401k contribution limits 2024

401k contribution limits 2024

401k contribution limits for 2024 are $23,000 per person, up from 22,500 in 2023. All 401k participants over the age of 50 can make a catch-up contribution of $7,500, for a total of $30,500

Retirement Calculator

What is 401k?

401k is a workplace retirement plan where employees and employers can make retirement contributions. These retirement plans can be one of the easiest and most effective ways to save for retirement. As an employee, you can automatically contribute your 401k directly through your company payroll. You can choose the percentage of your salary toward your retirement savings. Most 401k plans will provide you with multiple investment options in stocks and fixed income. Additionally, most companies offer a 401k match up to a certain percentage. In most cases, you must participate to receive your employer match.

There are three types of 401k contributions – traditional 401k tax-deferred, tax-exempt Roth 401k, and After-tax contributions.

You can select to make both types of tax-deferred and Roth contributions simultaneously. However,  the combined annual contribution amount cannot exceed your annual limit.

Tax-deferred 401k

Most employees commonly choose to make tax-deferred 401k contributions. These payments are tax-deductible. They will lower your tax bill for the current tax year. Your investments will grow on a tax-deferred basis. Therefore, you will only owe federal and state taxes when you start withdrawing your savings.

Roth 401k

Roth 401k contributions are pretax. You will pay all federal and state taxes before making your contributions. The advantage of Roth 401k is that your retirement savings will grow tax-free. If you keep your money until retirement, you will withdraw your gain tax-free. It’s a great alternative for young professionals and workers in a low tax bracket.

After-Tax 401k Contributions

Some 401k plans will allow you to make after-tax contributions. You can make these contributions if you have maximized your annual limit. Generally, after-tax contributions are made after you pay taxes on your income. Only your future gains will be taxable as ordinary income. Due to these tax complexities, after-tax contributions are more common as part of a Mega Backdoor Roth conversion.

Mega Backdoor Roth conversion

Mega back door conversion is a two-step process that allows you to make after-tax contributions to your 401k plan and immediately transfer the money to your Roth 401k account through in-service conversion.

What are my 401k contribution limits for 2024?

401k contribution limits change every year. IRS typically increases the maximum annual limit with the cost of living adjustment and inflation. These contribution limits apply to all employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Additionally, the limits apply to both tax-deferred and Roth contributions combined. 

  • Employees can contribute up to $23,000 to their 401(k) plan for 2024, a $500 increase from 2023.
  • Employees of age 50 or over are eligible for an additional catch-up contribution of $7,500 in 2024, the same amount as in 2023
  • The maximum 401k contribution limit for 2024, including employee contributions and employer match, is $69,000, up from 66,000 in 2023
  • If an employee makes the maximum allowed contribution, the company match cannot exceed  $46,,000, up from $43.500 in 2022
  • The total 401k contribution limit for 2023  from all sources, including catch-up contributions, is $76.500,000, up from 73,500 in 2022
  • The employee compensation limit for calculating 401k contributions is $345,000, up from $330,000 in 2022

Solo 401k contribution limits 2024

A solo 401k plan is a type of 401k plan with one participant. Those are usually solo entrepreneurs, consultants, freelancers, and other small business owners. Self-employed individuals can take advantage of solo 401k plans and save for retirement.

  • The maximum contribution limit in 2024 for a solo 401k plan is $69,000 or $76,500 with catch-up contributions. Solo entrepreneurs can make contributions both as an employee and an employer.
  • The employee contribution cannot exceed $23,000 in the solo 401(k) plan for 2024.
  • Self-employed 401k participants, age 50 or over, are eligible for an additional catch-up contribution of $7,500 in 2024.
  • The total self-employed compensation limit for calculating solo 401k contributions is $345,000.
  • Employer contribution cannot exceed 25% of the compensation
  • If you participate in more than one 401k plan simultaneously, you are subject to the same annual limits for all plans.

Please note that if you decide to hire other employees, you must include them in your 401k plan if they meet the plan eligibility requirements.

 

Roth IRA Contribution Limits 2024

Roth IRA Contribution Limits for 2024

The Roth IRA contribution limits for 2024 are $7,000 per person, with an additional $1,000 catch-up contribution for people who are 50 or older. There is a $500 increase from 2023.

Retirement Calculator

Roth IRA income limits for 2024

Roth IRA contribution limits for 2024 are based on your annual earnings. If you are single or a head of household and earn $146,000 or less, you can contribute up to $7,000 per year. If your aggregated gross income is between $146,000 and $161,000, you can still make a partial contribution with a lower value.

Married couples filing jointly can contribute up to $7,000 each if their combined income is less than $230,000. You can still make partial contributions if your aggregated gross income is between $230,000 and $240,000.

What is a Roth IRA?

A Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you retire, your withdrawals will be tax-free as well.

Roth vs. Traditional IRA

The Roth IRA and Traditional IRA have the same annual contribution limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax, depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints. These are some of the Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to plan your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those with 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in a Roth IRA if they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends, either.

There are no penalties if you withdraw your original investment

While not always recommended, a Roth IRA allows you to start your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say you invested $10,000 several years ago. And now the account has grown to $20,000. You can withdraw your initial contribution of $10,000 without penalties.

Diversify your future tax exposure.

A Roth IRA is ideal for investors in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, a Roth IRA adds a flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change when you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA has no minimum distribution requirements. Savers can withdraw their savings as they wish or keep them intact.

Legacy Planning

A Roth IRA is a great tool for general wealth transfer planning. If you decide to leave your Roth IRA to your heirs, they will not pay taxes on their distributions.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $6,000 in 2024, you could only contribute $6,000 to your Roth.

Last minute 401k moves to make in 2023

Last minute 401k moves to make in 2023

Last minute 401k moves to make in 2023 to boost your retirement savings. Do you have a 401k? These six 401k moves will help you grow your retirement savings and ensure that you take full advantage of your 401k benefits.

2023 has been a very choppy year for investors. Both stocks and bonds have experienced losses and large swings in both directions. As we approach the end of the year, you can take another look at your 401k, reassess your financial priorities, and reevaluate your retirement strategy. Let’s make sure your 401k works for you.

Retirement Calculator

What is a 401k plan?

A 401k is a workplace retirement plan allowing employees to build and grow their retirement savings. It is one of the most convenient and effective ways to save for retirement, as both employees and employers can make retirement contributions. You can set up automatic deductions to your 401k account directly through your company payroll as an employee. You can choose the exact percentage of your salary towards your retirement savings. In 2023, most 401k will provide multiple investment options in stock, fixed-income mutual funds, and ETFs. Furthermore, most employers offer a 401k match for up to a certain percentage. In most cases, you must participate in the plan to receive the match.

1. Maximize your 401k contributions in 2023

The smart way to boost your retirement savings is to maximize your 401k contributions each year.

Did you know that in 2023, you can contribute up to $22,500 to your 401k plan? If you are 50 or over, you are eligible for an additional catch-up contribution of $7,500 in 2023. Traditional 401k contributions are tax-deductible and will lower your overall tax bill in the current tax year.

Many employers offer a 401k match, which is free money for you. The only way to receive the match is to participate in the plan. If you cannot max out your dollar amount, try to deduct the highest possible percentage to capture the entire match from your employer. For example, if your company offers a 4% match on every dollar, at the very minimum, you should contribute 4% to get the entire match.

How to reach $1 million in your 401k by age 65?

Do you want to reach $1 million in your 401k by retirement? The secret recipe is to start early. For example, if you are 25 years old today, you only need to set aside $387 per month for 40 years, assuming a 7% annual return. If you are 35, the saving rate goes up to $820 monthly. If you start in your 50s, you must save about $3,000 a month to get to a million dollars.

401k Contributions by Age
Age | Monthly
Contribution
Yearly
Contribution
Lifetime
Contribution
25 $387 $4,644 $190,404
30 $560 $6,720 $241,920
35 $820 $9,840 $305,040
40 $1,220 $14,640 $380,640
45 $1,860 $22,320 $468,720
50 $3,000 $36,000 $576,000
55 $5,300 $63,600 $699,600

2. Review your investment options.

When did you last review the investment options inside your 401k plan? When was the last time you made any changes to your fund selection? With automatic contributions and investing, it is easy to get things on autopilot. But remember, this is d your retirement savings. Now is the best time to get a grip on your 401k investments.

Look at your fund performance over the last 1, 3, 5, and 10 years and make sure the fund returns are near or higher than their benchmark. Review the fund fees. Check if there have been new funds added to the lineup recently.

What is a Target Date Fund?

A target-date fund is an age-based retirement fund that automatically adjusts your stock and bond investment allocation as you approach retirement. Young investors have a higher allocation to equities, considered more risky assets. In comparison, investors approaching retirement receive a bigger share in safer investments such as bonds. By design, plan participants should choose one target-date fund, set it, and forget until they retire. The fund will automatically change the asset allocation as you near your retirement age.

However, in a recent study, Vanguard concluded that nearly 33% of 401k plan participants misuse their target-date funds.   A third of the people who own TDFs combine them with another fund.

Target date funds in your 401k in 2021

3. Change your asset allocation

Asset allocation tells you how your investments are spread between stocks, bonds, money markets, and other asset classes. Stocks typically are riskier but offer great earnings potential. Bonds are considered a safer investment but provide a limited annual return.

Your ideal asset allocation depends on your age, investment horizon, risk tolerance, and specific individual circumstances.

Typically, younger plan participants have a longer investment horizon and can withstand portfolio swings to achieve higher returns in the future. If you are one of these, investors can choose a higher allocation of stocks in your 401k.

However, if you are approaching retirement, you will have a much shorter investment horizon and probably a lower tolerance to investment losses. In this case, you should consider adding more bonds and cash to your asset allocation.

4. Consider contributing to Roth 401k in 2023

Are you worried that you will pay higher taxes in the future? The Roth 401k allows you to make pretax contributions and avoid taxes on your future earnings. All Roth contributions are made after paying all federal and state income taxes. The advantage is that all your prospective earnings will grow tax-free. If you keep your money until retirement or reach the age of 59 ½, you will withdraw your gains tax-free. If you are a young professional or believe your future tax rate will be higher, Roth 401k is an excellent alternative to your traditional tax-deferred 401k savings.

5. Do a Mega backdoor 401k conversion 

Mega Backdoor 401k is an acronym for after-tax Roth conversion within your 401k plan. Many high-income earners cannot make direct Roth contributions. At the same time, they may prefer traditional tax-deferred 401k contributions, which reduce their current taxes. Mega backdoor 401k allows you to get the best of both worlds. There is one caveat — your 401k plan must allow for after-tax contributions and in-plan conversions.

