The Perfect Plan for Retirement Savings: 8 Key Elements for Employees

Introduction

Retirement is a major life goal that requires careful planning and saving. However, many people are not sure how to prioritize their retirement savings and what options are available to them. In this article, we will explain the general retirement savings priority for employees and how to choose the best retirement plan for your situation.

1. Employer Matching Contribution

The first and most important step in saving for retirement is to take advantage of your employer's matching contribution. This is when your employer matches a certain percentage of your salary that you contribute to your workplace retirement plan, such as a 401(k) or a 403(b).

For example, if your employer matches up to 5% of your salary, you should save at least 5% in your retirement account. This way, you can get an instant 100% return on your investment, plus the tax benefits of saving in a retirement plan.

According to a study by Vanguard, 25% of employees do not save enough to get the full employer matching contribution. This is like leaving free money on the table, so there is no excuse (such as saving for an emergency fund, paying off debt, etc.) for not getting it.

2. Health Savings Account (HSA) for Medical Expenses

The next priority in saving for retirement is to use a Health Savings Account (HSA) for medical expenses. An HSA is a special type of savings account that allows you to save and invest money for future medical costs. You can contribute to an HSA if you have a High-Deductible Health Plan (HDHP) insurance.

An HSA is better than a 401(k) or an IRA without employer matching because it has triple tax benefits:

- You can deduct your contributions from your income tax.

- Your money grows tax-free in the account.

- You can withdraw your money tax-free when used for qualified medical expenses.

Also, unlike a 401(k), an HSA is not subject to FICA tax, which is 7.65% of your income that goes to Social Security and Medicare.

However, an HSA is not for everyone. If you have a lot of medical expenses, the cost of the deductible may be higher than the HSA benefit. Therefore, you should compare whether a regular insurance plan is better or a HDHP with an HSA is better.

3. Individual Retirement Account (IRA)

The third priority in saving for retirement is to open and contribute to an Individual Retirement Account (IRA). An IRA is a personal retirement account that allows you to save and invest money for retirement. There are two types of IRAs: Roth and Traditional.

A Roth IRA is a retirement account that you fund with after-tax dollars. This means that you pay tax on your contributions now, but you do not pay tax when you withdraw your money in retirement. A Roth IRA is ideal if you expect your tax rate to be the same or higher in retirement.

A Traditional IRA is a retirement account that you fund with pre-tax dollars. This means that you deduct your contributions from your income tax now, but you pay tax when you withdraw your money in retirement. A Traditional IRA is ideal if you expect your tax rate to be lower in retirement.

The main advantage of an IRA over a 401(k) is that you have more investment options. You can invest in many investment products, including individual stocks, bonds, mutual funds, ETFs, and more. This gives you more control and flexibility over your portfolio.

The main disadvantage of an IRA is that it has lower contribution limits than a 401(k). For 2024, you can contribute up to $7,000 per year to an IRA, or $8,000 if you are 50 or older. For a 401(k), you can contribute up to $19,500 per year, or $26,000 if you are 50 or older.

If you are not eligible for a Roth IRA because your income is too high, you can use a Backdoor Roth IRA. This is a strategy where you contribute to a Traditional IRA and then convert it to a Roth IRA. This way, you can enjoy the benefits of a Roth IRA regardless of your income.

If you are not interested in various investment products, including individual stocks, and the 401(k) fee offered by your company is low and you are satisfied with the investment products, you can skip this step and go to the next one.

• The Ultimate Guide to Roth IRA vs Traditional IRA: Which One Will Make You Richer?

4. 401(k) Max Out

The fourth priority in saving for retirement is to max out your 401(k) contribution. This means that you contribute the maximum amount allowed by law to your workplace retirement plan. For 2023 and 2024, this is $19,500 per year, or $26,000 if you are 50 or older.

Some employers also offer a Roth 401(k) option. This is similar to a Roth IRA, except that it has higher contribution limits and it is subject to your employer's plan rules. If you expect your tax rate to be lower in retirement, save in a Traditional 401(k). If you expect your tax rate to be the same or higher in retirement, max out in a Roth 401(k).

• How to Save for Retirement with 401K

5. Mega Backdoor Roth

The fifth priority in saving for retirement is to use the Mega Backdoor Roth strategy. This is a way to save up to an additional $37,500 per year in a Roth IRA or a Roth 401(k). This is possible if your 401(k) plan offers two features:

- After-tax contributions: This allows you to contribute more than the regular limit of $19,500 ($26,000 if 50 or older) to your 401(k), up to the total limit of $58,000 ($64,500 if 50 or older) for 2023 and $61,000 ($67,000 if 50 or older) for 2024. These contributions are not tax-deductible, but they grow tax-deferred in the account.

- In-service withdrawals or rollovers: This allows you to withdraw or rollover your after-tax contributions to a Roth IRA or a Roth 401(k) without penalty. This way, you can convert your after-tax money to tax-free money.

Not all 401(k) plans offer these features, so you need to check with your plan administrator before attempting this strategy.

6. SEP IRA

The sixth priority in saving for retirement is to open and contribute to a SEP IRA. A SEP IRA is a Simplified Employee Pension plan that allows you to save and invest money for retirement if you have extra income from a part-time job, a side hustle, or a freelance gig.

A SEP IRA is similar to a Traditional IRA, except that it has higher contribution limits. For 2023 and 2024, you can contribute up to 25% of your net self-employment income, up to a maximum of $58,000 and $61,000, respectively.

A SEP IRA is ideal if you want to save more money for retirement and reduce your taxable income from your self-employment activities.

7. Life Insurance Retirement Plan (LIRP)

The seventh priority in saving for retirement is to use a Life Insurance Retirement Plan (LIRP). A LIRP is a way of using the cash value of permanent life insurance as a tax-free retirement fund. In other words, it is a way of using life insurance as Term Insurance + Roth IRA.

A permanent life insurance policy is a type of life insurance that provides coverage for your entire life, as long as you pay the premiums. It also has a cash value component that accumulates over time and can be accessed through loans or withdrawals.

A LIRP is a strategy where you buy a permanent life insurance policy, pay more than the minimum premium, and build up the cash value. Then, you borrow or withdraw from the cash value in retirement and use it as income. The benefits of a LIRP are:

- You can access your money tax-free, as long as you follow the rules and do not lapse or surrender your policy.

- You can avoid the contribution limits and income restrictions of other retirement plans.

- You can provide a death benefit to your beneficiaries, in addition to your retirement income.

A LIRP is not for everyone. It has some drawbacks, such as:

- You need to pay high fees and commissions to buy and maintain a permanent life insurance policy.

- You need to pay interest on the loans you take from the cash value, which reduces your death benefit and your retirement income.

- You need to keep your policy in force until you die, or else you may face taxes and penalties on your withdrawals.

A LIRP is a complex and expensive strategy that requires careful planning and execution. You should consult a qualified financial professional before considering a LIRP.

8. College Savings Plan

The eighth and final priority in saving for retirement is to invest in a college savings plan for your children or grandchildren. A college savings plan is a type of investment account that allows you to save and invest money for future education expenses. The most common type of college savings plan is a 529 plan.

A 529 plan is a tax-advantaged investment account that allows you to save and invest money for qualified education expenses, such as tuition, fees, books, supplies, and room and board. The benefits of a 529 plan are:

- You can deduct your contributions from your state income tax, depending on your state's rules.

- Your money grows tax-free in the account.

- You can withdraw your money tax-free when used for qualified education

Explore the links for more insights!

• How much Retirement Savings Do You Need?
• Understanding Social Security Benefits: A Comprehensive Guide
• The 4% Rule for Retirement Fund Withdrawals