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Are You Making These 4 Major 401K Mistakes?

Re-posted from Are you Making these 4 Major 401K Mistakes?

If you’re lucky enough to have access to an employer-sponsored 401(k), you should know that you have a great opportunity to accumulate a bundle in time for retirement. That’s because 401(k)s allow you to contribute much more on an annual basis than IRAs. The current yearly limits are $18,500 for workers under 50 and $24,500 for those 50 and over. By comparison, IRAs max out at $5,500 and $6,500 a year, respectively.

Still, having a 401(k) will only get you so far if you don’t manage it wisely. With that in mind, here are a few major mistakes you should make every effort to avoid.

1. Not contributing enough to snag your employer’s match

One benefit of having a 401(k) is the opportunity to build wealth not just with your own money but your employer’s as well. In fact, 92% of companies that offer a 401(k) also match worker contributions to some degree. But to get that money, you’ll need to contribute money of your own. Unfortunately, an estimated 25% of workers don’t put in enough to capitalize fully on their employers’ matching dollars, and are thus leaving a collective $24 billion on the table each year.

If you’re not getting your employer match, you’re kissing free money goodbye — so don’t let that continue. Figure out how much you need to put into your 401(k) to get that match, and cut corners in your budget to make up for a slightly smaller paycheck. Otherwise, you’ll miss out on not just your company match itself, but the potential to invest it and grow it into a larger sum over time.

2. Not increasing your contributions year after year

Many workers get a raise year after year. If you’re one of them, then you’re doing yourself a major disservice by not sticking that extra money into your 401(k) before it shows up in your paychecks.

Think about it: Unless your expenses go up drastically from year to year, you can probably get by without that additional money. So, if you arrange to have it land in your 401(k) from the start, you won’t come to miss it.

3. Sticking with your plan’s default investment 

When you first sign up for a 401(k), you’ll be automatically invested in your plan’s default option until you select your own investments. That default option is usually a target date fund, and while that may be a good choice for some workers, it’s not necessarily the best choice for you.

Target date funds are designed to grow increasingly conservative as their associated milestones near. For example, if you invest in a target date fund for retirement over a 30-year period, you’ll generally start out with a more aggressive investment mix and will shift toward safer assets as that period winds down.

The problem with target date funds is that they don’t necessarily provide the best returns on investment, nor is your 401(k)’s default target date fund designed to align with your specific strategy or tolerance for risk. A better bet, therefore, is to review your plan’s investment options and choose those that are more likely to help you meet your goals. Keep in mind that you may, after reviewing your choices, decide to stick with that default fund, and that’s fine. Just don’t make the mistake of not exploring alternatives first.

4. Not paying attention to investment fees

Of the various investments you’ll get to choose from in your 401(k), some are bound to be more expensive than others. But if you don’t pay attention to fees, you could end up losing thousands upon thousands of dollars in your lifetime without being any the wiser. The funds in your 401(k) are required to disclose their associated fees, so take a look at those numbers and aim to keep them as low as possible without compromising on returns. You can generally pull this off by sticking mostly to index funds, which are passively managed and don’t have the same costs as actively managed mutual funds.

Participating in a 401(k) plan is a great way to set yourself up for a comfortable retirement. Avoiding these mistakes will help you make the most of that plan, leaving you with a higher ending balance by the time your golden years eventually roll around.

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Teresa Staker
Teresa Staker
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Retired Couple Finances

When It’s Time to Stop Saving for Retirement

Re-posted from Investopedia

You’ve done all the right things – financially speaking, at least – to get ready for retirement. You started saving early to take advantage of the power of compounding, maxed out your 401(k) and individual retirement account (IRA) contributions every year, made smart investments, squirreled away money into additional savings, paid down debt and figured out how to maximize your Social Security benefits.

Now what? When do you stop saving – and start enjoying the fruits of your labor?

A Nice Problem to Have (But a Problem All the Same)

Many people who have saved consistently for retirement have trouble making the transition from saver to spender when the time comes. Careful saving – for decades, after all – can be a hard habit to break. “Most good savers are terrible spenders,” says Joe Anderson, CFP, president of Pure Financial Advisors, Inc. in San Diego.

It’s a challenge most Americans will never face: More than half (55%) are at risk of being unable to cover essential living expenses – housing, healthcare, food and the like – during retirement, according to a recent study from Fidelity Investments.

Even though it’s an enviable predicament, being too thrifty during retirement can be its own kind of problem. “I see that many people in retirement have more anxiety about running out of money than they had working very stressful jobs,” says Anderson. “They begin to live that ‘just in case something happens’ retirement.”

Ultimately, that kind of fear can be the difference between having a dream retirement and a dreary one. For starters, penny-pinching can be hard on your health, especially if it means skimping on healthy food, not staying physically and mentally active, and putting off healthcare. (For more, see 7 Signs You’re Spending Too Little in Retirement.)

