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Why contribute to a supplemental retirement account?


First of all, your life expectancy is longer, potentially into your 90s, which means you may need to save more than what your 401(k) retirement savings plan allows. Secondly, the cost for everything in retirement is going up, especially healthcare. Save more for retirement by opening supplemental retirement account to your 401(k) to minimize risks of a retirement fund shortfall. This may be more financially feasible for families in their fifties who are finished with college expenses. Always "max out" your company 401(k) contributions before considering a supplemental individual retirement account.

First of all, your life expectancy is longer, potentially into your nineties, which means you may need to save more than what your 401(k) retirement savings plan allows. Secondly, think about how much everything will cost. We do not know what prices will be like in the future, but I bet they will be dramatically higher. The average inflation rate in the U.S. over the past century (1913-2013) was 3.22%. Plan for higher prices in the decades ahead. Healthcare costs are accelerating at double that rate. Expect healthcare costs in retirement to cost you more than you think. Health-care costs, the average couple will need $295,000 in today’s dollars for out-of-pocket medical expenses in retirement, excluding long-term care, according to Fidelity.

Lastly, if you are a conservative investor who likes the safety of bonds you will need to save even more because bonds are producing negative real returns. Bond yields are low and after inflation the real yield is negative! Cash-equivalents have lost value after inflation over the last twelve months. If your account is not growing over time, you will need to make up the retirement shortfall by adding more money to your retirement funds.

How much do you need to save for retirement?

That depends on your retirement goal and current standard of living. One simple way of estimating and monitoring your retirement savings goal is with an age-based savings factors. These are savings amounts expressed as multiples of your current income. For example, aim to save 1X your current income by 30, 3x by 40, 6x by 50, 8x by 60, and 10x by 67. Retirement experts agree that you will need 60%-80% of your pre-retirement income. Plan on the higher end of the range if your post retirement income was middle to upper income tax bracket.

What are your individual retirement account options?

1. Traditional Individual Retirement Account (Traditional IRA)

The IRA is a tax-advantaged investment account for individuals to use for retirement savings. Your contributions grow tax free and may be tax deductible if you qualify. Your money grows on a tax deferred basis. Tax deferred growth of assets grows faster than money that earns dividends and interest that is taxable each year all other things being equal. You will have to pay tax on the amount you take out of the account, but it is based on your current year’s tax rate. There is usually a 10% penalty for withdrawing funds before you turn 59 1/2 years old. See previous article for rules regarding maximum contributions and income limits for IRAs can change annually. As for how much you can contribute, currently you are allowed to invest $6,000 per year, though those 50 and older can save up to $7,000 a year using what is called catch-up contributions. Once you turn 72, though, you must start removing money from your IRA. The minimum required distribution will vary based on your account size and life expectancy. If you do not withdraw the required amount, you could get hit with a hefty tax penalty.

2. Roth IRA

Roth IRAs are different than traditional IRAs in two meaningful ways. The first is that contributions are made with after-tax dollars, which means you do not get a tax deduction when you invest. The upside is that when it comes time to withdraw you will not owe the IRS a thing. All your contributions can, therefore, grow tax-free over time. Like the IRA, you can only contribute $6,000 a year or $7,000 if you are over 50. There is an income limitation with a Roth IRA. In 2022, if you earn more than $129,000 or if you and a spouse earn more than a combined $204,000, your annual contribution room will be reduced. If you earn more $144,000 individually or $214,000 as a couple, you cannot contribute to a Roth IRA account.
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