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Should I Contribute to My Retirement Plan?

That's "Should I?" not "How much should I?"

by Rob Bertman, CFA, CFP® in Goals, Retirement
April 19, 2016

Summary

Many financial advisors out there recommend to contribute to your retirement plans as much as possible and as often as possible. Is that good advice for YOU?

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How Retirement Plans Work

You’re probably familiar with a 401k plan, a 403b, IRA, Roth IRA, Rollover IRA, SEP IRA. These are all retirement accounts, and they come in other shapes and sizes. Here’s how they work.

You put money into a retirement account (a “contribution”). There are limits to how much you can contribute depending on the type of account and if you have a certain level of income. Normally, you get a tax deduction against the amount of money you put in. The money in the account grows tax free.

You can take the money out (a distribution) starting when you’re 59.5 yrs old.  Distributions are taxed at income tax rates and the balance continues to grow tax free. With a Roth IRA or a Roth 401k there is no tax deduction upfront, but it still grows tax free, and you can take the money out tax-free.

Companies often have what’s called a “matching” program. When you make a contribution, your company may put in extra money on top of your contribution. That’s like free money.

The Trade Off

When you put money into a retirement account, you lose the flexibility of what you can use it for until you’re 60 years old.

#1 Mistake

But the #1 mistake when deciding if and how much to contribute to a retirement plan is not taking their other financial goals into account.

For example, let’s say a 30 year-old has set goals to be financial independent, to buy a house, and start a business in 5 years. This person has accumulated $100,000 in their retirement account and $5,000 in a savings account. The money in their savings account is the only thing they have to work with right now, because the $100,000 in their retirement account isn’t available until they turn 60. When they turn 60, they’ll be glad to have it, but it’s of no help to them now except if they want to pay the penalty fees which are pretty stiff.

The Solution

First, take the mindset that these “retirement accounts” can be used when you’re 60 years old or older.  I call it “60+ Money”.

Second, if your company offers a matching program, it’s probably good to take advantage of that in some way, shape or form.

Third, think about what financial goals you want to accomplish before turning 60. Savings will need to be dedicated to those goals too.

Retirement accounts offer great benefits but contributions should be balanced with the financial flexibility that you want until you turn 60.

Check out my “Financial Goals Are Boring!” blog for an exercise that will help you uncover what your real financial goals are.

You can also go to www.moneywithimpact.com and download my blueprint. It will walk you through my framework to help you get the most out of your money and reduce financial stress.

I’m here to help you on this journey so please connect with me to learn more and ask questions.

Thanks again for taking the time.  I greatly appreciate it and look forward to talking with you soon.

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Transcript

Many financial advisors out there recommend to contribute to your retirement plans as much as possible and as often as possible. Is that good advice?  Is that good advice for YOU?  Has anyone ever asked the question, “Should I be contributing to my retirement plan?” or even, “Should I put as much as possible into my retirement plan?”

I’ll cover that and will also tell you one of the #1 mistake I’ve seen people make when they decide to contribute to their retirement plan.

Before we get into that, I want to take a step back and talk about exactly what a retirement plan is, how they work, and some of the benefits.

How Retirement Plans Work

You’re probably familiar with a 401k plan, a 403b, IRA, Roth IRA, Rollover IRA, SEP IRA. These are all retirement accounts, and they come in other shapes and sizes. Basically they work like this:

You put money into a retirement account. This is often called a “contribution”. There are certain limits on the amount of money you can contribute in any given year depending on the type of retirement account.  There are also limits to how much you can contribute if you have a certain level of income.

When you make a contribution you can take a tax deduction against the amount of money you put in. Once the money is in the account, as it grows over time, you don’t have to pay any taxes along the way. It grows tax-free which to me is the best benefit of a retirement plan.

You can then take the money out, also called a take a “distribution” starting when you’re 60 years old or so.  At that point, you pay taxes on the amount of money that you take out, and the balance continues to grow tax free. Roth IRA or a Roth 401k is the same concept but works slightly differently. There is no tax deduction as you put money into a Roth, but it still grows tax free.  Since there was no tax benefit when you put the money in, you can take the money out tax-free.

Matching

One of the other big benefits of retirement plans is that companies often have what’s called a “matching” program. If you put a certain dollar amount into these retirement plans, your company may put in extra money on top of your contribution. For example, let’s say that a company has a 50% match.  When an employee puts $2,000 into their 401k plan the company that they work for will put in an extra $1,000 on top of that up to a certain limit. That’s like free money.

So you can see there are great benefits to saving in retirement plans or retirement accounts. The tax benefit and the matching program are some great ones.

The Trade Off

There is a trade off though. When you put money into a retirement account, you really can’t use it except under certain circumstances without a hefty penalty until you’re 60 years old. You’re still getting some great benefits so it can works out fine.

#1 Mistake

But the #1 mistake I’ve seen people make when deciding if and how much to contribute to a retirement plan is that they don’t take into account their other financial goals.

Let me give you an example of how that might work out. Let’s say someone has set financial goals to be financial independent down the road, to buy a house, and to start a business. This person has done a good job saving and has accumulated $100,000 in their retirement account, and also $5,000 in a savings account. This person is also 30 years old.  That means they have 30 years or so until they can touch that $100,000 in their retirement account.

Here’s the problem.  Because that $100,000 isn’t available to them (except under certain circumstances) If they want to buy a house, if they want to start a business, if they were planning to use savings to support their lifestyle while taking an income hit as they build up their, the only thing they have to work with is that $5,000 in their savings.

Don’t get me wrong, when they turn 60, it’s going to be great because they’re going to have these retirement assets available to them.

The Solution

First, take your mindset out of thinking that this money is for retirement. I don’t look at these accounts as retirement plans, because in 25 years or so when I turn 60, I don’t know if I’m going to want to retire at that point. So, I look at “retirement accounts” as money that I can use when I’m 60 years old or older.  I call it my “60+ Money”.

Second, if your company offers a matching program, that’s free money. It’s like your company giving you a raise, and it’s probably good to take advantage of that in some way, shape or form.

Third, go through your goal setting process and say, “What do I want to accomplish before I turn 60?” Then you have to dedicate savings to those different goals along the way, whether it’s buying a house, starting a business, or paying off some debt. This money could be saved in certain accounts that will get you there as efficiently as possible.

Now again, retirement accounts have a great benefit. You get the tax deductions and the tax-free growth along the way. All of that and that’s wonderful, but you also need to balance it with the financial flexibility that you want in your life over the next 30 years to accomplish certain goals or milestones before you turn 60 years old.

If you need help figuring out what your financial goals are, I did a blog awhile back call “Financial Goals Are Boring!” Check that out to get an exercise that will help you uncover what your real financial goals are.

Also, when you go to www.moneywithimpact.com, I have a blueprint that you can download which will walk you through my framework  to help you maximize your money and figure out how you should be spending and saving your money in a way that’s going to get you the things you want out of life today, but also set you up for tomorrow.

Please connect with me and ask me questions. You can reach me on Instagram & Twitter @BertmanRob. I’m also on Facebook and LinkedIn. If you like to email, you can send me an email at rob@moneywithimpact.com.

Again, please ask me questions, I’m here to help you on this journey.

Thanks again for taking the time.  I greatly appreciate it and look forward to talking with you soon.

Thanks!