Saving for retirement is something that we all know we have to do. Yet few of us use the right tools to set aside the right amount of money each month to ultimately be able to retire when the time comes. Saving is hard to do for a lot of people–and even harder when you are living paycheck to paycheck. It is something that we have all seen a generation struggle with as the Baby Boomers stay in the workforce longer, often with plans of working until they are no longer able to. And Generation X has taken a page from the Boomers’ book, opting to spend instead of save. It’s often with the thought that there will be plenty of time to save later, not realizing that they are drastically cutting into their hopes of a comfortable retirement with every paycheck that is spent rather than saved.
Start Saving Now
The sooner you start saving for retirement the better. Employer-matched savings plans are a great way to jump-start your retirement plan. 401K plans are one of the most common employer-sponsored retirement plans. Speaking with a financial adviser can help you to figure out the best way to invest your savings to help build up a nice little nest-egg for further down the road. We recommend contributing the maximum allowed, which is $18,000 in 2016 (for earners under the age of 50 and $24,000 for earners over 50). Many people don’t realize this is an option, but it allows you to put away much more than you think. Another consideration is a ROTH plan for retirement savings. The beauty of the ROTH retirement plan is that it allows you to sock money away. It is not deductible at the time of contribution; but it is completely tax-free when withdrawn at retirement age. To get both the contribution deduction AND the tax-free withdrawal, consider a 50/50 split to a ROTH and 401K.
Common Mistake: Dipping into Retirement Savings
Emergencies arise. Stuff happens. Furnaces quit. Computers crash. Cars break down. Taxpayers are often tempted to dip into their 401K to pay for large ticket items, not aware of the huge penalty they can incur as a result. Even if they ARE aware of the penalties, they often think that money can just be dumped back into their retirement accounts later on when finances are more stable. The problem is, people in the 25% tax bracket end up paying AT LEAST 35% on the money they withdraw from savings to taxes. There is also a state tax incurred on the withdrawal. That’s a huge amount to have to pay penalties on, and not worth it in the long run–not to mention the huge jump in taxable income that must be handed over to the IRS. The withdrawal from retirement accounts often puts taxpayers into a higher tax bracket, making their tax responsibility even higher. If you must dip into your 401K, consider taking it as a loan. The loan isn’t considered taxable as long as it is payed back. And it must be payed back with interest, which means you are making money on yourself! One thing to consider when taking a loan against your 401K: if you lose your job before it is paid back, you have 30 days to do so, otherwise it is considered a withdrawal and there are taxable penalties.
How Early Withdrawal from Retirement Savings Impacts your Taxes
If you do end up deciding to dip into your retirement fund regardless of the penalties, keep in mind there is an additional tax obligation. Depending on how much you withdraw, you may need to file additional tax forms. Form 5329 on the IRS website may be required in addition to your regular taxes. Speak with your tax professional to find out how the early withdrawal will affect you, and if dipping into your retirement pool is a wise decision.
A penny saved is a penny earned. Unless, of course, you are simply putting your pennies into an old mattress instead of a high-interest savings account. Then a penny saved is a penny that loses value due to inflation. But that’s another topic for another day. Retirement is something that seems so far off to so many taxpayers. But it’s astonishing how quickly the time goes by, and if you’re not saving for your golden years already, you may find yourself in the same situation as so many of the Baby Boomers–working until you are physically unable to. With the insecure future of Social Security looming on the horizon, most of us know that is likely not going to be a viable option for us when the time comes to enjoy some quiet time in our later years. That is why saving for retirement is so critical to insuring a secure future.