For 2023, the maximum 401k contributions of any kind (tax-deferred, Roth, after-tax, and employee match) is $66,000, up from $61,000 for 2022. If you’re 50 or older, the limit is $73,500, up from $67,500 in 2022. If you maximize your 401k allowance and receive an employee match, you can choose to make after-tax contributions up to the annual limit. Without any conversion, you will pay taxes on all your gains. The second step in the strategy requires an in-plan Roth conversion, which will move your after-tax money into Roth tax-exempt savings.

6. Rollover an old 401k plan

Do you have an old 401k plan stuck with your former employer? How often do you have a chance to review your balance? Unfortunately, many old 401k plans have been forgotten and ignored for years. Transferring an old 401k to a Rollover IRA can be a wise move.

The rollover is your chance to control your retirement savings. Furthermore, you will expand your investment options from the limited number of mutual funds to the entire universe of stocks, ETFs, and fund managers. Most importantly, you can manage your account according to your retirement goals.

Smart Strategies for Reducing Taxes on Required Minimum Distributions

Reduce taxes on Required Minimum Distributions

What is RMD?

Required Minimum Distributions (RMDs) are mandatory withdrawals that individuals with tax-advantaged retirement accounts like Traditional IRAs, SEP IRAs, and 401k must take after reaching a certain age. These accounts come with certain tax advantages. Typical contributions are tax-deductible. And all earnings grow tax-free.

The purpose of RMDs is to ensure that individuals eventually withdraw their retirement savings in these accounts and pay the appropriate taxes on those withdrawals.

Key points about Required Minimum Distributions:

Age Requirement: You are generally required to start taking RMDs from your retirement accounts by April 1 of the year following the year you turn 73. However, if you turned 70½ before January 1, 2020, the previous age for RMDs was 70½.

The SECURE Act of 2019 increased the RMD age from 70½ to 72 years. Eventually, the SECURE 2.0 Act of 2022 delayed the RMD age—from 72 to 73—starting in 2023. Furthermore, in 2033, the RMD age will increase to age 75.

Calculating RMDs: The IRS provides a formula to calculate your RMD for each account. Your RMD  will be based on your age, account balance, and life expectancy. The formula uses the account balance as of December 31 of the previous year.

Types of Accounts: RMD rules apply to Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans, 403(b) plans, and other tax-advantaged retirement accounts. Roth IRAs are not subject to RMDs during the original account holder’s lifetime.

Taxation: RMDs are generally taxable as ordinary income and are subject to income tax at your applicable tax rate for the year you take them.

Penalties for Not Taking RMDs: Failing to take the required distribution can result in substantial fines. The IRS imposes a penalty of 25% of the RMD amount not withdrawn. SECURE 2.0 Act dropped the excise tax rate 10% if you timely correct your RMDs within two years.

Withdrawal Flexibility: You can always withdraw more than the RMD amount. However, excess withdrawals do not count toward future RMDs.

Inherited Retirement Accounts: If you inherit a retirement account, RMD rules can vary depending on your relationship with the original account holder and the age of the deceased account holder at the time of their passing.

RMD Withdrawal strategies

As individuals approach retirement, they often face a new financial challenge – high taxes on Required Minimum Distributions (RMDs). These mandatory withdrawals from retirement accounts can lead to significant tax liabilities. However, there are several strategic approaches to minimize the tax burden from RMDs, ranging from early Roth contributions to charitable giving. Let’s explore some of these strategies and emphasize the importance of taking a comprehensive view of your retirement plan.

Early Roth Contributions

One of the most effective ways to reduce RMD taxes is by making early contributions to a Roth IRA and Roth 401. Unlike Traditional IRAs and 401(k)s, Roth IRAs allow for tax-free withdrawals in retirement. By contributing to a Roth IRA when you’re younger, you’re building a tax-free source of income for retirement. Moreover, Roth IRAs have no minimum distribution requirements during your lifetime, so you can let your investments grow tax-free for as long as you wish.

Roth Conversions

Considering a Roth conversion might be beneficial if you already have a substantial balance in your Traditional IRA or 401(k). Roth conversion involves transferring a portion of your pre-tax retirement savings into a Roth IRA. While you will pay taxes on the conversion amount, it can be a strategic move to lower future RMDs and ultimately reduce your overall tax burden in retirement. You can plan to make these conversions gradually over several years to lessen their tax impact.

Qualified Charitable Donations

Qualified Charitable Donations (QCDs) offer an excellent way to satisfy your RMD requirement while reducing your taxable income. You can directly transfer up to $100,000 per year from your IRA or 401k to a qualified charity without counting it as income. The QCD not only reduces your tax liability but also supports a cause you care about. QCDs are especially advantageous if you don’t need your entire RMD for living expenses.

Charitable Gift Annuity

A Charitable Gift Annuity (CGA) is another charitable giving option that can help lower your RMD tax burden. With a CGA, you donate a lump sum to a charity in exchange for regular fixed payments for life. These payments are typically partially tax-free, reducing your taxable income and potentially placing you in a lower tax bracket. The size of your payment depends on many factors, including your age when you set up the charitable gift annuity. Younger donors typically receive smaller amounts but for an extended period.

Take Distributions Early

Taking distributions early can be a strategic move for those who have control over their retirement accounts and aren’t relying solely on RMDs for income. By withdrawing money from your retirement accounts before age 73, you can manage your tax liability more effectively. This strategy lets you control when and how much you withdraw, potentially spreading the tax burden over several years.

Take a Comprehensive View

The key to effectively reducing the tax burden of your RMDs is to take a comprehensive view of your financial situation.

Taking a comprehensive view of your overall financial plan is paramount to ensuring a secure and comfortable retirement. It involves not only meeting the IRS requirements but also aligning these distributions with your broader financial goals and circumstances. By considering your entire financial portfolio, including other sources of income, investment strategies, tax implications, and long-term retirement objectives, you can optimize your RMD strategy. This holistic approach helps you strike a balance between satisfying regulatory requirements and making the most of your retirement savings. It also allows for modifications as your financial situation evolves over time, ensuring that your retirement plan remains flexible, robust, and tailored to your unique needs. In essence, taking a comprehensive view empowers you to navigate the intricacies of RMDs within the context of your broader financial well-being, ultimately enhancing your financial security during retirement.

Conclusion

RMDs are an inevitable part of retirement income. With the right strategies, you can significantly reduce the associated tax burden. From early Roth contributions and conversions to charitable giving options like QCDs and CGAs, there are numerous ways to optimize your retirement plan. It’s crucial to take a comprehensive view, considering all available strategies and their impact on your overall financial picture. By doing so, you can enjoy a more financially secure and tax-efficient retirement.

Consider working with a financial advisor or tax professional to create a retirement income strategy encompassing all available options. This strategy should align with your long-term financial goals, risk tolerance, and charitable intentions.

401k contribution limits 2023

401k contribution limits 2023

401k contribution limits for 2023 are $22,500 per person, up from 20,500 in 2022. All 401k participants over the age of 50 can make a catch-up contribution of $7,500, for a total of $30,000

Retirement Calculator

What is 401k?

401k is a workplace retirement plan where employees and employers can make retirement contributions. These retirement plans can be one of the easiest and most effective ways to save for retirement. As an employee, you can automatically contribute your 401k directly through your company payroll. You can choose the percentage of your salary toward your retirement savings. Most 401k plans will provide you with multiple investment options in stocks and fixed income. Additionally, most companies offer a 401k match up to a certain percentage. In most cases, you must participate to receive your employer match.

There are three types of 401k contributions – traditional 401k tax-deferred, tax-exempt Roth 401k, and After-tax contributions.

You can select to make both types of tax-deferred and Roth contributions simultaneously. However,  the combined annual contribution amount cannot exceed your annual limit.

Tax-deferred 401k

Most employees commonly choose to make tax-deferred 401k contributions. These payments are tax-deductible. They will lower your tax bill for the current tax year. Your investments will grow on a tax-deferred basis. Therefore, you will only owe federal and state taxes when you start withdrawing your savings.

Roth 401k

Roth 401k contributions are pretax. You will pay all federal and state taxes before making your contributions. The advantage of Roth 401k is that your retirement savings will grow tax-free. If you keep your money until retirement, you will withdraw your gain tax-free. It’s a great alternative for young professionals and workers in a low tax bracket.

After-Tax 401k Contributions

Some 401k plans will allow you to make after-tax contributions. You can make these contributions if you have maximized your annual limit. Generally, after-tax contributions are made after you pay taxes on your income. Only your future gains will be taxable as ordinary income. Due to these tax complexities, after-tax contributions are more common as part of a Mega Backdoor Roth conversion.

Mega Backdoor Roth conversion

Mega back door conversion is a two-step process that allows you to make after-tax contributions to your 401k plan and immediately transfer the money to your Roth 401k account through in-service conversion.

What are my 401k contribution limits for 2023?

401k contribution limits change every year. IRS typically increases the maximum annual limit with the cost of living adjustment and inflation. These contribution limits apply to all employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Additionally, the limits apply to both tax-deferred and Roth contributions combined. 

  • Employees can contribute up to $22,500 to their 401(k) plan for 2023, a $2,000 increase from 2022.
  • Employees of age 50 or over are eligible for an additional catch-up contribution of $7,500 in 2023, a $1,000 increase from  2022
  • If an employee makes the maximum allowed contribution, the company match cannot exceed  43,,500, up from 40.500 in 2022
  • The maximum 401k contribution limit for 2023, including employee contributions and employer match, is $66,000, up from 61,000 in 2022
  • The total 401k contribution limit for 2023  from all sources, including catch-up contributions, is $73.500,000, up from 67,500 in 2022
  • The employee compensation limit for calculating 401k contributions is $330,000, up from $305,000 in 2022

Solo 401k contribution limits 2023

A solo 401k plan is a type of 401k plan with one participant. Those are usually solo entrepreneurs, consultants, freelancers, and other small business owners. Self-employed individuals can take advantage of solo 401k plans and save for retirement.

  • The maximum contribution limit in 2023 for a solo 401k plan is $66,000 or $73,500 with catch-up contributions. Solo entrepreneurs can make contributions both as an employee and an employer.
  • The employee contribution cannot exceed $22,500 in the solo 401(k) plan for 2023.
  • Self-employed 401k participants, age 50 or over, are eligible for an additional catch-up contribution of $7,500 in 2023.
  • The total self-employed compensation limit for calculating solo 401k contributions is $330,000.
  • Employer contribution cannot exceed 25% of the compensation
  • If you participate in more than one 401k plan simultaneously, you are subject to the same annual limits for all plans.

Please note that if you decide to hire other employees, you must include them in your 401k plan if they meet the plan eligibility requirements.

