On the radio, Java and I sat down to discuss the ever-looming topic of retirement. This itself is a big topic with a ton of branches, but the callers made the show (as ever). We had calls about mortgages, getting kids interested in investing and some technical points about retirement accounts. I'll break down the show here, and flesh out some of these topics later!
The Alphabet Soup of Retirement Accounts
To start, we had to discuss the jargon that everyone encounters when opening accounts. There are IRAs, Roth IRAs, 401(k)s, SIMPLE and SEP IRAs, 403(b)s and governmental 457s, to name a few. The important thing to remember is that there are essentially three styles of account:
- Regular/Taxable. This is just a plan vanilla account. It can be in your name or you and a partner (individual or joint). There are generally no special tax rules or limits for putting money in or taking it out. You get no tax benefit to put money in, and none for taking money out. It is like a bank account where you only have to pay taxes on the income within the account. If you invest this money, there may be some tax advantages depending on what you invest in, some bonds pay interest tax-free, most stocks and stock funds grow and the gain that you earn isn't taxed until you sell it, giving you control of when you owe your taxes, and may have a favorable tax rate on that gain.
- Tax Deferred. This is an important one to retirement as it is classically the style of most employer retirement accounts like the traditional 401(k). Like the name suggests, this account allows you to defer income for tax purposes. You put money in this year, reducing your income for tax purposes and saving money on your taxes. You can invest the money and let it grow tax free while you don't need it. When you take money out in retirement, it counts as income. Since this account has special tax benefits, it also has tax limits. You are limited in the amount you can actually defer, and there are penalties for taking money out before retirement age.
- After Tax or Tax Free. This is a Roth style account and its tax treatment is the reverse of the tax deferred account. You put money in after you have paid taxes on it, it is tax free all while it remains in the account, and you do not pay taxes on qualified withdrawals. This is another style of retirement account and is becoming a more common feature of 401(k)s as well. Since there are special tax benefits, there are also limits on how much you can contribute and rules on when you can take the money out.
If you talk about retirement accounts, you have to cover the updated contribution limits for 2019. We have written about those previously here, but they bear repeating:
- IRA contribution limits, for Roth or Traditional, are $6,000 with a $1,000 additional catch up if you are over 50.
- 401(k) and similar plan employee contribution limits are $19,000 with a $6,000 additional catch up if you are over 50. The maximum, including employer contributions, is $56,000.
- SIMPLE IRA employee contribution limits are $13,000 with a $3,000 additional catch up if you are over 50.
Retirement Checkpoints!
One our first callers asked about savings checkpoints. How much should you save for retirement and how much should you have at certain ages. I cited the JP Morgan Guide to Retirement which is a great resource for understanding how to view the financial aspects of retirement.
In general, the amount to save and the amount you need will depend on how much you will be spending and how long you plan on living. This translates to higher earners needing to save a higher percentage of their income, and having higher savings checkpoints, than lower earners. The reason for this is that Social Security will replace income for everyone, but due to income limits and progressive calculation, it replaces a higher proportion of income for lower earners. The charts in the Guide to Retirement can give you an idea of where you might fall on the spectrum.
In general, we recommend that people save 15% of their income for retirement. The general idea of this is that if you save and invest 15% of your income over a working career of 35-40 years, with investment returns around 6%, you will be able to support your previous lifestyle entirely out of what you have saved. There are obviously a ton of variables here, and the calculation will be different for you, but that is the general idea.
Annuities in Retirement Accounts?
I told a caller that this is generally not a great idea. There is a weird little benefit to keeping annuities in retirement accounts when it comes to RMDs, but I generally find that is not worth the expense of the annuity in the first place.
He said that his annuity had a guaranteed 7% return. While I don't know the details of his policy, it is important to know that annuities are not the same as a fund, where you own the money. An annuity is a contract. It being a contract allows the issuing company to guarantee returns and distributions, but it is not the same as someone guaranteeing that you will get a guaranteed return on an account that you own and can put your hands on the money. Like any contract, there may be strict strings and limits that allow the bells and whistles to sound so appealing.
As always with annuities, read the fine print and get a second opinion.
Who Makes This Up Anyway?
A caller from deep in North Alabama (thanks for listening, Ginger!) called with a problem. She had a hard time finding contribution limits to her retirement account and wasn't sure she was contributing the right amount!
The IRS sets these limits, and while they get a bad reputation for customer service, their website is fairly straightforward if you know what you are looking for. Most things you will be able to find a black and white answer to a specific question. There are both maximum amounts that can go in, and limits that relate to your income. See the above information on contribution limits if you are interested.
How To Buy A House When You Have Student Loans?
I'm sure proud of our caller Denise, who called in ready to buy a house. She had student loans, and wasn't sure how that would affect her getting a loan. While there are several different companies setting different standards for mortgage loans, treatment of student loans in the calculations have generally gotten more generous. She mentioned that she was on an income based plan (which limits her loan payment as a percentage of her income) and was eligible for some forgiveness (which would lower her overall debt burden at some point). Having a mortgage broker who took all this into account would be important to her.
For your specific situation, do what I recommended to Denise and call a mortgage broker (or two, or three!) to see how much house you can afford and what the terms of the mortgage might be. Bear in mind that some mortgage brokers may have different areas of expertise, so finding one that is a good fit and experienced with your unique situation is fairly important!
Giving Kids Money
We had two calls on the topic of how to give money to kids. One was a parent and another a grandparent. Trisha asked about the appropriateness of setting up a roboadvisor account for her children. Roboadvisors are great tools for getting people into the good habits of investing. They take care of most aspects automatically and often display account information in a very informative way. My experience is mostly with Betterment, one of the largest and best known roboadvisors out there. I noted that while there are some problems to be considered, Betterment was probably a good choice for what she wanted to accomplish. Without a lot of background knowledge, you can set up an automatic draft to fund the account, set goals and get guidance on how to attain them and have the account automatically invested in line with the goals and tolerances of the account owner. Downsides include excessive trading leading to a lot of paperwork at tax time and the potential for big changes without you getting a heads up.
Tim called in wondering what the best account for starting his grandchildren's savings would be. He didn't want to save strictly for their college education, so he didn't need a 529. I recommended that he look into opening a custodial account, where he would be the "custodian" of the child's money before they reached the age of majority. The money is theirs, but a responsible adult is in charge of it. I noted that there were disadvantages to this sort of account around the time they apply for financial aid, but that otherwise, it was probably the easiest way to designate money for them.
Don't forget to tune in or subscribe to Money Talks at 9 AM every Tuesday on Mississippi Public Broadcasting, or online at http://www.mpbonline.org/moneytalks/. This episode is available online.
