Retirees routinely withdraw cash from retirement accounts to cover basic living expenses, but selling low could negatively affect your retirement portfolio. If the economy experiences a downturn during your retirement years, you can use the strategies discussed below to minimize the impact to your long-term financial plan.
Before Making Any Withdrawals
While younger investors are generally advised to leave their cash invested and wait for the market to rebound, retirees typically rely on market withdrawals to create cash flow. In an effort to avoid or postpone withdrawals during tricky market conditions, try to find assets unlinked to the market that you can tap into until the market normalizes. Market downturns and steep inflation can be considered financial emergencies if you’re struggling to make ends meet, so you can certainly dip into emergency funds without feeling guilty. Just be sure to prepare a plan to replenish the funds as soon as possible. If you must withdraw from your investment accounts, it’s important to be strategic in your withdrawals.
Begin with Interest and Dividends
Before selling low, try to leave your original investment intact by only withdrawing the interest and dividends from your taxable accounts. This move could allow you to conceivably grow your income when the market rebounds in the future.
Sell Lower Volatility Investments
Short-term bonds and bond funds generally aren’t as affected by market unpredictability, and their values are ordinarily stable. Selling them in a down market can supply necessary cash and not cause too much damage to your retirement savings. They also favor smaller price fluctuations than stocks during stretches of market volatility.
Rebalance Your Portfolio
If your investment portfolio is out of alignment with your asset allocation goals due to market volatility, it’s an opportune time to look for opportunities to raise needed cash by rebalancing. In order to return your allocation to its original goal, sell assets where values have increased disproportionately in value relative to your desired allocation, and buy assets that may have dropped in value.
Make Tax-Smart Choices
If you’re forced to sell assets from taxable accounts for needed cash flow, be sure to make tax-smart choices. You can minimize your taxes owed by selling investments that you’ve held longer than one year. Those gains are taxed at the long-term capital gains tax rate of 20% and not at the federal ordinary income tax rate. Keep in mind that some gains may also be subject to state and local taxes.
Approaching retirement planning when you’re late in the game can be a daunting task, but with the right strategies, you can get on track to build a nest egg that will provide some support by the time you reach retirement. Read on for proven catch-up options for late starters.
Identify How Much Savings You’ll Need
You might tell yourself that you won’t need much in retirement, but you might be surprised to learn that even a life of simplicity could require $1 million in the bank once you step away from the workforce. Given that most financial experts agree on an annual withdrawal of 3% to 4% of your retirement portfolio, that’s $30,000-$40,000 per year with a $1 million portfolio. This scenario excludes Social Security income as well as pensions, rental properties, or other sources of income.
Thinking through how much money you’ll need to live comfortably with the lifestyle you plan to lead in retirement will help you determine how aggressively you’ll need to save.
Pay Down Debt
While it’s important to pay down debt, you don’t want to surrender retirement goals to do so. You’ll need to come up with a plan to pay off credit card debt, car loans, and other high-interest or non-mortgage debt while also saving for retirement.
As for your mortgage, how you handle this debt as you approach retirement depends on where you are in your repayment journey. If you’re closer to the early stages of your mortgage and most of your monthly payment is assigned to interest, it might make sense to pay down some of the principle. However, if you are closer to the later stages of your mortgage and your payments are generally assigned to the principal, you might think about investing that money for retirement rather than putting any additional funds toward mortgage payments.
Invest Your Age
You might think that in order to make up for lost time, you should take on more investment risk. But with more risk comes the potential for more loss to your principal. Your risk should correlate with your age. While investors in their 20s and 30s can afford more risk because they have more time to recover any losses, investors in their 50s or older don’t have that luxury. As you near retirement you might consider one of the following blueprints for asset distribution, depending on your personal level of risk aversion:
High (but acceptable) risk: Invest in stock funds a percentage of 120 minus your age. Put the rest into bond funds.
Moderate risk: Invest in stock funds a percentage of 110 minus your age. Put the rest into bond funds.
Conservative risk: Invest in bond funds a percentage equivalent to your age. Put the rest in stock funds.