 

Roth IRA and why you probably need one – Updated for 2022

Roth IRA

Roth IRA is a tax-exempt investment account that allows you to make after-tax contributions to save for retirement. The Roth IRA has a tax-free status. It is a great way to save for retirement and meet your financial goals without paying a dime for taxes on your investments. It offers you a lot of flexibility with very few constraints.

Roth IRA is an excellent starting point for young professionals. It can help you reach your financial goals faster. So open your account now to maximize its full potential. Investing early in your career will lay out the path to your financial independence.

1. Plan for your future

Opening a Roth IRA account is a great way to plan for retirement and build financial independence. This tax-free account is an excellent saving opportunity for many young professionals and anyone with limited access to workplace retirement plans. Even those with 401k plans with their employer can open a Roth IRA.

If you are single and earn $129,000 or less in 2022, you can contribute up to $6,000 per year to your Roth IRA. Individuals 50 years old and above can add a catch-up contribution of $1,000. If you are married and filing jointly, you can contribute the full amount if your MAGI is under $204,000.

There is a phaseout amount between $129,000 and $144,000 for single filers and $204,000 and $214,000 for married filing jointly.

2. No age limit

There is no age limit for your contributions. You can contribute to your Roth IRA at any age as long as you earn income.

Minors who earn income can also invest in Roth IRA. While youngsters have fewer opportunities to make money, many sources of income will count – babysitting, garden cleaning, child acting, modeling, selling lemonade, distributing papers, etc.

3. No investment restrictions

Unlike most 401k plans, Roth IRAs do not have any restrictions on the type of investments in the account. You can invest in any asset class that suits your risk tolerance and financial goals.

4. No taxes

There are no taxes on the distributions from this account once you reach the age of 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends, either. Roth IRA is a great saving tool for investors at all income levels and tax brackets.

With an average historical growth rate of 7%, your investment of $6,000 today could bring you $45,674 in 30 years, completely tax-free. The cumulative effect of your return and the account’s tax status will help your investments grow faster.

If you are a California resident, your maximum tax rate on ordinary income can be over 52.5% – 37%  for Federal taxes, 13.3% for State Taxes, and 2.35% for Medicare. This figure excludes Social security and self-employment tax.

The maximum long-term capital gain tax in the US is 23.68%. California residents could pay up to 13,3% on their capital gains as California doesn’t differentiate between long-term and short-term gains.

5. No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contribution (but not the return) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

6. Diversify your future tax exposure

Most of your retirement savings will likely be in a 401k plan or an investment account. 401k plans are tax-deferred, and you will owe taxes on any distributions. Investment accounts are taxable, and you pay taxes on capital gains and dividends. In reality, nobody can predict your tax rate by the time you need to take out money from your retirement and investment accounts. Roth IRA adds this highly flexible tax-advantaged component to your investments.

7. No minimum distributions

Unlike 401k plans, Roth IRA doesn’t have any minimum distributions requirements. Investors can withdraw their savings at their wish or keep them intact indefinitely.

8. Do a backdoor Roth conversion

Due to recent legal changes, investors who do not satisfy the requirements for direct Roth IRA contributions can still make investments in it. The process starts with a taxable contribution, up to the annual limit, into a Traditional IRA. Eventually, the contributions are rolled from the Traditional IRA to the Roth IRA.

9. Roth conversion from Traditional IRA and 401k plans

Under certain circumstances, converting your Traditional IRA and an old 401k plan to Roth IRA could make sense. If you expect to earn less income or pay lower taxes in a particular year, it could be beneficial to consider this Roth conversion. Your rollover amount will be taxable at your current ordinary income tax level. An alternative strategy is to consider annual rollovers in amounts that will keep you within your tax bracket.

10. Estate planning

Roth IRA is an excellent estate planning tool. Due to its age flexibility and no minimum required distributions, it is a good option for generation transfer and leaving a legacy to your beloved ones.

Wise 401k moves to make in 2022

Wise 401k moves to make in 2022

Six wise 401k moves to make in 2022 to boost your retirement saving. Do you have a 401k? These five 401k moves will help you grow your retirement savings and ensure that you take full advantage of your 401k benefits.

2022 has been a very choppy year for investors. Both stocks and bonds have experienced losses and large swings in both directions. As we approach the end of the year, you can take another look at your 401k, reassess your financial priorities and .revaluate your retirement strategy,  Let’s make sure your 401k works for you.

Retirement Calculator

What is a 401k plan?

401k plan is a workplace retirement plan that allows employees to build and grow their retirement savings. It is one of the most convenient and effective ways to save for retirement, as both employees and employers can make retirement contributions. You can set up automatic deductions to your 401k account directly through your company payroll as an employee. You can choose the exact percentage of your salary towards your retirement savings. In 2022, most 401k will provide you with multiple investment options in stock, fixed-income mutual funds, and ETFs. Furthermore, most employers offer a 401k match for up to a certain percentage. In most cases, you must participate in the plan to receive the match.

1. Maximize your 401k contributions in 2022

The smart way to boost your retirement savings is to maximize your 401k contributions each year.

Did you know that in 2022 you can contribute up to $20,500 to your 401k plan? If you are 50 or over, you are eligible for an additional catch-up contribution of $6,500 in 2022. Traditional 401k contributions are tax-deductible and will lower your overall tax bill in the current tax year.

Many employers offer a 401k match, which is free money for you. The only way to receive the match is to participate in the plan. If you cannot max out your dollar amount, try to deduct the highest possible percentage so that you can capture the entire match from your employer. For example, if your company offers a 4% match on every dollar, at the very minimum, you should contribute 4% to get the entire match.

How to reach $1 million in your 401k by age 65?

Do you want to have $1 million in your 401k by retirement? The secret recipe is to start early. For example, if you are 25 years old today, you only need to set aside $387 per month for 40 years, assuming a 7% annual return. If you are 35, the saving rate goes up to $820 per month. If you start in your 50s, you need to save about $3,000 a month to get to a million dollars.

401k Contributions by Age
Age | Monthly
Contribution
Yearly
Contribution
Lifetime
Contribution
25 $387 $4,644 $190,404
30 $560 $6,720 $241,920
35 $820 $9,840 $305,040
40 $1,220 $14,640 $380,640
45 $1,860 $22,320 $468,720
50 $3,000 $36,000 $576,000
55 $5,300 $63,600 $699,600

2. Review your investment options

When was the last time you reviewed the investment options inside your 401k plan? When was the last time you made any changes to your fund selection? With automatic contributions and investing, it is easy to get things on autopilot. But remember, this is d your retirement savings. Now is the best time to get a grip on your 401k investments.

Look at your fund performance over the last 1, 3, 5, and 10 years and make sure the fund returns are near or higher than their benchmark. Review the fund fees. Check if there have been new funds added to the lineup recently.

What is a Target Date Fund?

A target-date fund is an age-based retirement fund that automatically adjusts your stock and bond investment allocation as you approach retirement. Young investors have a higher allocation to equities, considered more risky assets. In comparison, investors approaching retirement receive a bigger share in safer investments such as bonds. By design, plan participants should choose one target-date fund, set it, and forget until they retire. The fund will automatically change the asset allocation as you near your retirement age.

However, in a recent study, Vanguard concluded that nearly 33% of 401k plan participants misuse their target-date funds.   A third of the people who own TDFs,  combine them with another fund.

Target date funds in your 401k in 2021

3. Change your asset allocation

Asset allocation tells you how your investments are spread between stocks, bonds, money markets, and other asset classes. Stocks typically are riskier but offer great earnings potential. Bonds are considered a safer investment but provide a limited annual return.

Your ideal asset allocation depends on your age, investment horizon, risk tolerance, and specific individual circumstances.

Typically, younger plan participants have a longer investment horizon and can withstand portfolio swings to achieve higher returns in the future. If you are one of these, investors can choose a higher allocation of stocks in your 401k.

However, if you are approaching retirement, you would have a much shorter investment horizon and probably lower tolerance to investment losses. In this case, you should consider adding more bonds and cash to your asset allocation.

4. Consider contributing to Roth 401k in 2022

Are you worried that you will pay higher taxes in the future? The Roth 401k allows you to make pretax contributions and avoid taxes on your future earnings. All Roth contributions are made after paying all federal and state income taxes. The advantage is that all your prospective earnings will grow tax-free. If you keep your money until retirement or reach the age of 59 ½, you will withdraw your gains tax-free. If you are a young professional or believe your tax rate will grow higher in the future, Roth 401k is an excellent alternative to your traditional tax-deferred 401k savings.

5. Do a Mega backdoor 401k conversion 

Mega Backdoor 401k is an acronym for after-tax Roth conversion within your 401k plan. Many high-income earners cannot make direct Roth contributions. At the same time, they may prefer traditional tax-deferred 401k contributions, which reduce their current taxes. Mega backdoor 401k allows you to get the best of both worlds. There is one caveat — your 401k plan must allow for after-tax contributions and in-plan conversions.

For 2022, maximum 401k contributions of any kind (tax-deferred, Roth, after-tax, and employee match) is $61,000, up from $58,000 for 2021. If you’re 50 or older, the limit is $67,500, up from $64,500 in 2021. If you maximize your 401k allowance and receive an employee match, you can choose to make after-tax contributions up to the annual limit. Without any conversion, you will pay taxes on all your gains. The second step in the strategy requires an in-plan Roth conversion, which will move your after-tax money into Roth tax-exempt savings.

6. Rollover an old 401k plan

Do you have an old 401k plan stuck with your former employer? How often do you have a chance to review your balance? Unfortunately, many old 401k plans have been forgotten and ignored for years. Transferring an old 401k to a Rollover IRA can be a wise move.

The rollover is your chance to control your retirement savings. Furthermore, you will expand your investment options from the limited number of mutual funds to the entire universe of stocks, ETFs, and fund managers. Most importantly, you can manage your account according to your retirement goals.

Maximizing Roth savings for high-income earners

Maximizing Roth savings for high income earners

Maximizing your Roth savings is a terrific way to save for retirement for both high-income earners and professionals at all levels. Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement.

Key Roth benefits for high earners

  • Roth IRA offers tax-free retirement growth. All contributions are pre-tax. In other words, you pay taxes before you make them. Once your dollars hit your Roth IRA, they grow tax-free.
  • You won’t pay any taxes on future capital gains and dividends.
  • Roth IRA is not subject to required minimum distributions at age 72.
  • You can always withdraw your original contribution tax and penalty-free.
  • Maximizing your Roth savings, especially for high-income earners, is an effective way to diversify your future tax exposure
  • High earners can incorporate their Roth savings as part of their estate planning strategy

How much can I contribute to my Roth IRA?

