your IRA?
There were new rules recently passed for Required Minimum Distributions (RMDs). Under the SECURE Act of 2019, individuals who turn 70.5 in 2020 or later may now wait until age 72 to start taking their RMDs. The old rules required individuals to start taking RMDs when they turned 70.5. Once you reach age 72 (or 70.5 under the old rules), you have to start taking distributions from your IRA accounts. The reason you have to start taking out money is that Uncle Sam wants to start taxing some of this money, because it hasn’t been taxed since the day you contributed it, which in some cases may have been decades ago. So, the IRS requires you withdraw some money every year and pay tax on it. For most retired investors, it’s not that big of a deal because they are taking out money anyway for living expenses. If, however, you don’t need the distributions, you still have to take them out once over age 72. But you can pay tax on the distribution and then just reinvest the net proceeds in a taxable account if you don’t need the money. They key is to remember the RMD rules are all about requiring a minimum distribution and then paying income taxes on it.
How much do you have to withdraw?
The IRS has a schedule for the percentage you have to take out each year based on your age. It starts at around 3.5% to 4% in your early 70s and then goes up each year. For instance, in your early 80s, it’s in the 5% to 6% range. If you live long enough, past 115, you’ll basically be forced to take all the money out of the IRA.In terms of calculating the RMD amount, if you have your money at a brokerage firm, like Schwab or Fidelity, they will calculate the amount for you each year, so you know what you have to distribute. You can take it out all at once, or in installments, like monthly. It’s really up to you, but you have to take it out by year end. The penalty if you don’t is very high.
What if I inherit an IRA?
If you inherit an IRA, you have to start taking minimum distributions based on when you inherited the IRA. It’s not tied to the age 72 requirement that applies to your own IRA. So, if you have an inherited IRA, you’ll want to talk with your accountant about how to calculate the distributions. Prior to the SECURE Act, you could spread the distributions out over your life expectancy. But for those who inherit IRAs after passage of the SECURE Act, the funds in general must be taken out within 10 years. There are exceptions, however, for certain “eligible designated beneficiaries” such as spouses, minors and those who may meet certain disability definitions.
How do you generate retirement income?
Although it’s commonly referred to as retirement “income,” the reality is most retired investors live off a combination of income from interest and dividends, and then distributions from capital gains in portfolios. About 20 years ago, this was a lot easier because interest rates were much higher and retired investors could rely on more robust income streams from things like bonds and CDs. But in today’s financial markets, there is very little income available from both bonds and stock dividends. Both produce less than a 2% yield today.
Thus, most retired investors have to rely more on capital gains than ever before. That means retired investors often cannot be too conservative. If they are, they generally cannot generate the returns needed to cover their distributions and will then begin to eat into principal. And as you deplete principal, the income falls for the next year because you don’t have as much invested to generate income, and thus you need to consume even more principal, and a portfolio can spiral down pretty quickly.
So, while investors often do get more conservative when they retire, most cannot afford to be as conservative as prior generations of investors because there is much less income available in today’s markets.
Plus, with retirements lasting between 25 and 30 years, the distribution you take in year one of retirement will need to grow to keep up with the effects of inflation. If inflation runs at just 2%, you’ll need to distribute almost 65% more 25 years down the road. This is another reason why your retirement income portfolio still needs a growth component to it.
How do you minimize taxes in retirement?
Depending on the type of investment accounts you have, there are a number of things you can do to reduce your tax liability. If you have taxable investment accounts, like brokerage accounts or trust accounts, the primary way to reduce taxes is to follow a low turnover approach with your holdings and to try to only recognize long-term capital gains when you do sell things. Low turnover generally means you don’t sell much of your portfolio holdings each year. Turnover of under 15% of your portfolio would be considered low. And when you do sell or adjust things, it’s best to focus on selling those holdings you have held for more than one year so that you qualify for long term capital gains rates. The rate on long term capital gains is one of the lowest tax rates you will pay, and it’s generally under 20% for most taxpayers.
Also, if you have tax deferred accounts like IRAs, and you have some taxable accounts, you should consider allocating your slower growing ordinary income assets like bonds to the IRA, and your faster growing holdings that may qualify for long-term capital gains to your taxable account. By doing that, you are likely reducing the amount of Required Minimum Distributions you’ll have to take later in retirement because you are placing a slower growing asset in the IRAs. Conversely, if you were to allocate all your stocks to your IRA, then you’ll likely increase your RMDs later and you’ll convert securities that would have qualified for the lower capital gains tax rate to the higher ordinary income tax rate when you go to distribute the funds. So, to the extent you can, it’s often a good idea to favor bonds in IRAs and stocks in taxable accounts once you are retired.
Should you put your money in a revocable living trust at retirement?
If you have a revocable living trust, it can be helpful to put many of your investment accounts in the trust at the time of retirement. While you cannot hold IRA assets in the trust, you can hold taxable accounts and things like bank accounts in the name of your trust. One advantage to this is that you often have a successor trustee identified in your trust. For many people, it’s a spouse or child. And should you become ill or incapacitated and unable to handle your financial affairs, having the assets in a trust helps smooth the transition to having your spouse or other successor trustee oversee your assets. Essentially, your successor trustee can step in and manage things for you with minimal documentation. If you don’t have the assets in a trust, it can be quite burdensome and expensive for a spouse or child to get into the legal position to manage your affairs, particularly if you are incapacitated.
Placing investment or bank accounts in a trust is generally pretty easy. It requires you to re-title the account in the name of the trust, but it’s still reported under your Social Security number, so the tax issues are simple. Just ask your bank or account custodian to help you with this process.
The above material is for illustration and education purposes only. It does not constitute individual advice and does not take into account individual circumstances. Consult your individual tax, legal and financial advisors prior to making any decisions. There can be no assurances that any distribution rate can be supportable from a portfolio. Information presented is believed to be factual and up-to-date and we have used generally accepted methods in the rendering of this data. We do not guarantee its accuracy, and it should not be regarded as a complete analysis of any subjects discussed.Past performance is no guarantee of future returns. All investing involves the risk of the permanent loss of capital, and all distributions involve the risk of depleting a portfolio.
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