Fund a Roth IRA
If you are able to max out your 401(k), consider opening a Roth IRA and fully funding that as well. Roth IRAs are an opportune way to save and grow investments. Contributions to a Roth IRA grow tax-free, and qualified withdrawals are tax-free. The yearly contribution limit for both traditional and Roth IRAs is $6,000 for 2022. The catch-up contribution for those 50 years and older is $1,000.
Be Sure You Have Sufficient Insurance
Fact: Unforeseen hardship is the cause of most personal bankruptcies. You have a greater chance of avoiding bankruptcy when you have adequate health, disability, home and car insurance in place. Further, if you have dependents, think about term life insurance. Note that, in general, term life insurance is recommended over whole life insurance. Be sure to look for insurance agents who have a fiduciary duty to you, meaning the agent must legally and ethically act in your best interest.
Put Your Retirement Saving Plan First
It’s typically agreed that draining retirement funds to send children to college is a bad financial move. Aside from the fact that your 401(k) may not permit you to take out a loan on your retirement account balance, consider that your children have their entire working lives ahead of them, and they can begin saving for retirement much earlier than you did. At this stage in the game, protecting your own financial retirement security will help to ensure that the burden doesn’t fall to your children in the future.
A Roth IRA is a great vehicle for saving for retirement. Because you pay taxes on money going into your account, you can withdraw funds tax-free in retirement. And unlike other retirement funds, required minimum distributions don’t apply to Roth IRAs, so your money can grow tax-free for as long as you like. To be sure you’re getting the most from a Roth IRA account, this article will go over some common — and sometimes costly — mistakes people make with their Roth IRAs.
Don’t Skip a Roth IRA Just Because You Already Have a 401(k)
You might be tempted to skip a Roth IRA if you already have a 401(k), but this savings combination can help accrue a considerable nest egg. To take full advantage of both retirement plans, be sure you’re contributing enough to your 401(k) to get the full employer match, if your employer participates in a match program. Once you’ve maxed out your contribution to the employer match, open a Roth IRA and begin funding it.
Don’t Contribute If Your Income Doesn’t Allow You to Qualify
For 2022, married couples filing jointly can contribute to a Roth IRA if your modified adjusted gross income (MAGI) is $204,000 or less ($129,000 for single filers). Contributions begin phasing out above those amounts, and you’re not permitted to contribute to a Roth IRA once your income reaches $214,000 if married and filing jointly ($144,000 for single filers).
If you make contributions when your income places you above the contribution limit, it’s considered an excess contribution. The IRS will charge a 6% tax on the excess amount for each year it remains in your account.
Don’t Contribute Too Much
Just as with income limits, if you deposit more than you’re permitted to contribute to your Roth IRA, you’ll be subject to the same 6% excise tax on the extra funds every year until the overage is corrected. If this slip-up endures for a few years, it has the potential to be costly. To fix this problem, you have until your tax filing deadline to withdraw the excess funds without facing the penalty. Just be sure to also withdraw the interest and any other income generated from those surplus funds.
Don’t Discount a Backdoor Roth IRA
For those earners whose incomes fall above the Roth IRA limits, you have the option of a backdoor Roth IRA. Using this strategy, after-tax contributions are made to a traditional IRA, then the invested money is converted to a Roth IRA. However, because funds deposited into a traditional IRA are pre-tax, expect to pay income tax on the conversion. This move even has the potential to bump you into a higher tax bracket, so it’s never a bad idea to consult a tax professional when you’re considering a backdoor Roth IRA.
Don’t Miss Out on a Spousal IRA
A spousal IRA is an exception to the condition that an individual must have earned income to contribute to an IRA. It permits a working spouse to contribute to an IRA in the name of a spouse who has no income or very little income. Provided the working spouse’s income equals or surpasses the total IRA contributions made on behalf of both spouses, this is a strategic approach to investing.
Depending on your income, your maximum contribution to a spousal IRA is $6,000 each, which increases to $7,000 per person at age 50. So if you’re 51 and your spouse is 49, you’re able to contribute $13,000. Once your spouse reaches age 50 you can begin contributing the maximum $14,000.