You can contribute up to $6,000 to your Roth IRA in 2022 or $7,000 if you are 50 years or older. For 2023, you can contribute $6.500 or or $7,500 if you are 50 years or older

Income limits for Roth contributions

Roth IRA contribution limits for 2022 are based on your annual earnings. If you are single or a head of household and earn $129,000 or less, you can contribute up to the full amount of $6,000 per year. If your aggregated gross income is between $129,000 and $144,000, you can still make contributions with a lower value.

Married couples filing jointly can contribute up to $6,000 each if their combined income is less than $204,000. You can still make reduced contributions if your aggregated gross income is between $204,000 and $214,000.

If you are a high earner, you will not meet the income limits to make direct Roth contributions. However, you still have some options. Here are some ideas that can help you boost your Roth savings

Speak with a financial advisor to find out what Roth strategies make sense for you

Backdoor Roth IRA for high-income earners

The Backdoor Roth IRA is a multi-step process that allows high-income earners to bypass the Roth Income limits. The strategy comes with some conditions. While the IRS has kept the rules vague, it’s easy to make mistakes while following the process. I had seen more than one client who had made some mistakes when they followed the backdoor steps.

Here are the general guidelines. Remember that everyone’s circumstances are unique, and this article may not address all of them.

Backdoor Roth IRA steps

  1. Contribute to a non-deductible IRA. Roth IRA and Traditional IRA have the same income limits. If you do not qualify to make direct Roth contributions, you don’t qualify for tax-deductible IRA savings. When you contribute to a non-deductible IRA, you are making an after-tax contribution to an IRA. Theoretically, you will pay taxes on your future gain but the original amount.
  2. Convert your contribution to a Roth IRA. In the second step of the process, you must transfer your assets from the non-deductible IRA to your Roth IRA. Your IRA administrator or financial advisor will give you the instructions and paperwork. Every broker requires a slightly different process.
  3. File your taxes and submit Form 8606. You must file form 8606 to report your non-deductible contributions to traditional IRAs. Please consult your CPA or tax accountant for the exact requirements for filling out and submitting the form. Pay attention to this form when you file your taxes using tax software.
  4. The Pro-Rata Rule. The pro-rata rule has one of the biggest implications in the backdoor process. The rules stipulate that ALL Roth conversions must be made on a pro-rata basis. In other words, if you have an outstanding Traditional RA, SEP IRA, or Simple IRA, your Roth conversion must be pro-rated between all existing IRA accounts, not just the non-deductible IRA from which you want to make the transfer. In other words, the Backdoor Roth strategy could trigger a substantial taxable event for you if you own tax-deferred IRA savings.

Roth conversion from IRA and 401k

Roth conversion involves the transfer of the tax-deferred savings in your IRA or 401k accounts into tax-exempt investments in your Roth IRA. Roth conversion can be a brilliant move for high-income earners in the right circumstances.

Your current and future taxes are critical elements of any Roth conversion decision-making. The strategy becomes viable during low tax years or whenever you expect higher tax rates in the future. Higher future tax rates make a Roth IRA more appealing, while lower future tax rates would make a traditional IRA more attractive.

With some proactive planning, Roth IRA offers substantial tax-free benefits. Due to income limits, many high-income savers end up with significant amounts in tax-deferred accounts such as 401k and Traditional IRA. These plans give you initial tax relief to encourage retirement savings. However, all future distributions are fully taxable and subject to required minimum distributions.

Learn more about Roth conversion here

Roth 401k

Most corporate 401k plans allow you to make either traditional tax-deferred or Roth 401k contributions. Roth 401k is similar to Roth IRA as both accounts are funded with after-tax dollars.

The contribution limits for 2022 are $20,500 per person. All 401k participants over the age of 50 can add a catch-up contribution of $6,500.

Roth 401k vs. Roth IRA

Roth 401k and Roth IRA are very similar, but Roth 401k has major advantages for high-income earners

  1. No income limits – Unlike Roth IRA, the Roth 401l doesn’t have income limits. Anyone eligible to participate in their company’s 401k plan can make Roth 401k contributions.
  2. Higher Contribution limits – You can save a lot more in your company’s Roth 401k plan versus a personal Roth IRA. You can save up to $20,500 in your Roth 401k and $6,000 in your Roth IRA. If you are 50 or older, you can stash $27,000 vs. $7,000
  3. Company match – You are eligible for a company match even if you make Roth 401k contributions. All employer matching contributions will be tax-deferred and placed in a separate account
  4. Investment options – Roth IRA offers a broader range of investment options vs. 401k plans with a limited list of funds.
  5. Distributions rules – Roth 401k savings are subject to required maximum distributions at age of 72. You can avoid this rule by rolling over your Roth 401k into a Roth IRA once you stop contributing to the plan.

What Is a Mega Backdoor Roth 401k?

Mega Backdoor 401k is an acronym for after-tax Roth conversion within your 401k plan. Many high-income earners cannot make direct Roth contributions. At the same time, they may prefer traditional tax-deferred 401k contributions, which reduce their current taxes. Mega backdoor 401k allows you to get the best of both worlds. There is one caveat — your 401k plan must allow for after-tax contributions and in-plan conversions. Depending on your plan design, setting up a Mega backdoor 401k can be pretty complex or relatively simple.

For 2022, maximum 401k contributions of any kind (tax-deferred, Roth, after-tax, and employee match) is $61,000, up from $58,000 for 2021. If you’re 50 or older, the limit is $67,500, up from $64,500 in 2021. If you maximize your 401k allowance and receive an employee match, you can choose to make after-tax contributions up the annual limit. Without any conversion, you will pay taxes on all your gains. Since your original contribution was after-tax, you don’t pay taxes on that amount. Furthermore, the IRS limits the compensation eligible for 401k contributions to $305,000 or 2022. Depending on your specific circumstances, the final contribution amount to your 401k plan may vary,

Here is how Mega Backdoor Roth 401k works

  1. Maximize your 401k contributions for the year
  2. Opt-in for after-tax 401k contributions. Your plan must allow for this election
  3. Convert your after-tax contributions into Roth 401k as soon as possible to avoid possible taxable gains. Some plans may allow you to choose automatic conversions versus manual.
  4. Watch your Roth savings grow tax-free

Final words

Maximizing Roth savings can be highly advantageous for high-income earners and hard-working professionals. Since Roth IRAs have strict income limits, not everyone will qualify automatically for direct contributions. You will need careful planning to maneuver all the different rules and a long-term view to enjoy the benefits of your Roth savings.

401k contribution limits 2022

401k contribution limits 2022

401k contribution limits for 2022 are $20,500 per person. All 401k participants over the age of 50 can add a catch-up contribution of $6,500.

Retirement Calculator

What is 401k?

401k plan is a workplace retirement plan where both employees and employers can make retirement contributions. These retirement plans can be one of the easiest and most effective ways to save for retirement. As an employee, you can make automatic contributions to your 401k directly through your company payroll. You can choose the percentage of your salary that will go towards your retirement savings, Most 401k will provide you with multiple investment options in stocks and fixed income. Additionally, most companies offer a 401k match up to a certain percentage. In most cases, you need to participate in the plan in order to get the match.

There are two types of contributions – traditional 401k tax-deferred and tax-exempt Roth 401k contributions.

Tax-deferred 401k

Most employees, typically, choose to make tax-deferred 401k contributions. These payments are tax-deductible. They will lower your tax bill for the current tax year. Your investments will grow on a tax-deferred basis. Therefore, you will only owe federal and state taxes when you start withdrawing your savings.

Roth 401k

Roth 401k contributions are pretax. It means that you will pay all federal and state taxes before making your contributions. The advantage of Roth 401k is that your retirement savings will grow tax-free. As long as you keep your money until retirement, you will withdraw your gain tax-free. It’s a great alternative for young professionals and workers in a low tax bracket.

What are my 401k contribution limits for 2022?

401k contribution limits change every year. IRS typically increases the maximum annual limit with the cost of living adjustment and inflation. These contribution limits apply to all employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Additionally, the limits apply to both tax-deferred and Roth contributions combined. 

  • Employees can contribute up to $20,500 to their 401(k) plan for 2022, a $1,000 increase from 2021.
  • Employees of age 50 or over are eligible for an additional catch-up contribution of $6,500 in 2022, the same amount as  2021
  • The employee compensation limit for calculating 401k contributions is $305,000, $15,000 more than 2021
  • Companies can make a matching contribution up to the combined limit of $61,000 or $67,500 with the catch-up contribution. If an employee makes the maximum allowed contribution, the company match cannot exceed $40,500 in 2022.

Solo 401k contribution limits 2022

A solo 401k plan is a type of 401k plan with one participant. Those are usually solo entrepreneurs, consultants, freelancers, and other small business owners. Self-employed individuals can take advantage of solo 401k plans and save for retirement.

  • The maximum contribution limit in 2022 for a solo 401k plan is $61,000 or $67,500 with catch-up contributions. Solo entrepreneurs can make contributions both as an employee and an employer.
  • The employee contribution cannot exceed $19,500 in the solo 401(k) plan for 2021.
  • Self-employed 401k participants, age 50 or over are eligible for an additional catch-up contribution of $6,500 in 2021.
  • The total self-employed compensation limit for calculating solo 401k contributions is $290,000.
  • Employer contribution cannot exceed 25% of the compensation
  • If you participate in more than one 401k plan at the same time, you are subject to the same annual limits for all plans.

Please note that if you are self-employed and decide to hire other employees, they will have to be included in the 401k plan if they meet the plan eligibility requirements.

 

Roth IRA Contribution Limits 2023

Roth IRA Contribution Limits for 2023

The Roth IRA contribution limits for 2023 are $6,500 per person with an additional $1,000 catch-up contribution for people who are 50 or older. There is $500 increase from 2022.

Retirement Calculator

Roth IRA income limits for 2023

Roth IRA contribution limits for 2023 are based on your annual earnings. If you are single or a head of household and earn $138,000 or less, you can contribute up to the full amount of $6,500 per year.  If your aggregated gross income is between $138,000 and $153,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,500 each if their combined income is less than $218,000.  If your aggregated gross income is between $218,000 and $228,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

The Roth IRA and Traditional IRA have the same annual contributions limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $5,000 in 2023, you could only contribute $5,000 in your Roth

Roth IRA Contribution Limits 2022

Roth IRA Contribution Limits for 2022

The Roth IRA contribution limits for 2022 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older. There is no change from 2021.

Retirement Calculator

Roth IRA income limits for 2022

Roth IRA contribution limits for 2022 are based on your annual earnings. If you are single or a head of household and earn $129,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $129,000 and $144,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $204,000.  If your aggregated gross income is between $204,000 and $214,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

The Roth IRA and Traditional IRA have the same annual contributions limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

Achieving tax alpha and higher after tax returns on your investments

Achieving Tax Alpha

What is tax alpha?

