One of the easiest ways to become an investor is by participating in your employer’s workplace retirement plan, if there is one. For most people, there may not be a better opportunity to pursue financial wellness than this.
Automatic Savings. With a plan such as a 401(k), you pay yourself first — a core financial principal. Money is deposited from your pay to your account without you even having to think about it. It doesn’t get much easier than that.
Tax Savings. The amount you contribute to your retirement account reduces your taxable income, which lowers your tax bill. Let’s take an example of a worker earning $50,000, who is in the 22% tax bracket and saves $5,000 in their retirement account each year (10% of salary). They are reducing their tax bill by $1,100 each year ($5,000 x .22). Income tax won’t be due on this money until it is withdrawn from the account.
Tax-deferred Compounding. There’s that word again: compounding. As your retirement account grows, you pay no taxes on any earnings until you begin to withdraw your money at retirement. Compared to taxable savings accounts, investments with earnings that are tax-deferred have the potential to grow even faster when they are not being reduced by taxes each year.
Free Money from the Employer Match. If you can’t max out your workplace retirement plan, you should try to save enough to get the full employer match (subject to your plan’s vesting rules). A common employer match of 50 cents for each dollar you save in the plan up to 6% of pay is a 50% return on your investment. A dollar-for-dollar 401(k) match doubles your money. That’s a pretty excellent return!
Your Money Goes Where You Go. If you leave your employer for any reason, you can take your vested balance and roll it into an IRA or a new employer’s plan (if allowed). Other options include leaving your money in the 401(k) if allowed, or taking a cash distribution, which is a taxable event and may be subject to penalties if you are younger than 59½.
Account Management Made Easy. Your plan’s recordkeeper provides you with comprehensive account access where you can view your balance, perform transactions and talk to a call center representative for guidance. On top of that, you can view retirement planning education materials and calculators, and likely even model various saving scenarios and assumptions to help gauge your progress toward retirement readiness. TRADITIONAL OR ROTH SAVINGS OPTION?
Your retirement accounts have unique tax implications. A traditional 401(k) uses pre-tax dollars, lowering your tax burden while you work. However, you’ll pay income taxes when you withdraw money from your account during retirement. On the other hand, a Roth 401(k) contribution comes from money you have earned that has already been taxed. You’ll pay zero taxes on qualified withdrawals from this account when you’re retired.
In general, a Roth option may be a more favorable savings strategy for younger adults. At this stage in your career, you’re likely earning less today than you will in the future (there is an income cap for Roth accounts above which you can’t contribute). That means you’re in a lower tax bracket and paying lower taxes now. Of course, no one knows what the tax brackets will be in the future, so you could decide to diversify your contributions evenly between traditional and Roth (many employers offer this option to their employees). Depending on your circumstances, you can always decide to go heavier toward one option versus the other in the future.
ABOUT TARGET DATE FUNDS
Your workplace retirement plan offers a number of appropriate investment options to choose from. That usually includes individual mutual funds representing all the major asset classes, as well as pre-mixed portfolios that you can match up with your own personal tolerance for risk and timeline to retirement. Another option likely available to you is a target date fund. A target date fund is a mutual fund that invests with the assumption that investors will need to start withdrawing money from the fund at a specified time in the future. A professional fund manager monitors the fund and makes adjustments to the underlying investments as needed for the time frame.
The primary feature of a target date fund is that the fund adjusts its risk level over time. When the target date is still far away (2055, for example), target date funds invest more of their total assets in higher-risk investments like stocks, with little or no exposure to more conservative investments. As the target date approaches, the fund gradually shifts its asset allocation away from stocks and other risky assets in favor of bonds and other conservative, income-producing investments.
Each target date fund has a unique glide path, which describes how the asset mix in the fund changes over time. Some have what are called “to” glide paths, which means the fund will reach its most conservative asset mix right when it arrives at (or gets “to”) the target date. At that time these funds will typically be invested primarily in investments like bonds and money market funds. There are also target date funds that follow a “through” glide path approach, which means they will continue to pursue some level of exposure to stocks and riskier investments beyond (or “through”) the target date. Target date funds that have a “to” glide path approach are generally more conservative than those with a “through” glide path.IRAS: A RETIREMENT PLAN OPTION IF YOU’RE SELF-EMPLOYED
An individual retirement account (IRA), traditional or Roth, is a tax-deferred retirement savings account typically established by someone who is self-employed and doesn’t have access to a workplace retirement plan like a 401(k). IRA accounts are held by custodians, such as banks or brokerages. Unlike 401(k)s, IRAs allow account holders to choose from a much larger universe of choices that include stocks, mutual funds, ETF funds, bonds, treasury bills and certificates of deposit (CDs).
Like 401(k)s, contributions to traditional IRAs are generally tax deductible. Any earning and returns are tax-deferred and you pay tax on qualified withdrawals in retirement.
Contributions to a Roth IRA are made with after-tax dollars, and qualified withdrawals are tax-free in retirement. The annual contribution limit for traditional and Roth IRAs changes every year.
TACTICAL TIP
Your LPL financial professional can help you determine your retirement saving goals and how you can confidently pursue them. That includes helping you decide between a Roth and traditional contribution, creating and monitoring your investment strategy and balancing your retirement savings goal with other financial goals.
Important Disclosures:
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Investing in mutual funds involves risk, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective.
This material was prepared by LPL Financial, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. LPL Financial does not offer tax or legal advice.
This material was prepared by LPL Financial, LLC.
Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a
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