Don’t Do Rollovers Without Knowing the Rules
When you do a rollover — withdraw money from one retirement account and deposit it into another — you need to abide by certain rules in order to avoid tax consequences. For instance, if you withdraw funds from a retirement account like a 401(k), you have 60 days to deposit the full amount into your Roth IRA. Neglecting to do so will render the withdrawal a taxable distribution, and may also be subject to a 10% additional early-distribution tax. Also be aware that typically only one rollover per year is permitted.
You can also choose to do a direct rollover where all or a portion of your retirement funds are directly transferred from one qualified retirement plan to another. This move is not taxable, so you can move your money without facing tax penalties, and your money continues to grow tax-deferred until you make withdrawals. However, keep in mind that your contributions to a 401(k) or traditional IRA were pre-tax, so when you roll them into a Roth IRA, they’ll count as income in the year you made the rollover.
Don’t Forget About Beneficiaries
If you neglect to name a living beneficiary for your Roth IRA, the money typically will need to go through probate before your heirs gain access to it. Going to probate means that all your assets, including your Roth IRA, are lumped together, and all debt is paid before the funds are distributed to heirs. This, of course, means that your heirs may not end up with as much as you’d planned. Be sure your named beneficiaries are up to date.
Don’t Just Sit on Your Funds
You have to make contributions to your Roth IRA if you want to take advantage of the tax-free growth and compound interest. You also need to decide how you want to invest those funds. If investment strategy isn’t your strong suit, consider working with a financial professional.
After working for decades to save for retirement, you’re finally ready to retire. This calls for a pivotal shift in focus from growing your investment portfolio to planning how you’re going to live off those savings, possibly for decades to come. With the right strategies in place, you can help make sure your retirement savings last.
Establish Your Budget
First, you need to determine your known expenses in retirement (both needs and wants) so you can build your budget to meet those costs. Some examples include:
Mortgage payments
Travel goals
Debt repayment
Health insurance and costs
Any big purchases like a boat or a vacation home
Are you planning to minimize expenses in retirement? Are you able to tap into additional income sources in retirement through avenues such as passive income or a part-time job? Will your spending increase now that you’re not tied to a full-time job? These are just some examples of questions to ask yourself to be sure your assets can reach your goals. It’s important to answer them as honestly as possible. And if you start out with conservative estimates — meaning you plan for greater spending than what transpires — you’ll end up with more flexibility down the road. Of course, don’t forget to factor in extra expenses for unforeseen costs that tend to crop up
Is the 4-Percent Rule Right for You?
First, you need to figure out how many years of retirement you need to plan for. If you’re retiring at age 55, plan for at least 40 years of retirement. If you’re retiring earlier than age 55, plan to live until at least age 95 so you don’t run the risk of outliving your assets. If you’re retiring later than age 55, you won’t need to plan for quite as many decades.
Now that you know approximately how many years of retirement to plan for, you need to think about how much you should withdraw. The “4 percent rule” is typically a recommended starting point. Using this method, you would withdraw no more than 4 percent of your retirement savings. This leaves enough funds in the account to give your investments a chance to grow in future years. Growth is important to help withstand the impact of inflation on your assets.
While a 4 percent withdrawal rate will ensure that your money lasts a good while, a more current trend is to withdrawal just 3% from retirement accounts. This is due to the low returns on fixed income investments. Additionally, a more conservative withdrawal rate will give you more elbow room with your budget in the future.
Playing the conservative game is never a bad idea, and could even strengthen your financial position over time. For example, you can allow your accounts to grow by withdrawing just 3 or 4 percent if you consistently average 5 or 6 percent returns.
Balance Income and Growth
Your portfolio needs to line up with your goals, time horizon, and risk tolerance. This typically means selecting a combination of stocks, bonds, and cash investments that will work collectively to produce a steady flow of retirement income and prospective growth — while also helping to safeguard your money. For example, think about:
Building a bond ladder: This is a fixed income strategy where investors disperse their assets across multiple bonds with varying maturity dates. This method provides for short-term liquidity to help manage cash flow and also hedge against fluctuations in interest rates.