Tax Alpha is the ability to achieve an additional return on your investments by taking advantage of a wide range of tax strategies as part of your comprehensive wealth management and financial planning.  As you know, it is not about how much you make but how much you keep. And tax alpha measures the efficiency of your tax strategy and the incremental benefit to your after-tax returns.

Retirement Calculator

Why is tax alpha important to you?

The US has one of the most complex tax systems in the world. Navigating through all the tax rules and changes can quickly turn into a full-time job. Furthermore, the US budget deficit is growing exponentially every year. The government expenses are rising. The only way to fund the budget gap is by increasing taxes, both for corporations and individuals.

Obviously, our taxes pay our teachers, police officers, and firefighters, fund essential services, build new schools and fix our infrastructure. Our taxes help the world around us humming.  However, there will be times when taxes become a hurdle in your decision process. Taxes turn into a complex web of rules that is hard to understand and even harder to implement.

Achieving tax alpha is critical whether you are a novice or seasoned investor sitting on significant investment gains.  Making intelligent and well-informed decisions can help you improve the after-tax return of your investment in the long run.

Assuming that you can generate 1% in excess annual after-tax returns over 30-year, your will investments can grow as much as 32% in total dollar amount.

Tax alpha returns
Tax alpha returns

1. Holistic Financial Planning

For our firm, achieving Tax Alpha is a process that starts on day 1. Making smart tax decisions is at the core of our service. Preparing you for your big day is not a race. It’s a marathon.  It takes years of careful planning and patience. There will be uncertainty. Perhaps tax laws can change. Your circumstances may evolve. Whatever happens, It’s important to stay objective, disciplined, and proactive in preparing for different outcomes.

At our firm, we craft a comprehensive strategy that will maximize your financial outcome and lower your taxes in the long run. We start by taking a complete picture of your financial life and offer a road map to optimize your tax outcome. Achieving higher tax alpha only works in combination with your holistic financial plan. Whether you are planning for your retirement, owning a large number of stock options, or expecting a small windfall, planning your future taxes is quintessential for your financial success.

2. Tax Loss Harvesting

Tax-loss harvesting is an investment strategy that allows you to sell off assets that have declined in value to offset current or future gains from other sources. You can then replace this asset with a similar but identical investment to position yourself for future price recovery. Furthermore, you can use up to $3,000 of capital losses as a tax deduction to your ordinary income. Finally, you can carry forward any remaining losses for future tax years.

The real economic value of tax-loss harvesting lies in your ability to defer taxes into the future. You can think of tax-loss harvesting as an interest-free loan by the government, which you will pay off only after realizing capital gains.  Therefore, the ability to generate long-term compounding returns on TLH strategy can appeal to disciplined long-term investors with low to moderate trading practices.

How does tax-loss harvesting work?

Example: An investor owns 1,000 shares of company ABC, which she bought at $50 in her taxable account. The total cost of the purchase was $50,000. During a market sell-off a few months later, the stock drops to $40, and the initial investment is now worth $40,000.

Now the investor has two options. She can keep the stock and hope that the price will rebound. Alternatively,  she could sell the stock and realize a loss of $10,000. After the sale, she will have two options. She can either buy another stock with a similar risk profile or wait 30 days and repurchase ABC stock with the proceeds. By selling the shares of ABC, the investor will realize a capital loss of $10,000. Assuming she is paying 15% tax on capital gains, the tax benefit of the loss is equal to $1,500.  Furthermore, she can use the loss to offset future gains in her investment portfolio or other sources.

3. Direct Indexing

Direct indexing is a type of index investing. It combines the concepts of passive investing and tax-loss harvesting. The strategy relies on the purchase of a custom investment portfolio that mirrors the composition of an index.

Similar to buying an index fund or an ETF, direct indexing requires purchasing a broad basket of individual stocks that closely track the underlying index.  For example, if you want to create a portfolio that tracks S&P 500, you can buy all or a smaller number of  500 stocks inside the benchmark.

Owning a basket of individual securities offers you greater flexibility to customize your portfolio.  First, you can benefit from tax-loss harvesting opportunities by replacing stocks that have declined in value with other companies in the same category. Second, you can remove undesirable stocks or sectors you otherwise can’t do when buying an index fund or an ETF. Third, direct indexing can allow you to diversify your existing portfolio and defer realizing capital gains, especially when you hold significant holdings with a low-cost basis.

4. Tax Location

Tax location is a strategy that places your diversified investment portfolio according to each investment’s risk and tax profile. In the US, we have a wide range of investment and retirement accounts with various tax treatments. Individual investment accounts are fully taxable for capital gains and dividends. Employer 401k, SEP IRA and Traditional IRA are tax-differed savings vehicles. Your contributions are tax-deductible while your savings grow tax-free. You only pay taxes on your actual retirement withdrawals. Finally, Roth IRA, Roth 401k, and 529 require pre-tax contributions, but all your future earnings are tax-exempt. Most of our clients will have at least two or more of these different instrument vehicles.

Now, enter stocks, bonds, commodities, REITs, cryptocurrencies, hedge funds, private investments, stock options, etc. Each investment type has a different tax profile and carries a unique level of risk.

At our firm, we create a customized asset allocation for every client, depending on their circumstances and goals. Considering the tax implications of each asset in each investment or retirement account, we carefully create our tax location strategy to take advantage of any opportunities to achieve tax alpha.

5. Smart tax investing

Smart tax investing is a personalized investment strategy that combines various portfolio management techniques such as tax-loss harvesting, asset allocation, asset location, diversification, dollar-cost averaging, passive vs. active investing, and rebalancing.  The main focus of tax-mindful investing is achieving a higher after-tax return on your investment portfolio. Combined with your comprehensive financial planning, smart-tax investing can be a powerful tool to elevate your financial outcome.

Effective Roth Conversion Strategies for Tax-Free Growth

Roth Conversion

Roth conversion of your tax-deferred retirement savings can be a brilliant move. Learn the must-know rules and tax implications of Roth Conversion before you decide if it is right for you.

Retirement Calculator

What is a Roth Conversion?

Roth Conversion is the process of transferring the full or partial balance of your existing traditional IRA into a Roth IRA. The conversion effectively moves tax-deferred retirement savings into tax-exempt dollars.

A critical downside of Roth conversion is that you need to pay income taxes on the converted amount. For that reason, it is beneficial to have additional taxable savings to cover the tax cost of the conversion.

Unfortunately, not everybody is the right candidate for Roth conversion. Consider your specific financial and tax circumstances before moving forward.

Watch your tax bracket

A crucial element of any Roth conversion decision making is your taxes. The strategy becomes feasible during low tax years or whenever you expect higher tax rates in the future. Higher future tax rates make a Roth IRA more appealing, while lower future tax rates would make a traditional IRA more attractive.

Consider your investment horizon

Generally, you will achieve a higher benefit if you perform your conversions earlier. Your Roth IRA will have time to grow tax-free for longer and will offset the cost of paying taxes upfront. 

Roth IRA 5-year rule

When you do a Roth conversion, you need to be mindful of the 5-year rule. The rule requires that 5 years have passed since your first Roth contributions before taking penalty-free withdrawals of your tax-free earnings.

You can still withdraw your original contributions at any time. However, your earnings are subject to the 5-year minimum restriction. If you do not meet the minimum 5-year holding period, your profits can be subject to ordinary income tax as well as a 10% penalty for early withdrawal.

Furthermore, each separate Roth conversion has a five-year limit. The Five-Year clock begins ticking on January 1st of the year when you make the conversion.

The advantages of Roth conversion

Converting your tax-deferred dollars to Roth RIA can have several financial and estate benefits.

Your money grows tax-free

Savings in your Roth IRA grow tax-free. As long as you meet the 5-year rule, you will not owe any taxes on your distributions. Roth IRA contributions are pre-tax. You are paying taxes beforehand but do not owe taxes on any future earnings.

In comparison, contributions to Traditional IRA are typically tax-deductible. When you take distributions from Traditional IRA, you have to pay ordinary income taxes on your entire withdrawal amount. 

Tax Diversification

If your future tax rate is uncertain for various reasons, you may want to diversify your tax risk through Roth conversion. You will benefit from holding both tax-deferred and tax-exempt retirement accounts. Tax diversification gives you more flexibility when it comes to future retirement withdrawals and tax planning. 

Asset Location

Asset location is a tax-optimization strategy that takes advantage of different types of investments, getting different tax treatments. Investors who own a variety of taxable, tax-deferred, and tax-exempt accounts can benefit from asset location. By doing Roth conversion, you can determine which securities should be held in tax-deferred accounts and which in Roth accounts to maximize your after-tax returns.

No Required Minimum Distributions

Traditional IRA rules mandate you to take taxable required minimum distributions (RMDs) every year after you reach age 72.

Alternatively, your Roth IRA does not require minimum distributions at any age. Your money can stay in the account and grow tax-free for as long as you want them.

Leave behind a tax-free legacy

The Roth IRA can play a crucial role in your estate planning. Your heirs who inherit your Roth IRA will receive a tax-free gift. They will be required to take distributions from the account. However, they will not have to pay any income tax on the withdrawals if the Roth IRA has been open for at least five years. Roth IRA is especially appealing if your heirs are in a higher tax bracket than you.

Keep Social Security income tax and Medicare Premiums low

Another hidden benefit of the Roth conversion is it could potentially lower your future social security income tax and Medicare Premiums.

Up to 85% of your Social Security checks can be taxable for individuals earning more than $34,000 and families receiving more than $44,000 per year.

Your Medicare Plan B premium will be calculated based on your reported income-related monthly adjustment amount (IRMAA) 2 years prior to your application. Even a dollar higher can push in a higher premium bracket,

Roth Conversion Strategies

With some planning, Roth IRA offers substantial tax-free benefits. Due to income limits, many retirement savers end up with significant amounts in tax-deferred accounts such as 401k and Traditional IRA. These plans give you initial tax relief to encourage retirement savings. However, all future distributions are fully taxable.

The Roth conversion may help you reduce your future tax burden and unlock some of the befits of Roth IRA. Here are some of the strategies that can be helpful in your decision process.

  

End-of-year Roth conversion

The stability of your income can be critical to your success. Each conversion must be completed by the end of each tax year. If your income is constant, you can process the conversion at any time. If your income is less predictable, your only choice will be to make your conversions towards the end of the year when you will have more visibility on your earnings.

Conversion during low-income years

The Roth conversion is generally more attractive during your low-income years when you will be in a lower tax bracket. The additional reported income from the conversion will add on to your base earnings. If you do the math right, you will be able to maintain your taxes relatively low. Analyze your tax bracket and convert the amount that will keep in your desired marginal tax rate.