Being stuck in saving mode can also cause you to miss out on valuable experiences, from visiting friends and family to learning a new skill to traveling. All these activities have been linked to healthy aging, providing physical, cognitive and social benefits. (For more, see Retirement Travel: Good and Good for You.)

One reason people have trouble with the transition is fear: in particular, the fear that they will outlive their savings or have medical expenses that leave them destitute. One thing to keep in mind that spending naturally declines during retirement in several ways. You won’t be paying Social Security and Medicare taxes anymore, for example, or contributing to a retirement plan. Plus, many of your work-related expenses – commuting, clothing and frequent lunches out, to name three – will cost less or disappear.

To calm people’s nerves, Anderson does a demo for them: “running a cash-flow projection based on a very safe withdrawal rate of 1% to  2% of their investable assets. Through the projection they can determine how much money they will have, factoring in their spending, inflation, taxes, etc. This will show them that it’s OK to spend the money.”

Another reason some retirees resist spending is that they have a particular dollar figure in mind that they want to leave their kids or some other beneficiary. That’s admirable – to a point. It doesn’t make sense to live off peanut butter and jelly during retirement just to make things easier for your heirs. (For more, see Designating a Minor as an IRA Beneficiary.)

“Retirees should always prioritize their needs over their children’s,” says Mark Hebner, founder and president of Index Fund Advisors in Irvine, Calif.  “Although it is always the desire for parents to take care of their children, it should never come at the expense of their own needs while in retirement. Many parents don’t want to become a burden on their children in retirement and ensuring their own financial success will make sure they maintain their independence.”

When to Start Spending

Since there’s no magical age that dictates when it’s time to switch from saver to spender (some people can retire at 40 while most have to wait until their 60s or even 70+), you have to consider your own financial situation and lifestyle. A general rule of thumb says it’s safe to stop saving and start spending once you are debt-free and your retirement income from Social Security, pension, retirement accounts, etc. can cover your expenses and inflation.

Of course, this approach only works if you don’t go overboard with your spending; creating a budget can help you stay on track. (For more, see The Complete Guide to Planning a Yearly Budget.)

Line in the Sand

Even if you find it hard to spend your nest egg, you’ll have to start cashing out a portion of your retirement savings each year once you turn 70-1/2  years old. That’s when the IRS requires you to take required minimum distributions, or RMDs, from your IRA, SIMPLE IRASEP IRA or retirement plan accounts (Roth IRAs don’t apply) – or risk paying tax penalties. And these aren’t trivial penalties: If you don’t take your RMD, you will owe the IRS a penalty equal to 50% of what you should have withdrawn. So, for example, if you should have taken out $5,000 and didn’t, you’ll owe $2,500 in penalties.

If you’re not a big spender, RMDs are no reason to freak out. “Although RMDs are required to be distributed, they are not required to be spent,” Charlotte A. Dougherty, CFP, of Dougherty & Associates in Cincinnati, points out. “In other words, they must come out of the retirement account and go through the ‘tax fence,’ as we say, and then can be directed to an after-tax account which then can be spent or invested as goals dictate.”

As Thomas J. Cymer, DFP, CRPC, of Opulen Financial Group in Arlington, Va., notes: If individuals “are fortunate enough to not need the funds they can reinvest them using a regular brokerage account. Or they may want to start using this forced withdrawal as an opportunity to make annual gifts to grandkids, kids or even favorite charities (which can help reduce the taxable income). For those who will be subject to estate taxes these annual gifts can help to reduce their taxable estates below the estate tax threshold.”

Since RMD rules are complicated, especially if you have more than one account, it’s a good idea to check with your tax professional to make sure your RMD calculations and distributions meet current requirements.

The Bottom Line

You may be perfectly happy living on less during retirement and leaving more to your kids. Still, allowing yourself to enjoy some of the simple pleasures – whether it’s traveling, funding a new hobby or making a habit of dining out – can make for a more fulfilling retirement.

And don’t wait too long to start: Early retirement is when you’re likely to be most active, as The 4 Phases of Retirement and How to Budget for Them makes clear.

Read more: When It’s Time to Stop Saving for Retirement | Investopedia https://www.investopedia.com/articles/personal-finance/021816/when-its-time-stop-saving-retirement.asp#ixzz52ZWCAOIj
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Can Your 401(k) Impact Your SS Benefits?

By Claire Boyte-White | Updated June 26, 2017 — 6:00 AM EDT

Reposted from Investopedia

While income you receive from your 401(k) or other qualified retirement plan does not affect the amount of Social Security retirement benefits you receive each month, you may be required to pay taxes on some or all of your benefits if your annual income exceeds a certain threshold.

Why Doesn’t 401(k) Income Affect Social Security?