Adding dividend-paying stocks to your portfolio: Essentially, each share of owned stock entitles investors to a set dividend payment, which is paid in regular scheduled payments, either in cash or in the form of additional company stock. In this way, they are almost like passive income. They are tax-advantaged and provide protection against inflation, especially when they can grow over time.
Continuing to Hold Enough in Stocks: To keep up with inflation and grow your assets, you still need to stay in the stock game. While stocks are volatile, insufficiency runs an even greater risk of depleting your nest egg too soon. Your stock allocation should align with your investment objectives and time horizon first, then modified for risk tolerance.
Withdrawal Sequencing Matters
The longer your tax-advantaged retirement accounts have to compound, the better off you’ll be in the long run. Therefore, it’s typically recommended to withdraw from taxable accounts first, followed by tax-deferred accounts, and finally tax-exempt accounts like Roth IRAs and 401(k)s. Of course, like anything with taxes, withdrawal sequencing has a number of caveats and exceptions to consider when it comes to your personal circumstances, but this is a reliable starting point.
Manage Your Money
You can help to preserve the long-term growth of your portfolio by managing your day-to-day finances. This means funding an emergency fund — ideally with at least a year’s worth of expenses. Additionally, you can adhere to the three-bucket school of thought:
Immediate Bucket: This is where you stash quick-access funds for safekeeping. A high-yield savings account or a money market account fits the bill because the focus of this bucket is not to earn a high interest rate or return.
Intermediate Bucket: You want the funds in this bucket to grow enough to carry you a little more into the future. You still want to avoid high risk or volatility, so opt for a low-to-moderate risk category that offers a reasonable return on your money — think bonds or CDs. Real estate investment could also fall into this bucket.
Long-term Bucket: This bucket is for growing investments and outpacing inflation. If you’ve set up your immediate and intermediate buckets properly, you won’t need to touch your long-term bucket for at least a decade. Because the goal of these funds is to outlast you, you need to invest into this bucket more aggressively. Stocks, real estate investment trusts, annuities, etc. provide the most growth potential, so this is the bucket for those investments. It’s important to work closely with the guidance of a financial advisor on this strategy.
Individual Retirement Accounts (IRAs) allow for a tax-advantaged way to invest your money long-term. Whether you choose to invest in a traditional IRA or a Roth IRA (or a combination of the two), you’ll defer paying income tax on the money you set aside for retirement. Follow these IRA investment strategies to boost your retirement savings and maximize the value of you IRA.
Max it Out
The maximum amount you can contribute to an IRA for 2022 is $6,000, and it is generally worth making the maximum contribution. Note that there are income limits. You can make a full contribution if your income is less than $144,000 ($214,000 if you are married filing jointly). For 2022, retirement savers age 49 and younger can max out an IRA by saving $500 per month or making a deposit any time before the 2022 IRA contribution deadline of April 15, 2023.
Make Catch-Up Contributions
As of the calendar year you turn age 50, you are eligible to contribute an extra $1,000 to your IRAs for that year, and all following years. If you weren’t able to save as much as you would’ve liked earlier in your career, catch-up contributions offer an opportunity to boost your yearly savings until retirement.
Don’t Wait Until the Contribution Deadline
It’s true that you can make a contribution to an IRA up until the mid-April tax filing deadline and apply it to the previous tax year. By shifting some funds into an IRA, you may be able to reduce your tax bill or boost your refund. However, that may not be the most beneficial move depending on your circumstances. When you wait to contribute, you miss out on potential growth. There is also the chance that you will be making an investment at a high point in the market. Contributing to an IRA at the beginning of the tax year enables the funds to compound for a longer stretch of time. You can also consider making small monthly contributions as a budget-friendly approach that will still yield favorable results.