Conversion during a market downturn

Another popular strategy is performing Roth conversion during a market downturn. A Roth conversion could become appealing if your Traditional IRA is down 20% or 30%. At the same time, you have a long-term investment horizon and believe that your portfolio will recover the losses over time.

Your largest benefit will come from the potential tax-free portfolio gains after the stock market goes higher. With this approach, your underlying taxes take a lower priority versus the ability to earn higher tax-free income in the future. However, you still need to determine whether saving taxes on future gains provides a higher benefit than paying higher taxes now.

Monthly or quarterly cost averaging

Timing the stock market is hard. The cost averaging strategy removes the headache of trying to figure out when the stock market will go up or down. This approach calls for making planned periodic, monthly, or quarterly, conversions. The benefit of this method is that at least part of your portfolio may benefit from lower stock values. It is a way to hedge your bets on surprising stock market moves. If your portfolio goes higher consistently throughout the year, your earlier conversions will benefit from lower stock values. If the stock market goes down in the second half of the year, your later-in-the-year conversion will produce a higher benefit.

Roth Conversion barbelling

This strategy makes sense if your annual income is variable and less predictable. For example, your income fluctuates due to adjustments in commissions, bonuses, royalties, or other payments. With barbelling, you perform two conversions per year. You make the first conversion early in the year based on a projected income that is at the high end of the range. The second conversion will occur towards the end of the year, when your income becomes more predictable. If your income is high, you may convert a much smaller amount or even nothing. If your earnings for the year are at the lower end of expectation, then you convert a larger amount.

Roth Conversion Ladder

As I mentioned earlier, each Roth conversion is subject to its own 5-year rule. The 5-year period starts on January 1st of the tax year of your Roth conversion. Every subsequent conversion will have a separate 5-year holding period.

The Roth Conversion ladder strategy requires a bit of initial planning. This approach stipulates that you make consistent annual conversions year after year. After every five years, you can withdraw your savings tax-free from the Roth IRA. In effect, you are creating a ladder similar to the CD ladder.

Keep in mind that this strategy only makes sense under two conditions. One, you can afford to pay taxes for the conversion from another taxable account. Second, your future taxable income is expected to increase, and therefore you would be in a higher tax bracket.

Conclusion

Roth Conversion can be a great way to manage your future taxes. However, not every person or every family is an ideal candidate for a Roth conversion. In reality, most people tend to have lower reportable income when they retire. For them keeping your Traditional IRA and taking distributions at a lower tax rate makes a lot of sense. However, there are a lot of financial, personal, and legacy planning factors that come into play. Make your decision carefully. Take a comprehensive look at your finance before you decide if Roth conversion is right for you.

5 smart 401k moves to make in 2021

5 smart 401k moves to make in 2021 to boost your retirement saving. Do you have a 401k? These five 401k moves will help you grow your retirement savings and ensure that you take full advantage of your 401k benefits.

After a very challenging 2020, 2021 allows you to take another look at your 401k, reassess your financial priorities and .revaluate your retirement strategy,  Let’s make sure that your 401k works for you.

Retirement Calculator

What is a 401k plan?

401k plan is a workplace retirement plan that allows employees to build and grow their retirement savings. It is one of the most convenient and effective ways to save for retirement as both employees and employers can make retirement contributions. You can set up automatic deductions to your 401k account directly through your company payroll as an employee.  You can choose the exact percentage of your salary that will go towards your retirement savings. In 2021, most 401k will provide you with multiple investment options in stocks, fixed-income mutual funds, and ETFs. Furthermore, most employers offer a 401k match up to a certain percentage. In most cases, you need to participate in the plan to receive the match.

1. Maximize your 401k contributions in 2021

The smart way to boost your retirement savings is to maximize your 401k contributions each year.

Did you know that in 2021, you can contribute up to $19,500 to your 401k plan? If you are 50 or over, you are eligible for an additional catch-up contribution of $6,500 in 2021. Traditional 401k contributions are tax-deductible and will lower your overall tax bill in the current tax year.

Many employers offer a 401k match, which is free money for you. The only way to receive it is to participate in the plan. If you cannot max out your dollar contributions, try to deduct the highest possible percentage so that you can capture the entire match from your employer. For example, if your company offers a 4% match on every dollar, at the very minimum, you should contribute 4% to get the full match.

How to reach $1 million in your 401k by age 65?

Do you want to have $1 million in your 401k by the time you retire? The secret recipe is to start early.  For example, if you are 25 old today, you only need to set aside $387 per month for 40 years, assuming a 7% annual return. If you are 35, the saving rate goes up to $820 per month.  If you have a late start, you need to save about $3,000 a month in your 50s to get to a million dollars at the age of 65.

401k Contributions by Age
Age | Monthly
Contribution
Yearly
Contribution
Lifetime
Contribution
25 $387 $4,644 $190,404
30 $560 $6,720 $241,920
35 $820 $9,840 $305,040
40 $1,220 $14,640 $380,640
45 $1,860 $22,320 $468,720
50 $3,000 $36,000 $576,000
55 $5,300 $63,600 $699,600

2. Review your investment options

When was the last time you reviewed the investment options inside your 401k plan? When is the last time you made any changes to your fund selection? With automatic contributions and investing, it is easy to get things on autopilot. But remember, this is d your retirement savings. Now is the best time to get a grip on your 401k investments.

Look at your fund performance over the last 1, 3, 5, and 10 years and make sure the fund returns are close or higher than their benchmark. Review the fund fees. Check if there have been new funds added to the lineup recently.

What is a Target Date Fund?

A target-date fund is an age-based retirement fund that automatically adjusts your stock and bond investments allocation as you approach retirement. Young investors have a higher allocation to equities which are considered more risky assets. In comparison, investors approaching retirement receive a bigger share in safer investments such as bonds. By design, plan participants should choose one target-date fund, set it, and forget until they retire. The fund will automatically change the asset allocation as you near your retirement age.

However, in a recent study, Vanguard concluded that nearly 33% percent of 401k plan participants misuse their target-date fund.   A third of the people who own TDFs,  combine them with another fund.

Target date funds in your 401k in 2021

So if you own one or more target-date funds or combine them with other equity and bond funds, you need to take another look at your investment choices.

3. Change your asset allocation

Asset allocation tells you how your investments are spread between stocks, bonds, money markets, and other asset classes. Stocks typically are riskier but offer great earnings potential. Bonds are considered a safer investment but provide a limited annual return.

Your ideal asset allocation depends on your age, investment horizon, risk tolerance, and specific individual circumstances.

Typically, younger plan participants have a longer investment horizon and can withstand portfolio swings to achieve higher returns in the future.  If you are one of these, investors can choose a higher allocation of stocks in your 401k.

However, if you are approaching retirement, you would have a much shorter investment horizon and probably lower tolerance to investment losses. In this case, you should consider adding more bonds and cash to your asset allocation.

4. Consider contributing to Roth 401k in 2021

Are you worried that you would pay higher taxes in the future? The Roth 401k allows you to make pretax contributions and avoid taxes on your future earnings. All Roth contributions are made after paying all federal and state income taxes now. The advantage is that all your prospective earnings will grow tax-free. If you keep your money until retirement or reaching the age of 59 ½, you will withdraw your gains tax-free. If you are a young professional or you believe that your tax rate will grow higher in the future, Roth 401k is an excellent alternative to your traditional tax-deferred 401k savings.

5. Rollover an old 401k plan

Do you have an old 401k plan stuck with your former employer? How often do you have a chance to review your balance? Unfortunately, many old 401k plans have become forgotten and ignored for many years.

It is a smart move to transfer an old 401k to a Rollover IRA.

The rollover is your chance to gain full control of your retirement savings. Furthermore, you will expand your investment options from the limited number of mutual funds to the entire universe of stocks, ETFs, and fund managers. Most importantly, you can manage your account according to your retirement goals.

Understanding Tail Risk and how to protect your investments

Understanding tail risk

What is Tail Risk?

Tail Risk is the possibility of suffering large investment losses due to sudden and unforeseen events. The name tail risk comes from the shape of the bell curve. Under normal circumstances, your most likely investment returns will gravitate in the middle of the curve. For long term investors, this will represent your average expected return. The more extreme returns have a lower probability of occurring and will taper away toward the end of the curve.

Understanding tail risk
Source: Pimco

The tail on the far-left side represents the probability of unexpected losses. The far-right represents the most extreme outcomes of substantial investment gains. For long-term investors, the ideal portfolio strategy will seek to minimize left tail risk without restricting the right tail growth potential.

Why is tail risk important?

Intuitively, we all want to be on the ride side of the bell curve. We want to achieve above-average returns and occasionally “hit the jackpot” with sizeable gains.

In real life, abrupt economic, social, and geopolitical events appear a lot more frequently than a rational human mind would predict. Furthermore, significant market shocks have been occurring about every three to five years resulting in “fatter” tails.

Also known as “Black Swans, they are rare and unique. These “one-off” events impose adverse pressure on your investment portfolio and create risk for outsized losses. Tail risk events bring a massive amount of financial and economic uncertainty and often lead to extreme turbulence on the stock market.

The Covid outbreak, Brexit, the European credit crisis, the collapse of Lehman Brothers, the Enron scandal, the US housing market downfall, and the 9/11 terrorist attacks are examples of idiosyncratic stock market shocks. Very few experts could have predicted them. More notably, they caused dramatic changes to our society and our economy, our consumer habits, and the way we conduct business.

Assessing your tail risk exposure

Retirees and those close to retirement, people who need immediate liquidity, executives, and employees holding a large amount of corporate stock are more susceptible to tail risk events. If you fall into one of these categories, you need to review your level of risk tolerance.

Investing is risky. There are no truly risk-free investments. There are only investments with different levels of risk. It is impossible to avoid risk altogether. The challenge for you is to have a reasonably balanced approach to all the risks you face. Ignoring one risk to help you prevent another risk does not mean you are in the clear.

Winners and losers

It is important to remember that every shock to the system leads to winners and losers. For example, the covid outbreak disproportionately hurt leisure, travel, retail, energy, and entertainment businesses. But it also benefited many tech companies as it accelerated the digital transformation. As bad as it was, the global financial crisis damaged many big and small regional banks. But it also opened the door for many successful fintech companies such as Visa, Mastercard, PayPal, and Square and exchange-traded fund managers like BlackRock and Vanguard. The aftermath of 9/11 drove the stock market down, but it led to a boost in defense and cybersecurity stocks.

