Dear Penny Answers: 6 Tricky Questions About Money and Retirement
For most of us, retiring someday is the ultimate financial goal.
But getting there involves so much guesswork: Will you need a tax break decades from now more than you need it today? How much will you really need for your retirement budget? Plus, how do you navigate the scores of complicated IRS rules for saving and spending your funds?
Here I answer six of your toughest questions about money and your golden years. If you have a tricky question about retirement, email me at [email protected].
Q: I’ve read that we should save 15% pre-tax in a retirement plan, but how much should we save post-tax in an IRA or savings account?
A: I think if you can save 15% in any retirement account, pre-tax or post-tax, you’re doing just great! There’s no single savings percentage that works for everyone, but here’s how I’d prioritize.
I’d focus first on contributing whatever you need to get your employer’s full retirement match. If you have a traditional 401(k) plan, you do this pre-tax. So say your employer matches 50% up to 6%, you’d contribute 12%, but if it matches dollar-for-dollar up to 6%, you’d pause at 6%. (Note that some employers offer a Roth 401(k), which lets you contribute post-tax, but let’s assume we’re starting with a traditional pre-tax 401(k) contribution.)
From there, I’d focus on building a three-month emergency fund.
Once you’ve done that, try to max out your Roth IRA contribution, which you’ll make after taxes. The 2020 Roth IRA limits on contributions are $6,000 in 2020 or $7,000 if you’re over 50. An added bonus: The Roth IRA withdrawal rules are a lot more flexible than the 401(k) withdrawal rules. You can withdraw your contributions anytime without paying taxes or a penalty, whereas early 401(k) withdrawals result in income taxes and a 10% penalty.
If you have extra money to put toward savings after you’ve maxed out your IRA, it’s up to you: You can build a bigger savings account or split the difference between the two.
Q: Do you have any suggestions for those already retired on how to make your retirement and emergency funds last longer in a time of rising prices and a volatile market?
A: I’d recommend that you meet with a fee-based financial advisor now — as in, when the stock market is good — to make sure you have your investments allocated appropriately for your age.
Usually once you’re retired, you want to have less money invested in stocks than you did during your working years and more invested in bonds and other safe assets, like CDs. But a lot of people don’t think to rebalance until after a stock market crash. Reviewing your options when you can get top dollar for your investments is obviously the better strategy.
Of course, getting your expenses as low as possible is key to making retirement savings last, which I know is a lot easier said than done. If you can work part time even for a few hours a week, it can make a difference. Any money that you don’t have to withdraw from your savings is helpful.
Also, while buying an annuity certainly isn’t something I’d recommend to everyone, in some situations, it makes sense. They have huge fees and commissions, and they’re confusing even to financial pros, but they’re basically an insurance policy in case you’re worried about outliving your money.
It won’t make sense if you have a lot of medical problems, but if you’re in great health and people in your family often live into their late 90s, it may be worth considering.
Q: My employer is no longer contributing to my 403(b). I already have a Roth IRA, but I’ll reach the $6,000 limit soon. Do you recommend that I stop contributing to the 403(b) and move those funds to an IRA instead? I would incur fewer fees and have more freedom with my investments.
A: The only way you can roll over your 403(b) into an IRA is to either leave your job or to reach age 59 1/2, at which point you can take what’s called an in-service distribution.
Even if you cashed out — something I’d never recommend doing unless the circumstances are truly dire — you wouldn’t be able to put your money in an IRA since you’ll soon reach the $6,000 limit for people under 50. The $6,000 limit is the total amount you’re allowed to contribute to IRAs for the year, even if you have both a Roth and a traditional IRA.
I think you should keep making your 403(b) contributions as usual, even though it’s frustrating that you’re not getting your employer match. Hopefully this is just a temporary setback.
Q: I contributed the maximum of $7,000 for 2020 to my Roth IRA in January. Now it looks like I won’t have enough earned income to contribute that amount. What should I do? Is there a penalty?
A: This is pretty easy to fix. The 2020 Roth IRA limits are $6,000 or $7,000 if you’re over 50, but you can’t contribute more than you earned. You’ll need to withdraw the excess amount plus their earnings, and you’ll want to do so before you file your taxes for 2020 next year to avoid a 6% penalty on the excess contribution.
Contact your brokerage and tell them you overfunded your account. It’s a pretty common problem, so they’ll be able to give you specific instructions. You’ll owe income taxes on the earnings (but not the amount you contributed). If you’re under 59 ½, you may owe a 10% early withdrawal penalty on the earnings, but again, not on your contribution.
Q: I’m 39 with little savings and make less than $35,000 annually. What type of IRA is best for me?
A: A Roth IRA is probably your best bet. You won’t be able to deduct your contribution when you do your taxes, but all the money you put in there AND all the money you earn will be all yours tax-free when you retire.
But beyond the tax stuff, one big advantage of the Roth is that your contributions (but not the earnings) are yours to withdraw at any time. Of course you don’t want to do this unless it’s absolutely necessary. But in an emergency, your Roth IRA contributions are an option you can turn to, whereas for a traditional IRA, you’d pay income tax on any amount you withdraw, plus a 10% penalty if you’re younger than 59 1/2.
As far as choosing an account, look for low fees (aim for 0.25% annually or less) and no minimum deposit. Happy saving!
Q: Does your IRA contribution affect how much you can contribute to an employer-sponsored account?
A: The $6,000 contribution limit (or $7,000 if you’re 50+) is the total limit for all IRAs that you have. But your IRA contributions don’t affect how much you can save in an employer-sponsored account, like a 401(k).
So if you have both a Roth IRA and a traditional IRA, you can only contribute $6,000 or $7,000 total between the accounts. But if you have a 401(k), you can still contribute up to $19,500 in 2020 (or $25,000 if you’re over 50).
Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. Send your tricky money questions to [email protected].