Retirement strategies for the “established” worker

Stick figure holding a piece of a puzzle

We recently came across an interesting study that highlighted the record high that 401(k) account balances have hit. In addition, participants in employer-sponsored plans are increasingly optimistic: 3/4 of respondents reported feeling confident about financing their golden years. While there are many factors that go into this specific study – such as expected market direction, demographic of those polled, etc. – the study invites further discussion about general retirement savings efforts. If American workers are feeling confident about their savings, what other strategies might they consider to bolster retirement funding?

To determine which specific strategies might work best for an individual requires a thorough understanding of that person’s situation. We can, however, take a look at some common scenarios and identify opportunities that individuals might wish to take advantage of in their effort to enjoy a successful retirement.

Demographic #1:  The younger professional (currently, the “millennial”) who is early in his/her career, lower tax bracket

 If you are fortunate enough to have a traditional 401(k) plan in which your employer matches some or all of your contribution, you will definitely want to make contributions to this plan your first order of concern. In essence, the match itself is an immediate return on your money. If however, you have met your annual contribution limit, or don’t have that company match, you may want to take a close look at a Roth 401(k) – if it is available – or a Roth IRA contribution.

A Roth 401(k) allows young employees to take advantage of their currently lower tax brackets. The assets in a Roth can then grow tax-free and may be withdrawn tax-free after reaching retirement age. The goal of this approach is to leverage your currently low tax rate and accelerate your ability to benefit from tax-free compounded returns over time so that you are able to meet your income needs and control your tax exposure during retirement.

Another benefit of the Roth 401(k) and Roth IRA is that you can withdraw your contributions at any time. Since this would be done at the cost of your future retirement, we recommend considering this option only as a last resort when facing a dire emergency. In such cases, it will be important to work with your tax advisor to properly report the withdrawal.

 Demographic #2: Entering the stride of a career, can expect or has experienced significant compensation increase, 10+ years into career.

The next step in one’s career development is that new employment opportunities may arise that offer greater responsibility and potentially greater compensation. At this point, many millennial and Gen X employees are seeing their income increase with each job jump. When this happens, you may find that you now have a number of “old” 401(k) or IRA accounts.

If your compensation precludes you from making a Roth IRA contribution, there may yet be a way for you to build those highly coveted tax-free Roth assets. To do this, you will need to consider rolling all of your “old” accounts into your current employer’s traditional 401(k). This may be advisable IF . . .

  1. Your current plan must permits this,
  2. The asset being rolled over are only from previous retirement plans and you have made no subsequent IRA contributions.
  3. Your current employer-sponsored plan offers an attractive menu of options. This is important – though not essential – since you are consolidating everything in one place.  If the current plan does not offer a reasonably robust menu of investment choices, you may wish to forgo consolidation and the opportunity to build Roth assets.  In such cases, you may be better served by the wide array of options available to you in a Rollover IRA.

Assuming all three criteria have been satisfied, you may now be able to make a “back-door” Roth IRA contribution. This strategy is particularly attractive for employees who need the tax deduction of a 401(k) contribution, are making too much to directly contribute to the Roth IRA, and yet want to build  tax-free assets for retirement. Essentially, the employee will make a contribution up to $5,500 (or $6,500 if over 50 years of age) to a traditional IRA, and then convert those assets to a Roth IRA.  For this to work efficiently, there must not be any other IRA assets. (Hence, the need to consolidate them in your employer-sponsored plan.)

Demographic #3: Mature (Baby Boom) employee, 5-10 years outside of anticipated retirement

Those who have been building significant assets in their traditional 401(k) and/or IRA may find that they face a different challenge when they retire: potentially high tax rates. That is because withdrawals from these accounts will be subject to ordinary income tax rates. As a result, each withdrawal will come with a tax bill. For this reason, many retirees prefer to limit withdrawals to the minimal amount needed.

If you want to be able to have more control over your tax exposure or spend more freely, it will be important to build up accounts (such as a Roth 401(k)) that will not incur a significant tax consequence every time a withdrawal is made. Since this may entail redirecting how you make your retirement contributions – such as investing part of your contribution in the traditional 401(k) and part in a Roth 401(k) – it is vital to discuss options and consequences with your tax advisor. Fort Pitt does not provide tax advice but we encourage you to work with your tax advisor to evaluate.

All Demographics:

Your retirement is the largest expense you will ever have. No matter what strategy you use, be sure to maximize savings and make retirement contributions a large component of your monthly “budget.” You are building a portfolio that you will eventually need to take care of you. Pay your future self first and when it comes time to leave the workforce, you will feel confident about your nest egg.

Nathan Boxx, Bradley Newman, Jason Seltzer

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