Know your investments

The first step in managing your tail risk is knowing your investments. That is especially important if you have concentrated positions in a specific industry, a cluster of companies, or a single stock. Black Swan events could impact different stocks, sectors, and countries differently. For instance, the Brexit decision mostly hurt the performance of the UK and European companies and had no long-term effect on the US economy.

Know your investment horizon

Investors with a long-term investment horizon are more likely to withstand sudden losses. The stock market is forward-looking. It will absorb the new information, take a hit, and move on.

I always give this as an example. If you invested $1,000 in the S&P 500 index on January 1, 2008, just before the financial crisis, you would have doubled your money in 10 years. Unfortunately, if you needed your investment in one or two years, you would have been in big trouble. It took more than three years to recover your losses entirely.

Diversify

Never put all your eggs in one basket. The most effective way to protect yourself from unexpected losses is diversification. Diversification is the only free lunch you will ever get in investing. It allows you to spread your risk between different companies, sectors, asset classes, and even countries will allow your investment portfolio to avoid choppy swings in various market conditions. One prominent downside of diversification is that while you protect yourself from the left tail risk, you also limit the right tail potential for outsized returns.

Hold cash

Keeping cash reserves is another way to protect yourself from tail risk. You need to have enough liquidity to meet your immediate and near-term spending needs. I regularly advise my clients to maintain an emergency fund equal to six to twelve months of your budget. Put it in a safe place, but make sure that you still earn some interest.

Remember what we said earlier. There is no risk-free investment – even cash. Cash is sensitive to inflation. For instance, $100,000 in 2000 is worth only $66,800 in 2020. So, having a boatload of cash will not guarantee your long-term financial security. You must make it earn a higher return than inflation.

Furthermore, cash has a huge opportunity cost tag. In other words, by holding a large amount of money, you face the risk of missing out on potential gain from choosing other alternatives.

US Treasuries

US Government bonds have historically been a safe haven for investors during turbulent times. We have seen the demand for treasuries spiking during periods of extreme uncertainty and volatility. And inversely, investors tend to drop them when they feel confident about the stock market. Depending on their maturity, US treasuries may give you a slightly higher interest than holding cash in a savings account.

While offering some return potential, treasuries are still exposed to high inflation and opportunity cost risk. Also, government bonds are very sensitive to changes in interest rates. If interest rates go up, the value of your bonds will go down. On the other hand, when interest rates go down, the value of your bonds will decrease.

Gold

Gold is another popular option for conservative investors. Similar to treasuries, the demand for gold tends to go up during uncertain times. The faith for gold stems from its historical role as a currency and store of value. It has been a part of our economic and social life in many cultures for thousands of years.

As we moved away from the Gold standard, the Gold’s role in the economy has diminished over time. Nowadays, the price of gold is purely based on price and demand. One notable fact is that gold tends to perform well during periods of high inflation and political uncertainty.

In his 2011 letter to shareholders of Berkshire Hathaway, Warren Buffet described gold as an “asset that will never produce anything, but that is purchased in the buyer’s hope that someone else … will pay more for them in the future…..If you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Buying Put Options to hedge tail risk

Buying put options om major stock indices is an advanced strategy for tail risk hedging. In essence, an investor will enter into an option agreement for the right to sell a financial instrument at a specified price on a specific day in the future. Typically, this fixed price known as a strike price is lower than the current levels where the instrument is trading. For instance, the stock of XYZ is currently trading at $100. I can buy a put option to sell that stock at $80 three months from now. The option agreement will cost me $2. If the stock price of XYZ goes to $70, I can buy it at $70 and exercise my option to sell it at $80. By doing that, I will have an immediate gain of $10. This is just an illustration. In real life, things can get more complicated.

The real value of buying put options comes during times of extreme overvaluation in the stock market. For the average investor, purchasing put options to tail risk hedging can be expensive, time-consuming, and quite complicated. Most long-term investors will just weather the storm and reap benefits from being patient.

Final words

Managing your tail risk is not a one-size-fits-all strategy. Black Swam events are distinctive in nature, lengh, and magnitude. Because every investor has specific personal and financial circumstances, the left tail risk can affect them differently depending on a variety of factors. For most long-term investors, the left tail and right tail events will offset each other in the long run. However, specific groups of investors need to pay close attention to their unique risk exposure and try to mitigate it when possible.

10 practical ways to pay off debt before retirement

Pay off debt before retirement

Pay off debt before retirement is a top priority for many of you who are planning to retire in the near future. In my article Retirement Checklist, I discussed a 12-step roadmap to planning a successful and carefree retirement. One of the most important steps was paying off your debt. According to the Federal Reserve, US households owe $4 trillion in non-housing loans and $10 trillion in mortgage debt. In today’s world, it is easy and effortless to get credit. Loan and credit card offers are lurking on every corner.

Why is it essential to pay off debt before retirement?

Being debt-free is a significant milestone in becoming financially independent. Retirement opens a new chapter in new life. You can no longer rely on your working wage. Your retirement income will come from a combination of steady income sources such as social security, pension, retirement savings, and possibly annuities.  Your income will drop, your healthcare cost will rise, and your debt payments will remain the same. Having a large amount of debt during retirement will reduce your disposable income and strain your financial strength.

For those of you who are committed to paying debt before retirement, I have created a multi-step guide that can help you navigate through the challenges of becoming debt-free

1. Set your goals

Setting your financial and retirement goals is an essential pathway in your life journey. Pay off debt before retirement starts with establishing up your goals. Having goals give you structure and will prepare you for the future. If you do not know where you are going, you can end up anywhere. Following your objectives will provide you with essential life milestones. Achieving your goals will give you a sense of accomplishment and boost your confidence.

2. Take control of your spending habits

If you are approaching retirement with considerable debt, you need to rein in spending habits. You can not be a big spender. Therefore, as long as you spend more than you earn, you will need to cut back. I know it is a painful task. It is not easy to make changes to your lifestyle. Still, think of it as a small and responsible sacrifice today so you can live a better tomorrow.

3. Create a budget

If you find yourself spending more than you make, you will need to set up a budget. Numerous websites and mobile apps can help you track your income and expenses by groups, categories, and periods. Regular budgeting can help you steer away from outsized spending and frivolous purchases.

4. Build an emergency fund

An emergency fund is the amount of cash you need to cover 6 to 12 months of essential expenses. Financially successful people maintain an emergency fund to cover high, unexpected costs. Your rainy-day stash can serve as a buffer if you lose your job or lose your ability to earn income. By maintaining an emergency fund, you could avoid taking debt and cover temporary gaps in your budget. Suppose you don’t have an emergency fund. Start with setting up a certain percentage of your wage that will automatically go to your savings account. Don’t get discouraged if it takes a long time to build your rainy-day fund.  It is okay. Look forward and keep saving.

5. Track your loans

Did you notice that the first four steps of becoming debt-free did not involve debt at all? I hope you will agree that building long-lasting financial habits is the key to financial independence.

So, if you have reviewed my first four recommendations, it is time to look at your debt.

Make a list of all your loans – credit cards, auto, mortgage, student, home equity, personal loans. Sort them by amount and interest rate. Pay attention to due dates and monthly interest charges. Do not miss payments. Late or missed payments can trigger enormous late fees and penalty charges. Stay on top of your loans. Track them daily and monthly.

6. Pay off higher interest loans first

I strongly recommend that you pay off your highest interest loans first. Credit cards tend to have the highest interest rates and the most punishing late fees. If you have credit card debt, there is a high chance that you need to tackle it first.  Remember, there are always exceptions to the rules, and every one case is different.

Another popular theory suggests that you pay off your smaller loans first and repay the bigger loans next. The reasoning behind this recommendation is that paying off even smaller loans awards you with the feeling of accomplishment. You can also focus on the big picture once you eliminate the smaller loans.

Mathematically, paying off your highest interest loans makes more sense. Emotionally, paying off the smaller debt first could be more effective. In the end, you can find a happy medium. Use the approach that works best for you and your specific situation.

7. Pay off or refinance your mortgage

I recommend that you pay off your mortgage by the time you retire. Owning your house without the burden of debt is the ultimate American dream and the secret to a happy retirement. In today’s world, there is nothing more liberating than owning your home. Your home is your fortress. It’s the place where you can be yourself. You can host your family and friends and enjoy your favorite hobby.

Now, if you are still making mortgage payments, you may want to look into refinancing options. With record-low interest rates, today offers an excellent opportunity to lower your monthly mortgage bill. It’s certainly will be easier to refinance your mortgage while still working and having regular income and paystubs. I highly recommend that you shop around for the best offer. Banks and mortgage brokers will offer you a wide range of interest rates, closing costs, and refinancing rules. Generally, stay away from bids with high closing costs. Evaluate your savings for each offer and choose the option that best suits your need.

8. Downsize and relocate

Another popular way to control your cost and pay off debt before retirement is downsizing and relocating. Sometimes you can do them both at the same time. Owning a big house requires high maintenance, bills, and possibly higher property taxes. Moving to a smaller home in a more affordable location can save you a lot of money in the long run. The USA offers a wide range of affordable locations in smaller states and communities. Choose a location that fits your budget, health insurance needs, and lifestyle.

9. Work longer

if you are approaching retirement age and holding debt, you may want to consider working longer. Working after retirement is no longer a stigma. Many retirees choose to work part-time, remain active, and earn an extra income.  The additional money can help your pay off your remaining loans. You can use the extra cash to maintain your emergency fund or support your current lifestyle.

10. Do not touch your retirement savings

Your retirement savings are sacred. They are your ticket to financial freedom. It can be tempting to pay your debt before retirement by tapping into your 401k or IRA. However, this strategy rarely ends very well.  Do not withdraw your 401k or IRA savings unless you are in dire need. Hold on to your retirement savings until you exhaust your other options.  One, when drawing from your retirement plan, you will need to pay taxes. Furthermore, you may have to pay a penalty charge if you are younger than 59 ½. Second, paying off debt without controlling your expense will only have a short-term impact. You will be back where you started in just a couple of months or years. And lastly, tapping your retirement savings now will reduce your future income. How confident are you that you can replace your lost revenue in the future?

Benefits and drawbacks to buying Indexed Universal Life Insurance

Indexed Universal Life Insurance IUL

Today, I am going off the beaten path for me and will discuss the pros and cons of buying Indexed Universal Life Insurance. As a fee-only advisor, I do not sell any insurance or commission-based products. However, on numerous occasions, I have received requests from clients to review their existing insurance coverage. I certainly do not know every IUL product out there. And I might be missing some of the nuances and differences between them. My observation is that IUL is not suitable for the average person due to its complexity and high cost. And yet, the IUL might be the right product for you if you can take advantage of the benefits that it offers. 

Retirement Calculator

What is an Indexed Universal Life Insurance (IUL)?

