By Marcia Mantell, RMA
For the last 40 years, we’ve learned to save for retirement using our employer plans. Saving for retirement is, of course, very important, as most of us will be on our own to create our retirement paychecks. However, it is no longer sufficient to save for retirement only in a 401(k) or 403(b).
If you want to maintain your general standard of living in retirement, you’re probably going to be better off modernizing your savings strategy. You should save more than you think you need. And save in multiple different “buckets” earmarked to address specific retirement expenses or goals.
Many near-retirees have been too busy during their career years to notice how dramatically the retirement savings landscape has changed. Each person’s retirement savings strategy now needs to account for spending that is not best served through a 401(k) or 403(b).
So, where should you start to lay out a new blueprint of your retirement financial house?
Start here: Understand spending in early retirement years
The focus of retirement financing over the past few decades has been on accumulating assets. Today, the focus needs to be on how much you’ll be spending. It’s about your cash flow when there’s no paycheck. The amount you’ll need to accumulate for retirement is based on the bills you’ll have to pay. And the places you want to go. And the grandchildren you’ll love to spoil.
A variety of current research studies and analyses have revealed that during the early retirement years, we continue to spend at a good clip. Sure, we might scale back commuting costs and dry-cleaning bills, but we now have free time. And, free time costs money. These studies show that eventually we scale back spending as we age, but don’t plan on it in those first years of retirement. Most anecdotal and quantitative findings show that it isn’t until around age 75 that we take the first big step back in our spending.
So, the question becomes, how are you going to successfully pay for your retirement in the first 10 to 15 years, assuming you will spend about the same as while you were working, then stretch the rest of your savings over the next 20 years or so?
One answer: Build specific savings outside of that 401(k) or 403(b)
We can no longer afford to pretend that retirement will be cheap. There are simply too many financial obligations to juggle in retirement:
· Housing costs continue to be the top area of spending throughout retirement.
· Health care tends to increase along with age. The costs are significant and escalate fast.
· Retirement needs usually include travel (when it comes back), technology, and traditions, costing a pretty penny to stay connected with friends and family.
· Then, there are all the basics of living, plus taxes.
It may be impossible to save enough for all you need and want using just your employer plan. You’ll certainly want to take full advantage of the company match, but beyond that, where should your savings dollars be directed?
Let’s look at four reasons you should be saving more outside of your 401(k) or 403(b).
Get better tax advantages for future health care spending using an HSA
The Health Savings Accounts (HSAs) have become an important account for defraying many different health care costs before and during retirement. They are triple tax-advantaged accounts that many employers now offer to their employees, or that you may be able to enroll in, so long as your health insurance policy is a “high-deductible health plan” or HDHP.
An HSA is similar to both a 401(k)/403(b) and a regular checking account. You put money in on a tax-deductible basis, so you lower your taxable income (like your traditional 401(k)/403(b) contributions). Plus, any withdrawals to pay for qualified health care expenses come out tax-free (like your checking account). And even better: if you choose to invest any of your HSA savings, any earnings grow tax-free.
Depending on your family situation at any given time, an HSA will act more as a tax-advantaged “flow through” account to pay for current medical bills or more as a saving and investment account for your future health care needs in retirement. How you use your HSA can change over time, and if you can use it as a saving and investment vehicle, it has more tax-advantages than simply saving for retirement health care expenses in your 401(k) or 403(b).
Offset taxable retirement income with a bucket of tax-free money
Most people like the benefits of saving in their employer’s plan because every dollar they contribute reduces the amount of income they pay tax on. But that is only temporary. At some point in the future, it comes time to pay taxes on your hard-earned savings. And, long-term savers are none too happy to be paying taxes in retirement.
But, all regular (non-Roth) contributions to your 401(k) or 403(b), plus all the growth from your investments, are tax-deferred contributions and will be subject to tax in retirement.
A solution to future tax obligations in retirement is to build a bucket of future tax-free assets. Saving outside the plan in a Roth IRA can help lower your tax obligation in retirement. Most everyone is eligible to convert existing, traditional IRA money to a Roth IRA and pay the tax bill the year of the conversion. Or, save directly in a Roth IRA each month or year, if your earnings are under the required amounts.
Having tax-free assets in retirement can help offset the taxable income you will have from distributions from your 401(k) or 403(b), Social Security payments, pension income, income annuities, investments in taxable accounts, etc. And, having a bucket of tax-free money gives you additional flexibility for withdrawing money and for estate and legacy planning. Plus, Roth IRAs do not have required minimum distributions for the owners.
Create more pension-like, guaranteed income
Retirees who have traditional pensions, Social Security, and their own savings have the highest probability of financial success over a long retirement. They are confident they won’t outlive their money. Assets in a 401(k) or 403(b) do not guarantee that you’ll always have money. To get a stream of guaranteed, pension-like income, you need a financial product with guaranteed income. One to consider is the deferred income annuity (DIA).
How DIAs work: Take a chunk of your current savings and park it with an insurance company. You decide when to start receiving future income, generally 10, 20 or 25 years from your purchase date. So, if you are 65 today, you can use your own savings and investments for income until you are 80 (your first 15 years of retirement), then “turn on” your DIA to deliver monthly income as long as your retirement lasts. There are a variety of options with DIA’s such as guarantee periods and joint ownership.
This is a different path to consider, with a longer view for creating your retirement income. The idea of a DIA is appealing to many who recognize that abilities and capabilities in the later years may diminish. Locking in a guaranteed income stream that starts when you’re in your 70s or 80s may be worth consideration.
Pre-pay your early retirement years
In these uncertain times, it’s more important than ever to think about the possibility of retiring early. It may not be in your control. And, in many cases, early retirement comes well before you should ideally claim Social Security or tap your 401(k)/403(b). Take the opportunity now to create a savings strategy where you are “pre-paying” a couple of early retirement years.
To employ this strategy, you need to know how much you’ll spend each year in retirement. If you’ll spend $50,000 this year, plan on spending $50,000 the first year in retirement. Assuming you do not want to start taking distributions from your tax-advantaged retirement accounts, or limit the amount you have to draw to protect future income, you’ll need short-term investments available.
Start saving outside your 401(k)/403(b), accumulating what you’ll need to pre-pay the first year or two of early retirement. Your state municipal bonds or bond funds may be an investment option to consider. Or other liquid investments that hold their value in the short-term.
It’s about the prioritization of your savings dollars
As with most things in life, moderation and prioritization are key approaches that can lead to success. There are many more savings vehicles available today than ever before. It’s important to explore if you can squeak out more of your cash flow to save in new accounts or if you should consider reducing your 401(k)/403(b) savings in order to redirect some of those savings dollars to different accounts.
In short, our retirement financial households have evolved well beyond just saving in a company retirement plan. It’s time to look at specific savings “buckets” for specific expenses or income needs in retirement. In this complex world of retirement financing, it’s important to look at your spending buckets and prioritize where you are putting your savings dollars.
About the author: Marcia Mantell
Marcia Mantell, RMA®, NSSA®, is the founder and president of Mantell Retirement Consulting, Inc., a retirement business development, marketing & communications, and education company supporting the financial services industry, advisors, and their clients. She is author of “What’s the Deal with Retirement Planning for Women?”, the newly published “What’s the Deal with Social Security for Women?” and blogs at BoomerRetirementBriefs.com.