By FPA member Jon Beyrer, CFP®, EA
Last Updated: May 31, 2012
If you are nearing retirement age and your retirement nest egg isn’t where it needs to be to provide for a comfortable retirement, then you may have some catching up to do. Luckily, there are ways to do this, and you can even get some help from the Internal Revenue Service (IRS).
Start with a Plan
Your retirement is a far too important goal to just leave to chance and hope for the best. Like a general facing a military campaign, you need a “plan of attack” to determine what your objectives are, what resources are available, and how to overcome the challenges you will face.
The key to a successful retirement savings plan is to determine how much you'll need and then develop a plan to achieve your goal. There are a number of things your plan must consider.
Here are a few:
- Your Desired Lifestyle in Retirement: How much annual income will you need in retirement? Determining this starts with analyzing your spending now, envisioning what your lifestyle will be in retirement, and how it may be different than now.
- Longevity: There is a possibility that you (and your spouse, if you’re married) may live a long life. This requires you to withdraw less from retirement assets to ensure that enough will be available in case you live a long time. Put another way: more retirement savings are needed to provide a source of income for potentially many years.
- Health Care Costs: Health care costs for retirees are a major part of retiree’s spending, especially later in life, and this will increase as costs rise and Medicare benefits are likely reduced for future retirees.
- Inflation: The dollars you have saved now will buy less in the future as inflation erodes their purchasing power.
Developing your plan is best done with help from a professional such as a financial planner.
Commit to Savings Goals
With your plan in place, you should have clear targets for how much you need to save each year to meet your retirement goal. You should also have a clear spending plan that allows for enough of your income to be set aside for savings. This may require you to sacrifice in some areas, such as driving a nicer/newer car, dining out a lot, or taking expensive vacations. This may be uncomfortable, but the pay off is a more comfortable retirement. The next step is to determine which type of accounts to add your savings to.
Retirement Accounts and Individual Retirement Accounts (IRAs)
A Qualified Retirement Plan account, such as a 401(k), is often the first place to add to retirement savings. Automatic payroll deferrals make it simple to pay yourself first. In many cases, your employer matches your contribution. If you are age 50 or older, you can make additional “catch-up” contributions.
The second is to supplement with IRAs. If you qualify, you can make tax-deductible contributions or Roth contributions. If your income is too high to qualify for tax-deductible or Roth contributions, you can contribute to an IRA on an after-tax basis. As with qualified plans, you can make additional “catch-up” contributions if you are age 50 or older. By making contributions to tax-advantaged accounts like Qualified Plans and IRAs, you can benefit from the tax-deferred compounded growth over time.
If your savings targets call for more than can be added to Qualified Plans and IRAs, you can add to non-qualified formats like brokerage accounts. While non-qualified accounts are not tax-deferred, they offer some important tax-advantages: the “basis" of the accounts are not taxed on distribution, and dividends and capital gains typically qualify for special tax rates.
You may also decide to add to deferred annuity contracts. Deferred annuities often allow guarantee riders to be added, which can help protect against the risk of losing principal due to market fluctuations. However, deferred annuities can have high expenses and be illiquid, so care should be taken in choosing these vehicles.
Cash Management and Emergency Funds
An important component of your retirement savings plan is to make sure you are properly managing your expenses so that you don’t have any surprise expenses that might derail your plan. This includes having enough reserves on hand for emergencies.
Fees and interest paid on debts like credit cards can keep you from meeting your goals. One way to look at debt interest is as a negative interest income — it works against your savings goals. Your retirement plan should include a plan to eliminate consumer debt and manage longer-term debt such as mortgages. Maintaining high debt balances in retirement increases your fixed expenses, which increases the spending you need to live on, and also reduces your flexibility in retirement.
Income taxes will be part of your expenses in retirement, so reducing income taxes will also reduce your spending needs. Since withdrawals from pre-tax accounts like 401(k)s and IRAs will be taxable, you can reduce taxes by controlling how much you withdraw from pre-tax accounts. One way to do this is to have enough of your retirement savings in non-qualified accounts to provide income, especially in the early years of retirement.
By having a plan and sticking to it, you can put yourself in a position to have a better, more secure retirement, even if you are currently behind on your saving.
FPA member Jon Beyrer, CFP®, EA, is Vice President, Wealth Management at Blankinship & Foster, LLC.