Low- and Moderate-Income Workers Can Claim the Savers Credit
If your adjusted gross income (AGI) is below $34,000 as an individual or $68,000 as a couple in 2022, you may be eligible to claim the saver’s tax credit as well as the tax deduction for your IRA contribution. This credit is worth between 10% and 50% of the amount you contribute to an IRA up to $2,000 for individuals and $4,000 for couples.
Use Your Tax Refund to Contribute to Your IRA
You can use IRS Form 8888 to deposit all or part of your tax refund directly into an IRA. Provided the deposit is made by the due date of your tax return, you can file a tax return claiming a traditional IRA contribution before the money has actually been deposited in the account. In other words, if you file earlier rather than later, it’s possible to use your tax refund to make an IRA contribution you already claimed on your tax return.
Consider Converting to a Roth IRA
For some taxpayers, it may be beneficial to convert an existing traditional IRA to a Roth IRA. Expect to pay income taxes on the conversion amount, which could be substantial, so be sure to do the math before you make the leap. The funds that are moved into the Roth grow tax-free and will be tax-free upon withdrawal in the future, provided the account is at least five years old. The decision to convert to a Roth IRA basically boils down to whether you want to take the tax hit now or later. The farther away you are from retirement, the more advantageous a Roth IRA could be, because the Roth’s earnings will have more years to compound.
If you are a freelancer, an independent contractor, or a self-employed individual, you know the perks of working for yourself, but you likely also notice one major drawback: the lack of an employer-sponsored retirement plan like a 401(k). Enter the Solo 401(k) plan. Below we’ll discuss how this plan provides the highest savings potential for solo business owners.
What is a Solo 401(k) Plan?
A solo 401(k) is a tax-advantaged retirement account for self-employed business owners as well as spouses who work for them at least part-time. Individuals who hold a full-time job with access to workplace retirement plans are also permitted to save for retirement in a solo 401(k) with funds earned from a side hustle. A solo 401(k) is also referred to as an individual 401(k), one-participant 401(k) plan, or a self-employed 401(k).
Eligibility Rules and Contribution Limits
There are no age or income restrictions with a 401(k), but you must be a business owner with no employees (apart from a spouse). You may be able to contribute up to $61,000 in 2022 (up from $58,000 in 2021). If you are 50 or older, you can make an additional $6,500 in catch-up contributions.
Solo 401(k) Tax Advantages
With a solo 401(k) you can pick your tax advantage: a traditional 401(k) or a Roth solo 401(K).
Traditional solo 401(k): Contributions reduce your income in the year they are made, which reduces taxable income. However, distributions in retirement will be taxed as ordinary income. You may owe a 10% penalty in addition to ordinary income taxes on withdrawals you make from a traditional solo 401(k) before age 59 ½.
Roth solo 401(k): Offers no initial tax break but allows for tax-free distributions in retirement. You may be subject to penalties on withdrawals before age 59 ½.
Generally, if you expect your income to increase in retirement, a Roth solo 401(k) is the better option. If you expect your income to decrease in retirement, go for for the tax break now with a traditional 401(k).
How to Open a Solo 401(k)
If you decide to set up a solo 401(k), you can do so through a financial institution that administers 401(k) plans. Set-up typically follows these steps:
If you don’t already have one, you need to get an Employer Identification Number (EIN) from the IRS.
Choose a provider. When reviewing potential plan administrators, look into any applicable fees. You many also want to look for a plan that offers a mix of investment options, including mutual funds, stocks, bonds, ETFs, and CDs.
Fill out an application and any required documents. The IRS requires an annual report on Form 5500-SF if your 401(k) plan has $250,000 or more in assets at the end of a given year.
Once you are ready to fund the account, you can roll over money from another retirement account or set up a transfer from a checking or savings accounts.
Finally, choose your investments and establish contribution levels. Keep in mind that there is no minimum contribution requirement, so you can increase contributions in good years and save less in years when you need more cash reserves for your business.
With high contribution levels, flexible investment options, and fairly easy administration, the solo 401(k) could be a good fit for a one-person business operation, freelancer, or independent contractor, especially if you want the option to save aggressively for the future.
