With just a few weeks left in the year, now is a good time to review your 401(k) or other defined contribution deposits. A 401(k), 403(b) or 457 plan all have employee contribution limits of $18,500 for 2018, with the added benefit of a $6,000 “catch-up” contribution for those age 50 or older. However, since contributions must run through your payroll department, waiting until the last minute may leave your savings goals short….and bring the ire of your co-workers responsible for cutting your paycheck.
Additionally, now is a smart time to look ahead to 2019. The employee limits for defined contribution plans increase to $19,000. That extra $500 per year over thirty years can deliver another $50,000 at retirement. The catch-up limit remains $6,000. Targeting a goal of $25,000 in savings next year is no easy goal. As such, it is better to pace yourself through the year.
With the Tax Cuts & Jobs Act implemented late last year, many workers are finding themselves in a lower tax bracket. Given this, the immediate reduction in taxes provided by a traditional plan may not be as valuable as it was previously. As such, now is a great time to review whether you should focus on “traditional” or “Roth” contributions.
The traditional contribution reduces current income taxes and grows savings in a tax-deferred manner. However, once you start withdrawing funds you are required to pay income taxes on everything not previously taxed.
Conversely, Roth contributions do not provide an up-front tax deduction, but the savings grow in a tax-exempt manner. Roth withdrawals are fully income tax-free upon reaching age 65.
You can also split the difference and contribute some that is “pre-tax” and some that is “after-tax.”
Contributing to both a Roth and a traditional plan diversifies the income tax consequences associated with your savings when you need them at retirement. Many successful investors are finding that Age 70 ½ Required Minimum Distributions are adding significant income taxes as well as increased Medicare co-pays. It is important to note that in addition to Roth contributions being tax-exempt upon withdrawal, they are not subject to Required Minimum Distributions. This allows earnings to grow longer if they are not needed for living expenses.
If you don’t have a defined contribution plan available to you at work, anyone with earned income can contribute to an Individual Retirement Account. The limit for 2018 is $5,500 with a $1,000 catch-up provision for those age 50 or older.
Although you have until April 15th of next year to make an IRA contribution for this year, you don’t have to wait. In fact, the earlier you get the contribution in the sooner it can start earning. Over forty years, a contribution made on January 1st, as opposed to the end of the year, can result in an extra $100,000 at retirement.
IRA contribution limits increase to $6,000 in 2019 with the same catch-up provision. When evaluating an IRA, a couple points are worth considering.
First, if you have a non-employed spouse, you can still make a traditional or Roth IRA contribution on their behalf if you have enough in earned income.
Secondly, anyone, regardless of income level can contribute to a traditional IRA. However, if you are a joint tax-filer making more than $121,000 the contribution does not qualify for a reduction in taxes. That said, it is still worth considering an after-tax contribution to an IRA as it still grows tax-deferred.
Third, as with a defined contribution Roth plan, it is worth evaluating a Roth IRA as it changes the earnings and withdrawals from tax-deferred to tax-exempt. This may spread out and lessen the impact of taxes depending upon the types of accounts used to fund a healthy retirement.
A direct contribution to a Roth IRA is limited to earners with joint taxable income of less than $199,000. However, even if above this threshold, consider making a non-deductible contribution to a traditional IRA and then later convert it to a Roth IRA. Although there are limits on direct contributions to Roth IRA’s, there are no limits on conversions from a traditional IRA to a Roth.
Lastly, all retirement plans have beneficiary designations. This designation supersedes the language in your will. It is always a good idea to review your beneficiaries at least once a year.