I got side tracked with the City Club Rooms and Bucky. Now back to the good stuff. Money! Getting rich.
It looks like Grasshopper No. 4 is starting to get real money flowing into his cask. Usually a new employer will inevitably ask, “how much of your hard earned money to you want to set aside in a 401(k) for your retirement”? You and millions of other Americans get that silly look on their face signalling that you don’t have a clue.
First, let me create perspective. The average American lives to age 80. The first 20 years are spent living off the parents. That represents 25% of your life having fun and sitting on your ass. Then you work to age 65. That is 45 years or 56% of your life working and living. You get to raise your own kids that suck you dry. Then if you are lucky, you get 15 years to live an extravagant retirement. The retirement is 19% of your life.
So the whole retirement strategy is take care of 19% of your life. If they raise retirement age to 68 or 70, retirement would be less than 12% of your life. Only you can decide how you want the last years to be.
The retirement plans encouraged by your government are designed to defer taxes or avoid taxes. Rest assured that you will pay some tax. Pay now or pay later. I am not the brightest person in the world but my guess is that taxes are only going to increase with time as we create bigger and bigger federal and state budget deficits. My point is that paying taxes on retirement accounts now will be at a lessor rate than in the future.
Okay! Your employer makes a 401(k) available to you and you feel guilty if you don’t show him/her that you are responsible and set money aside. After all taxes are DEFERRED until you pull the money out of the account in the future (potentially at higher tax rates). The deferred money gets subtracted from your earnings each year and reduces the current year’s taxable income. Good also. Remember, if you have to pull the money out before 59.5, it will be at a 10% penalty and you will pay appropriate taxes.
My humble opinion is that if your employer matches your contribution to a 401(K) up to a certain value, maximize your contribution limiting it to the amount of the match. Where else can you get a 25%, 50% or 100% return on your money instantaneously. Your 401(k) will earn deferred until you reach 59.5 or retire. Here is a common sense test though. If you are deferring so much money that you have to starve the kiddies at home, kiddies come first. Remember that your productive fun years are 56-60% of your life. Starving to cover the 12% retirement portion of your life doesn’t make sense. You will pay taxes on the money as you take it out of your 401(k) and you must start pulling it out at age 70.5
If your employer doesn’t match, the first priority should be a Roth IRA. In this case you do not defer through you employer, you take home more cash but you pay more federal and state takes now. But with a Roth IRA, you can invest up to $3,000 per year and it earns TAX FREE FOR THE REST OF YOUR LIFE. You do not pay taxes when you pull it out. There is a 5 year period where you can not touch the earnings. If you assume tax rates are going to go up over time, paying taxes now and deferring earnings tax free in perpetuity is a really good deal. I think early withdrawal before age 59.5 has the same penalty as a 401(k), 10%. Over 20-40 years, money invested wisely, tax free is a good deal. To qualify, you must earn under $110,000 as a single, $160,000 as a married couple to qualify. So beware you big earners.
There are clever insurance products such as deferred annuities that you purchase with hard earned after-tax dollars. The sales person screws you by taking an absurd commission, contractually obligates you to pay a penalty if you pull out money in the first 7-10 years of the annuity and then will pay you a monthly amount for the rest of a contractual period or your lifetime. If you die before the annuity is paid out, the insurance company usually keeps the money that is left, not your family. Bottom dwelling, skum sucking insurance sales people! As a rule, don’t buy annuities!
So for your “retirement plans” the priority of selection should be (1) contribute to your 401(k) up to the amount that your employer matches, (2) contribute to a Roth IRA first if your employer does not do a matching program up to allowable $3,000, and (3) after you’ve done the first two, defer additional amounts through your 401(k).
So lets say you have $50,000 of income. An employer matches dollar for dollar what you set aside up to 5% of your income. That would be $2,500 deferred (and you get a free $2,500 matching) to invest going forward. Once you’ve taken maximum advantage of the matching program, stop contributing to your 401(k). Then from your earnings that you take home and have paid taxes on, put up to $3,000 in a Roth IRA. The returns will be deferred from taxes forever. Now let me see, in this case, you would have set aside $2,500 in 401(k), $3,000 in a Roth for a total of $5,500 (and another $2,500 from your employer). That is a lot for a $50,000 income. But if you are frugal and can deny yourself BMW’s, boats and extravagant vacations, you can put another $11,500 into your deferred 401(k).
Save some money for retirement. Defer and avoid taxes if possible. You might just reach age 65 to 70 and need additional income. But develop a plan. It becomes your plan. YOU WILL LIVE YOUR STRATEGY.
Love,
Dad (Just Chas.)