Interview with Michael Foguth, Brighton Investment Advisor
Did you know that only 22 percent of families have developed a retirement savings plan and stuck to it? That’s what we found in MassMutual's latest State of the American Family Study .
It’s understandable that retirement planning often takes a backseat to more immediate financial concerns. But saving for retirement is actually easier the sooner you start: it gives your money more years to grow.
Another retirement planning problem many people face is not knowing how to start. This article will help with that. It will tell you about:
- The plans your employer might offer.
- How to sign up.
- Starting your own plan.
- How much to contribute.
- What to do if you’re self-employed.
- Investing your retirement savings.
You might wish that you had set up your plan five, ten, or even twenty years ago—but what’s done is done. The next-best time to start your plan is today.
Not all employers offer their workers a retirement plan, but here’s a list of the types of plans you might have access to, depending on your employer.
- 401(k), Roth 401(k): private sector companies
- 403(b): public schools and nonprofits
- 457: state and local governments
- Thrift Savings Plan: federal government.
- SEP IRA: small, private sector companies
- SIMPLE IRA, SIMPLE 401(k): small, private sector companies with fewer than 100 employees
Some companies automatically enroll new employees in retirement plans because it dramatically increases employee participation, from 50 percent in plans where employees must opt in to more than 90 percent in plans with automatic enrollment, according to a 2017 study by the Pew Charitable Trusts .
If you aren’t already enrolled, getting signed up is typically as simple as talking to your company’s human resources department and filling out a form that specifies what percentage of your salary to contribute. Your employer will automatically deduct it from each paycheck, on a pretax basis, and place it in your retirement account.
About 17 percent of employers do not offer a 401(k) or similar defined contribution retirement plan, according to the 2018 MassMutual Workplace Benefits Study . If you find yourself in this category, you’ll need to take saving for retirement into your own hands.
You have two options:
- Traditional IRA: contribute pretax dollars.
- Roth IRA: contribute after-tax dollars.
The best thing about these accounts is that they give you complete control over where to put your money. You decide what brokerage firm to use and what fees you’re willing to pay. Plus, you’ll have thousands of investments to choose from.
IRAs have several big downsides, however:
- Low contribution limits: You can only contribute about one-third ($6,000 in 2019, with a catch-up contribution limit of $1,000 for those age 50 and older) of what you can contribute to an employer-sponsored retirement account ($19,000 in 2019, with a catch-up contribution limit of $1,000 for those age 50 and older).
- Traditional IRA deduction limits: You may be able to claim a deduction on your federal income tax return for the amount you contributed to your IRA, but this depends on your tax-filing status, your modified adjusted gross income and whether you are covered by a retirement plan at work. (Analysis includes whether your spouse is covered by a plan at work.)
- Income limits: The ability to make contributions to a Roth IRA may be limited based on your income and tax-filing status. For 2019, if you’re single and earn $137,000 or more, or if you’re married and earn $203,000 or more, you can’t contribute to a Roth IRA.
Learn more: Retirement savings catch-up: 3 moves
If you’re putting pretax dollars into a workplace retirement savings plan, it usually makes sense to give yourself tax diversification by choosing a Roth IRA for your individual plan. However, if you don’t have a workplace plan, should you choose a Roth IRA, traditional IRA, or both?
“Whether you save pretax or after-tax dollars depends on a few factors and it isn’t always cut and dry,” said Brandon Renfro, assistant professor of finance at East Texas Baptist University and a fee-only financial advisor in Marshall, Texas. “The main thing to think about is your tax rate. Do you think it will be higher now or in retirement? If you think your tax rate is higher now, then ... you should save pretax.”
The problem with making any assumptions about your future tax rate is that the government can always change tax rates. In 1990 , a married couple earning more than $32,450 fell into the 28 percent tax bracket. In 2019, a couple at that same income level, adjusted for inflation, would fall into the 12 percent tax bracket.
Renfro said that, generally, the earlier you start saving, the more you save from each paycheck, and the higher the return you achieve, the more likely your tax rate will be higher in retirement and then Roth contributions make more sense.