Indexed Universal Life is a popular insurance product that promises protection coverage with stock market-like performance and a zero-downside risk. Like other universal life insurance, IUL offers a death benefit and a cash value. Your cash value account can earn interest based on the performance of a specific stock market index such as the S&P 500, Dow Jones Industrial Average, the Nasdaq 100, and Russell 2000.

IUL Illustration rate

IUL policies use an illustration rate for advertising and hypothetically projecting the policy values in their sales materials. The Illustration rate is the fixed rate derived from historical performance. Usually, the illustration rate ranges between 5% and 10%.

Is IUL right for me?

On the surface, Indexed Universal Life Insurance sounds like a great deal. You receive a stock market upside with zero risks for losses. Nevertheless, IUL comes with some severe caveats.

Let’s break down the main benefits and drawbacks of IUL.

 Benefits of Indexed Universal Life Insurance

Tax-Deferred Accumulation

Index Universal Life Insurance allows you to grow your policy cash value and death benefit on a tax-deferred basis. Typically, you will not owe income taxes on the interest credited to your cash value and death benefit.

Tax-Free Distribution

Life Insurance, in general, is a lucrative tool for legacy planning. With IUL, your policy beneficiaries will receive the death benefit tax-free. As long as you maintain your insurance premiums and don’t take outsized loans, you can pass tax-free wealth to the next generation.

Access to a cash value

You can always withdraw your policy basis (original premiums paid) tax-free. In most cases, you can also access your cash value through tax-favorable policy loans or withdrawals. In case of emergency, you may borrow from your indexed universal life insurance policy. You can access your cash value without any penalty regardless of your age.

Supplemental Retirement Income

You can use the cash value from your policy as a source of supplemental retirement income.  You can also use it to cover future medical expenses.

Limited downside risk

IUL offers protection against stock market volatility. An IUL delivers stock market-linked gains without the risks of losing principal due to the stock market declines. With the IUL’s principal-protection guarantee, your annual gains are locked in. Your principal cash value remains the same, even if the stock market goes down.

A guaranteed minimum rate

Many IUL policies come with a guaranteed minimum annual interest rate. This rate is a floor of how much you can earn every year. The guaranteed allows you to receive a certain percentage regardless of how the market performs. This floor rate depends on the specific insurance, and it could vary between 0% and 2%.

Drawbacks of Indexed Universal Life Insurance

IUL is complex

IUL is an extremely complex insurance product. There are many moving parts in your UIL policy, making it confusing and hard to understand. Most sales illustration packages portray an ideal scenario with non-guaranteed average market performance figures. In reality, between your annual premiums, cap rates, floors, fees, market returns, cash value accumulation, riders, and so on, it is tough to predict the outcome of your insurance benefits.

Upfront Commissions

The people who sell IUL are highly trained sales professionals who may not be qualified to provide fiduciary financial advice. The IUL comes with a hefty upfront commission, which is often buried in the fine print and gets subtracted from your first premium payment.

IUL has high fees

The policy fees will shock you and eat your lunch literally. I have personally seen charges in the neighborhood of 11% to 13% annually. These fees will always reduce the benefits of your annual premium and earned interest.

Limited earnings potential

IUL policies will typically limit your stock market returns and will exclude all dividends. Most IULs offer some combination of participation rate and capped rate in comparison to the illustration rate used in their marketing materials.

Participation Rate is the percentage of positive index movement credited to the policy. For example, if the S&P 500 increased 10% and the IUL has an annual participation rate of 50%, your policy would receive 5% interest on the anniversary date.

Cap Rate is the maximum rate that you can earn annually. The cap rate can vary significantly from policy to policy and from insurance provider to the next.

 Why capped upside is an issue?

The problem with cap rates and participation rates is they limit your gains during, especially good years. Historically, the stock market returns are not linear and sequential, as the policy illustration rates suggest. In the 40 years between 1980 and 2019, the stock market earned an average of 11.27% per year. During this period, there were only eight years when the stock market had negative returns or 20% of that period. There were only seven years when the stock market posted returns between 0% and 10%. And there were 25 years when the stock market earned more than 10% per year. In 17 of those 25 periods, the stock market investors gained more than 20% or 42% of the time.

In other words, historically, the odds of outsized gains have been a lot higher than the odds of losses.

However, as humans, the pain of losing money is a lot stronger than the joy of gaining.

In effect, long-term IUL policyholders will give up the potential of earning these outsized profits to reduce their anxiety and stress of losing money.

Surrender charges

IULs have hefty surrender charges. If you change your mind in a couple of years and decide to cancel your policy, you may not be able to receive the full cash value. Before you get into a contract, please find out the surrender charges and when they expire.

Expensive Riders

Indexed Universal Life Insurance typically offers riders. The policy riders are contract add-ons that provide particular benefits in exchange for an additional fee. These provisions can include long-term care services, disability waivers, enhanced performance, children’s’ term insurance, no-lapse guarantee, and many more. The extra fee for each rider will reduce your cash value, similar to the regular policy fees. You need to assess each rider individually as the cumulative cost may outweigh your benefit and vice versa,

Cash value withdrawals reduce your death benefit

In most cases, you might be able to make a tax-free withdrawal from the cash value of your IUL policy. These withdrawals are often treated as loans. However, legacy-minded policyholders need to remember that withdrawing your cash value reduces your beneficiaries’ death benefit when you pass away.

Potential taxable income

There is still a chance to pay taxes on your IUL policy. If you let your policy lapse or decide to surrender it, the money you have withdrawn previously could be taxable. Withdrawals are treated as taxable when they exceed your original cost basis or paid premiums.

401k contribution limits 2021

401k contribution limits 2021

401k contribution limits for 2021 are $19,500 per person. All 401k participants over the age of 50 can add a catch-up contribution of $6,500.

Retirement Calculator

What is 401k?

401k plan is a workplace retirement plan where both employees and employers can make retirement contributions. These retirement plans can be one of the easiest and most effective ways to save for retirement. As an employee, you can make automatic contributions to your 401k directly through your company payroll. You can choose the percentage of your salary that will go towards your retirement savings, Most 401k will provide you with multiple investment options in stocks and fixed income. Additionally, most companies offer a 401k match up to a certain percentage. In most cases, you need to participate in the plan in order to get the match.

There are two types of contributions – traditional 401k tax-deferred and tax-exempt Roth 401k contributions.

Tax-deferred 401k

Most employees, typically, choose to make tax-deferred 401k contributions. These payments are tax-deductible. They will lower your tax bill for the current tax year. Your investments will grow on a tax-deferred basis. Therefore, you will only owe federal and state taxes when you start withdrawing your savings.

Roth 401k

Roth 401k contributions are pretax. It means that you will pay all federal and state taxes before making your contributions. The advantage of Roth 401k is that your retirement savings will grow tax-free. As long as you keep your money until retirement, you will withdraw your gain tax-free. It’s a great alternative for young professionals and workers in a low tax bracket.

How much can I contribute to my 401k in 2021?

401k contribution limits change every year. IRS typically increases the maximum annual limit with the cost of living adjustment and inflation. These contribution limits apply to all employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Additionally, the limits apply to both tax-deferred and Roth contributions combined. 

  • Employees can contribute up to $19,500 to their 401(k) plan for 2021,  the same amount as  2020.
  • Employees of age 50 or over are eligible for an additional catch-up contribution of $6,500 in 2021, the same amount as  2020
  • The employee compensation limit for calculating 401k contributions is $290,000, $5,000 more than 2020
  • Companies can make a matching contribution up to the combined limit of $58,000 or $64,500 with the catch-up contribution. If an employee makes the maximum allowed contribution, the company match cannot exceed $38,500 in 2021.

Solo 401k contribution limits 2021

A solo 401k plan is a type of 401k plan with one participant. Those are usually solo entrepreneurs, consultants, freelancers, and other small business owners. Self-employed individuals can take advantage of solo 401k plans and save for retirement.

  • The maximum contribution limit in 2021 for a solo 401k plan is $57,000 or $63,500 with catch-up contributions. Solo entrepreneurs can make contributions both as an employee and an employer.
  • The employee contribution cannot exceed $19,500 in the solo 401(k) plan for 2021.
  • Self-employed 401k participants, age 50 or over are eligible for an additional catch-up contribution of $6,500 in 2021.
  • The total self-employed compensation limit for calculating solo 401k contributions is $285,000.
  • Employer contribution cannot exceed 25% of the compensation
  • If you participate in more than one 401k plan at the same time, you are subject to the same annual limits for all plans.

Please note that if you are self-employed and decide to hire other employees, they will have to be included in the 401k plan if they meet the plan eligibility requirements.

 

Roth IRA Contribution Limits 2021

Roth IRA Contribution Limits for 2021

The Roth IRA contribution limits for 2021 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older.

Retirement Calculator

Roth IRA income limits for 2021

Roth IRA contribution limits for 2021 are based on your annual earnings. If you are single and earn $125,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $125,000 and $140,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $198,000.  If your aggregated gross income is between $198,000 and $208,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

Roth IRA allows you to make after-tax contributions towards retirement. In comparisons. Traditional IRA has the same annual contributions limits. The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and take full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

IRA Contribution Limits 2022

IRA Contribution Limits for 2022

The IRA contribution limits for 2022 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older. Contribution limits remain the same as 2021.

Retirement Calculator

What is an IRA?

IRA or Traditional IRA is a tax-deferred retirement savings account that allows you to make tax-deductible contributions to save towards retirement. Your savings grow tax-free. You do not owe taxes on dividends and capital gains. Once you reach retirement age, you can start taking money out of the account. All distributions from the IRA are taxable as ordinary income in the year of withdrawal.

IRA income limits for 2022

The tax-deductible IRA contribution limits for 2022 are based on your annual income. If you are single and earn $129,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $129,000 and $144,000 you can still make contributions but with a smaller amount.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $204,000.  If your aggregated gross income is between $204,000 and $214,000 you can still make reduced contributions.

Spousal IRA

If you are married and not earning income, you can still make contributions. As long as your spouse earns income and you file a joint return, you may be able to contribute to an IRA even if you did not have taxable compensation. Keep in mind that, your combined contributions can’t be more than the taxable compensation reported on your joint return.

IRA vs 401k

IRA is an individual retirement account.  401k plan is a workplace retirement plan, which is established by your employer. You can contribute to a 401k plan if it’s offered by your company.  In comparison, anyone who is earning income can open and contribute to a traditional IRA regardless of your age.

IRA vs Roth IRA 

Traditional and Roth IRA have the same annual contribution limits.  The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. In comparison. Roth IRA allows you to make after-tax contributions towards retirement. Another difference, your Traditional IRA retirement savings grow tax-deferred, while Roth IRA earnings are tax-free.