Your Social Security benefits are determined by the amount of money you earned during your working years for which you paid Social Security taxes. Since contributions to your 401(k) are made with compensation received from employment by a U.S. company, you have already paid Social Security taxes on those dollars.

This holds true even for traditional 401(k) accounts. Contributions to traditional accounts are made with pretax dollars, but this tax shelter only applies to income taxes, not Social Security. While you don’t pay income tax on traditional 401(k) funds until you withdraw them, you still pay Social Security taxes on the full amount of your compensation in the year you earned it.

“Contributions to a 401(k) are subject to Social Security and Medicare taxes, but are not subject to income taxes, unless you are making a Roth (after-tax) contribution,” notes Mark Hebner, founder and president of Index Fund Advisors, Inc., Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.”

The Tax Impact of 401(k) Savings

Though the amount of your benefit is not affected by your 401(k) savings, you may have to pay income taxes on some of your benefits if your combined annual income exceeds a certain amount. In fact, about one-third of benefit recipients must pay taxes on a portion of their benefits.

The income thresholds are based on your combined income, which is equal to the sum of your adjusted gross income (AGI) – which includes withdrawals from any retirement savings accounts – any non-taxable interest earned and one-half of your Social Security benefits. If you take large distributions from your 401(k) in any given year that you receive benefits, you are more likely to exceed the income threshold and increase your tax liability for the year.

In 2017, if your total income for the year is less than $25,000 and you file as an individual, you won’t be required to pay taxes on any portion of your Social Security benefits. If you file jointly as a married couple, this limit is raised to $32,000. You may be required to pay taxes on up to 50% of your benefits if you are an individual with income between $25,000 and $34,000, or if you file jointly and have income between $32,000 and $44,000. Up to 85% of your benefits may be taxable if you are single and earn more than $34,000 or if you are married and earn more than $44,000. If you are married but file a separate return, you are likely to be liable to for income tax on the total amount of your benefits, regardless of your income level.

Other Types of Retirement Income

In some cases, other types of retirement income may affect your benefit amount, even if you collect benefits on your spouse’s account. Your benefits may be reduced to account for income you receive from a pension based on earnings from a government job or from another job for which your earnings were not subject to Social Security taxes. This primarily affects people working in state or local government positions, the federal civil service or those who have worked for a foreign company.

If you work in a government position and receive a pension for work not subject to Social Security taxes, your Social Security benefits received as a spouse or widow or widower are reduced by two-thirds of the amount of the pension. This rule is called the government pension offset (GPO). For example, if you are eligible to receive $1,200 in Social Security but also receive $900 per month from a government pension, your Social Security benefits are reduced by $600 to account for your pension income. This means your Social Security benefit amount is reduced to $600, but your total monthly income is still $1,500.

The windfall elimination provision (WEP) reduces the unfair advantage given to those who receive benefits on their own account and receive income from a pension based on earnings for which they did not pay Social Security taxes. In these cases, the WEP simply reduces Social Security benefits by a certain factor, depending on the age and birth date of the applicant.

How Your Is Benefit Determined?

Your Social Security benefit amount is largely determined by how much you earned during your working years, your age when you retire and your expected life span.

The first factor that influences your benefit amount is the average amount that you earned while working. Essentially, the more you earned, the higher your benefits will be, up to the maximum benefit amount of $3,538. The Social Security Administration (SSA) calculates an average monthly benefit amount based on your average income and the number of years you are expected to live.

In addition to these factors, your age when you retire also plays a crucial role in determining your benefit amount. While you can begin receiving Social Security benefits as early as age 62, your benefit amount is reduced for each month that you begin collecting before your full retirement age. Full retirement age varies between 65 and 67, depending on your year of birth. Conversely, your benefit amount may be increased if you continue to work and delay receiving benefits beyond full retirement age. For example, in 2017, the maximum monthly benefit amount for those retiring at full retirement age is $2,687. For those retiring early, at age 62, the maximum drops to $2,153, while those who defer collection until age 70 – the latest age at which collection can commence – can collect a benefit of $3,538 per month.

“Delaying Social Security until age 70 can be beneficial since you will receive an 8% gain every year after reaching your full retirement age,” says Carlos Dias Jr., wealth manager, Excel Tax & Wealth Group, Lake Mary, Fla.

Eligibility Requirements

To receive Social Security benefits, you must have accrued 40 credits, which you earn by working and paying into the Social Security system. Each year of work is worth a maximum of four credits, so you must work a minimum of 10 years to be eligible. However, each credit is equivalent to $1,300 of taxable earnings in 2017. Once you’ve earned $5,200 in any given year, you have already earned the maximum four credits. This means you could elect to stop working for the rest of year without endangering your eligibility, though this is not a very sustainable strategy. For one thing, a lower income will mean your benefits will be lower.

 

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