Conversely, he explained, “If you’ve waited a long time to start, don’t save much, and are very conservative and earn a low rate of return, it probably makes more sense to make pretax contributions.”
Retirement experts generally recommend prioritizing your retirement plan contributions like this:
- Contribute enough to your employer-sponsored retirement plan to get any company match.
- Contribute the maximum to a traditional IRA and/or a Roth IRA, if you can.
- Continue contributing to your employer-sponsored plan up to the annual maximum.
If you don’t contribute enough to your employer plan to get the full match, you’re throwing away free money, said Chartered Financial Analyst ® Lou Haverty, owner of Financial Analyst Insider , a website for aspiring financial industry professionals.
Here’s how matching contributions work.
“In most cases, your employer will set the match based on a specified contribution percentage you make to the plan,” Haverty explained. “They may offer to match 100 percent of your first 6 percent that you contribute from your income.”
For example, if you earn $100,000 and contribute 6 percent, or $6,000, your employer will kick in another $6,000 in this scenario.
Learn more: Millennials: A 401(k), Roth combo may win
Matching contributions may have limitations. If you leave the company for any reason, you might receive a partial match or no match, depending on your employer’s vesting schedule and how long you’ve contributed to the plan.
“Some employers may make you wait one to five years before you qualify for the match,” said Michael Foguth , president and founder of Foguth Financial Group in Brighton, Michigan.
Experts then usually recommend contributing to a traditional or a Roth IRA, if you can. The Roth could be particularly useful because many experts think the ability to withdraw tax-free dollars from a Roth in retirement has an edge over paying taxes on 401(k) or traditional IRA withdrawals in retirement.
Of course, not everyone can contribute to a Roth IRA. And for many, the “set it and forget it” routine with an employer-sponsored plan can be easier versus having to be diligent about saving for Roth IRA contributions. Indeed, the “set it and forget it” approach makes it easy to contribute to your employer-sponsored plan up to the maximum. Be careful not to go beyond the maximum, however, as it has tax consequences.
If you earn profits as an independent contractor, you’d be remiss not to open a self-employed retirement account. (Learn more: Freelancer’s benefit checklist )
For example, with a solo 401(k) , not only can you contribute up to the annual limit of $19,000 in 2019, but you can also make profit-sharing contributions of up to 25 percent of compensation as defined by the plan for a total maximum contribution of $56,000. The major brokerage firms make these plans straightforward to set up, contribute to, and manage.
The next set of decisions you’ll need to make is how to invest your retirement contributions.
Generally, the more years you have until retirement, the more risk you can take with your investments. That means you might tilt the balance of your portfolio more toward stocks and away from bonds. ( Learn more:Understanding your risk profile )
Taking more risk, up to a point, has been correlated with higher returns. Historically, stocks have earned an average of eight to 10 percent per year, while bonds have returned about half as much. Many people will need the higher return potential stocks can offer to accumulate enough for retirement.
Diversification is another key to retirement planning that you should be familiar with.
“Your asset allocation — mix of stocks and bonds — is the most important part of the investment plan,” Renfro said. “Choose investments that are low cost and broadly diversified.”
Mutual funds (of which index funds are a type) and exchange-traded funds let you invest in a large number of stocks or bonds without having a large sum to invest and without having to research individual stocks and bonds. Funds make it easy to start investing and keep investing even if you don’t have a lot of investing knowledge or extra time.
Learn more: Mutual fund and ETF basics
Many people aim to save up 15 times their annual income for retirement. But today, the best thing you can do is get started.
Enroll in your employer’s plan, open an IRA, or start a self-employed plan. Save as much as you can, and invest the money in a low-cost, broadly diversified portfolio of stocks and bonds that takes on enough risk to earn the returns you need—but not so much that you can’t sleep at night.
Before you know it, you’ll have a nest egg to be proud of and you’ll be well on your way to meeting your retirement goals. If you ever have questions, MassMutual’s financial advisors are here to help.