Have you received a pay raise, bonus or an inheritance and as a result changed your spending habits? Have you bought things such as expensive items, cars or even a new home because of one of these events? Soon, your lifestyle starts to inflate or creep to where your standard of living resets at this new higher income level. Spending can quickly become unsustainable if your income doesn’t stay at the same pace and continue to rise. Importantly, you’ll need to save substantially more now to continue that lifestyle in retirement than originally planned. From experience, most families continue at near the same spending level if not more in retirement, especially when grandchildren enter the picture!
There isn’t any harm with spending more money if you make more, however you need to also increase your savings for important goals at the same level. For example, if your income is now $250,000 or above, you’ll need to save quite a bit more than the $19,000 401(k) contribution to maintain your lifestyle when you decide to retire. These savings targets increase much more if you want to “make work optional” at an earlier age.
It’s inevitable that your income will rise as you progress through your career, however there are good habits to follow to prepare for the future while still enjoying the “now”:
Prepare and follow a budget
No matter your income level, having a household budget is key to achieving your goals. It allows you to put all your income and expenses on one sheet of paper to determine how much savings you can automate each month. Many households are cash flow “rich” thereby they are best served by figuring out monthly savings targets. This article discusses a budget technique that can be used as a template for your budgeting. It’s especially important to have a cash flow plan for families where cash bonuses and restricted stock make up a large portion of their annual income.
Develop and adhere to a pre-determined plan for extra income
If you receive a bonus, you should have a pre-determined savings allocation for those extra resources. This meaning that of the bonus that you receive after-tax, possibly 25% is allocated to spending (i.e. the fun stuff), 25% to travel and short-term savings, and 50% to long-term savings. That way, you get to spend and enjoy a large portion of your bonus while also saving a large sum towards the future. Too often do people receive a bonus and quickly spend it. Having a pre-determined plan or formula for how to allocate these excess dollars is important as your budget won’t account for this income.
Routinely update your retirement projections
Your financial plan needs to be updated each time your spending level increases as the plan is not going to be successful if it is based on $100,000 of annual spending in retirement when your lifestyle now requires $200,000 a year. Many households attempt to exclude child costs from this figure as they won’t have dependents in retirement, however experience has taught that the spending has been replaced by spending on trips and supporting children and grandchildren.
We suggest reading the book Making Work Optional: Steps to Financial Freedom to learn about how best to prioritize your savings to achieve your long-term goals. Importantly, make sure to read the section about “mistakes to avoid” on your path to financial freedom.
Please contact Merriman if you have any questions about developing a cash flow plan or for any of your other financial planning needs.
Everyone thinks about saving for retirement, and not many people want to work forever. However, have you thought about the best way to save for the future? If you are setting aside the yearly max in your 401(k) and channeling extra savings to your brokerage, you might be missing out on powerful tax-advantaged saving opportunities. In this article, we will show you how we help clients maximize savings, minimize taxes and secure their future using the Mega Backdoor Roth IRA.
Most people know they can contribute to their employer’s retirement plan from their paychecks through pre-tax and Roth contributions up to $19,000 a year ($25,000 if age 50 or older; IRS, 2018). What people miss is whether their retirement plan allows for additional after-tax contributions beyond this limit. Enter the supercharged savings!
It turns out that some company plans permit you to contribute up to the IRS maximum for total contributions to a retirement plan, which is $56,000 in 2019 ($62,000 with catch-up contributions; IRS, 2018). The IRS maximum counts contributions from all sources, including pre-tax employee deferrals, employer matching contributions, and even after-tax contributions for the Mega Backdoor Roth. That means you might be able to contribute an additional $20,000 or more after-tax each year after maxing your elective deferral and receiving your match. You can then convert the extra after-tax savings to Roth dollars tax-free. This more than doubles what most individuals can contribute to their retirement plan, and you won’t have to pay taxes on your Roth account distributions in retirement. This benefit is even greater when both spouses have this option available through their employers, so be sure to check both plans.
Retirement plans like those at Boeing, Facebook, and Microsoft permit easy conversions of after-tax to Roth dollars within the retirement plan. Other companies offer a variation where you can make in-service distributions and move after-tax dollars into a Roth IRA. Make sure to check with your benefits team to find out if your company’s retirement plan supports after-tax contributions and Roth conversions, the steps involved and the maximum amount you can contribute to the after-tax portion of your retirement plan. It’s important not to run afoul of plan rules or IRS requirements, so also be sure to consult experts like your accountant or financial advisor if you have any questions.
