Retirement Planning Using a Roth IRA, a 401, 457, or ???
When I was working, I thought that putting a little away in the 401 or 457 was a great plan, but looking back today, I don’t believe it is the best option. For most of us, we probably won’t be in a lower tax bracket when we retire. In fact, when you start taking money out of your 401 or 457, it could boost you into an even higher tax bracket than you had planned for. If I could go back and do it all over again, I would have put every one of those dollars into a Roth IRA, rather than the 401 & 457 that I used. Paying taxes at 10%-15% when I was working is not looking like a great trade off now that I am being taxed at 25%. And, I am not even withdrawing funds from the 401 & 457 yet. When I do, the tax rate will jump to 28%. That is only counting the Federal taxes, not the state taxes. Besides, what can be better than completely tax free money when you are retired and living on a fixed income?
Therefore, I will would suggest that you first set up and fund your Roth IRA so that you will be able to take that money tax free when you retire. Then, set up your Savings Plus Plan. That program, administered through DPA, gives you a choice of either a 401 or 457. Both plans allow you to defer taxes on the money deposited until you withdraw the funds after retirement. Not as good as a Roth IRA, but both are great plans. Here’s why!
If you want the IRS to help pay for your retirement, then you should read this information and get started immediately.
What I am saying is that you need to understand how this program works and use it to your benefit. For example, if you are in the 15% tax bracket, you will pay 15% of your income in taxes. If you are in the 28% tax bracket, you will pay that amount in taxes, above a certain level of income. The bottom line is that if you put money into either of the two tax deferred options above, you will not pay taxes on that deposit. That means that if you are in the 15% tax bracket and you choose to put $200 into your tax deferred account, your take home check will only go down by about $160 because of the savings on state and federal taxes. At that level, you gained an extra $40 per month.
Just think, if you were putting in $1,000 per month, and you and your spouse were in the 28% tax bracket, that deposit would only cost you about $700 per month. You won’t complain about getting a $300 monthly raise will you?
Additionally, you will be amazed at how fast those deposits grow. With a growth rate of 10%, your money will double every 7.2 years. In a 30 year career that means that your first deposit doubled 4 times.
To get started, stop by your HR office and ask for the deferred comp package. Fill it out and get started.
When I started, I could only afford about $25 each month. I didn’t miss it and bumped it up to $50 the following month. A few months later I bumped it up to $100 per month. Each pay raise after that was added to the deposit(back when we actually got pay raises). Before I knew it, I was up to the maximum at the time which was about $650 per month. I think the current maximum is about $1,000 per month.
Did you know that if you only put in $300 per month during the first 10 years of your career and never deposited another cent, that you would have more money at retirement than a person who started deposits in the 11th year of their career and made the same $300 per month deposits for the next 20 years? Yes, that is what I said. The person who started late would have put away twice as much money, but would have less than the person who started 10 years earlier. Time is your friend. Even if you can only start small, you need to start soon so that your deposits have time to grow.
Keep in mind that there are other options to consider for your retirement planning. Doing a 401 or 457 gives you the benefit of allowing your tax deductible dollars to grow tax deferred. That will increase the amount that the money grows, but if you are not in a lower tax level after retirement, you will end up paying more in taxes after retirement than you would have paid if you had made deposits in an after tax vehicle that had tax free gains and no taxes at withdrawal. There are two examples that meet this requirement, one is the Roth IRA and the other is investment grade universal life insurance. I would take the time to read either one of the books by Douglass Andrew, “Missed Fortune” or Missed Fortune 101″ to get a better handle on the pros and cons of your retirement planning options. You can learn more about it at www.MissedFortune.com.
The bottom line is that you really want to start now, not later.
For more info, check out the Savings Plus Website
By the way, what are some of the pros and cons of using a state sponsored 401 vs a state sponsored 457 supplemental retirement plan?
There are several differences, for example, if your funds are in the 401 plan and you die, your funds should be available to roll over into a regular IRA for your beneficiary. But, if your funds are in the 457 plan, your beneficiary will be cashed out. All the time and effort to put money into a tax deferred account will be ruined. You may want to consider using the 401 as your first choice and only open the 457 a few months before retirement if you need to roll excess vacation dollars into two accounts. See Vacation or Annual Leave Credits at Retirement — Cash out or dump $ into 401-457 plan? for more info.