By Kristi De Rycke, Registered Assistant
Imagine this real life scenario: You and your spouse both work for companies that have a good 401K plan. You are both avid savers. You have gradually increased your contributions over the years and have a very healthy nest egg. Maybe you decide at 52 that you have saved enough money to retire early. You understand that Medicare and social security won’t kick in for a number of years but with the wealth that you have accumulated in your 401K your expenses will be covered. Often people with 401Ks at a company may not meet with a financial advisor until it is time to retire. Investing in the 401K to accumulate is fairly easy. Maybe you set up a meeting with an advisor now that it is time to withdraw money and need assistance with retirement planning. You walk into the office with confidence explaining that you are both ready to retire in 3 months. You are going to explore other activities or travel while you are young. Now the person across the table says that is great you do have a lot in your 401K but how will you cover medical insurance before Medicare kicks in. Well you explain to him or her that there is ample in the 401K to cover medical and other expenses until Medicare. Ummmm…now the advisor has to explain that you can’t tap your 401K until 59 ½ (or 55 if you leave your employment the year you turn 55). Do you have money in non- retirement accounts that can cover those costs until you can tap the 401K? ….And the reality sinks in that you don’t.
This real life situation really bothers me. When people do all of the right things and save enough only to lose the option to retire early as all of their money is tied up in tax deferred retirement accounts.
We are often reminded how big of a benefit it is to have a 401K and how the amount the company matches is part of our compensation package. So it is very easy to put all of our eggs into that basket. We hear over and over “It is best to let the money grow tax deferred”. You may also have a Roth or Traditional IRA but again the rules on those accounts are also 59 ½ unless for specified reasons for a Roth like education expenses or first time owner.
Putting some of your money into a taxable individual account would open up more options for you. You could access that money at any time when you need it without penalty. There are no strings on when you can take that money out. This has been a big lesson to me over the past couple of years as I have seen real life situations where this has happened. It might be best to meet with an advisor several years from retirement to make certain that you have things lined up the way you want and that your outlook for an early or regular retirement is good.
By Greg Johnson
It is an absolute must to identify all of your financial goals and assemble a strategy to reach them. This is a perfect example of folks who think they are doing the right thing, but are just not fully educated on what limitations or restrictions might hinder their progress. It is easy to save money into your 401k, but when it comes to taxation, liquidity, and choice the 401k may not provide you all the options you are looking for. We tell our clients to take advantage of the match provided by their employers as free money is the best type of money in the world, but then sit down and really examine your goals before putting another penny into plans like these.
Another major factor Kristi does not touch on much is knowing what your tax bracket will be when you do retire. The reality is there is no way for you to know that information, so saving all of your money into a tax-deferred account may not be to your advantage anyways. We are in the lowest tax environment we have been in for decades so paying some income tax today to give yourself liquidity in the future may make sense.