Why contribute extra after-tax? Now that we have covered the high-level view, let’s hammer down the why. The benefit of contributing to your employer’s after-tax retirement plan is that those contributions can subsequently be converted to Roth tax-free. This is sometimes called a ‘Mega Backdoor Roth,’whereby you can contribute and convert thousands of dollars per year depending on your retirement plan. Once converted, these Roth assets can grow tax-free and be distributed in retirement tax-free. After several years of Mega Backdoor Roth contributions, you can amass a meaningful amount of wealth in a tax-free retirement account
How do I contribute? 1. Log in to your employer’s retirement plan through their provider website, such as Fidelity.
2. Find the area where you change your paycheck and bonus contributions (i.e., deferrals).
3. Find “after-tax” on the list showing how much you elected to contribute pre-tax, Roth, or after-tax to your 401(k).
4. Enter a percentage to have withheld after-tax from your upcoming paychecks and bonuses that works for your budget.
5. Select an automated conversion schedule, such as quarterly (Microsoft’s retirement plan even offers daily conversions!). If your plan doesn’t offer automated periodic conversions, contact your retirement plan provider regularly throughout the year to convert the assets.
6. Remember to select an appropriate investment allocation for your retirement account that aligns with your overall investment plan.
Is any part of the conversion taxed? For retirement plans that don’t convert after-tax contributions to Roth daily, there may be growth in the account prior to conversion. This growth is subject to taxation at ordinary income tax rates. For example, if you converted $22,000 ($20,000 contributions + $2,000 investment growth over the period), you’ll owe income tax on the $2,000.
We suggest speaking with a Merriman advisor to determine if your retirement plan allows additional after-tax contributions, how to fit it within your budget and its impact on your retirement savings goals.
Young professionals juggle ramping up their careers, paying off debt, starting retirement nest eggs, buying homes and potentially building families. There is no shortage of goals for funneling your hard-earned dollars, and we can’t forget to have some fun along the way. It’s time to figure out how to take finances to the next level by supercharging savings and intelligently managing debt, so what do we tackle first?
Life can throw you curveballs and if you aren’t prepared financially, these curveballs can turn into major problems. That’s why it’s so important to have a savings buffer, also called an emergency fund. An emergency fund is a cash account that you keep separate for life’s unexpected events. It can help prevent additional stress when these events occur. (more…)
My grandmother was born in 1927. At that time, the life expectancy for women was about 60 years, but here we are in 2013 and she is doing amazingly well. During the last 80 years, technological and medical advances have tacked another 26+ years onto her life. Already she has lived 50% longer than the initial expectation.
My son was born in the fall of 2012. He is expected to live about 80 years. Following my grandmother’s case, he would live to 120 years of age. Put another way, he can expect his pre-retirement and retirement periods to be about the same. Clearly, retirement nest eggs and pensions are going to be stretched a lot further than they ever have been.
This is the trend that we need to plan for. The following are key areas of consideration for our increasing life spans.
Inflation. At 3% inflation, a $100,000 annual income need today becomes $242,726 30 years down the road. This substantial difference requires careful consideration. Do your pensions have an annual cost of living adjustment built in? Have you built inflation protection into your retirement accounts?
Health care costs. Along the same lines, the estimated rate of inflation for health care in 2014 is 6.5%. Should you insure to protect against this risk?
Portfolio withdrawal rate. What is a sustainable rate that can last throughout your retirement period? Is your portfolio structure congruent with this rate? That is, do you have the appropriate mix of stocks and bonds with sufficient diversification?
Your end of life wishes. Statistically speaking, the majority of medical costs occur in the last five years of life. And, there is little doubt that advances in medicine and technology will afford increasingly difficult decisions. Having a clear medical directive can save significant emotional and financial resources.
Savings rate. Pensions are becoming a thing of the past. This has shifted a huge responsibility to the saver. If you are still in your accumulation years, figuring out the savings rate that corresponds to your retirement goals is more important than ever.
As life expectancies increase, so do the complexities of retirement planning. Inflation protection and an appreciable return that keeps up with your distribution needs are just the beginning. If you have not already done so, take the time to meet with your advisor to build a goal-centric plan that is specific to your unique retirement needs.