For most people, the days of working for a single company their entire lives are over! Employees can switch organizations or change careers without it completely affecting their financial future.
This shift began when changes were made to the retirement system. The responsibility of planning for the future and growing a nest egg switched from employer to employee.
In the past, most employees would work for a single company throughout their career. The longer they stayed with a company, the more they would receive during retirement. This encouraged them to continue trading their time for money. They knew that one day they would be able to stop working and still could pay their expenses with defined monthly benefits (also known as a pension).
Today, most companies don’t offer pensions. The ones that still do, are phasing them out because they’re a huge liability.
The retirement system switched from defined benefits to defined contributions. Now, most companies match part of the contributions an employee makes to their retirement account. But unfortunately, some don’t help their workers at all!
The burden of planning for retirement is yours! The lifestyle you’ll live during your Golden Years will get determined by how you manage your money today and in the years to come.
But, there’s a catch. This change took place decades ago, but the education system was never updated to account for it. Workers have more financial responsibilities than ever before and most have limited knowledge of how to grow their nest egg.
There are many types of retirement accounts available to workers. They all will help you to create wealth and reach your financial goals but it’s important to realize that some are more advantageous than others.
The IRS was extra creative when they came up with the name of traditional retirement accounts. They pulled it straight from the area of the tax code that deals with them, Section 401(k)!
These accounts are company-sponsored. Employers are responsible for setting them up and offering them to their workforce.
For most workers, these retirement vehicles have the highest contribution limits. Also, most company’s match a portion of the money that an employee puts into the account.
For example, imagine your employer matches up to 5% of your contributions. You put in 5%, they put in 5%. That’s free money and an instant 100% rate of return. There is no reason not to take full advantage of your company’s match!
The amount of money an employer contributes will vary. Contact your HR Department to find out what your company offers. Then contribute at least that amount!
There are two main types of employer-sponsored retirement plans. They are a Traditional and a Roth 401k.
This retirement account is the most common. It’s a tax-advantaged plan where the contributions get made using pre-tax money. Since you don’t pay taxes upfront, the money that’s put in reduces your earned income. This helps you stay in a lower tax bracket and cuts down your 2nd largest expense, taxes!
The money that’s invested in a Traditional 401k grows tax-free. When it’s withdrawn, It gets taxed at ordinary income rates.
Most Traditional 401k’s offer limited investment options. Many only offer target-date funds or mutual funds, which can have high total expense ratios. Over time, these fees can add up and reduce the size of your nest egg!
The money that’s put into this account is tax-deferred. It grows tax-free and gets taxed when the funds are taken out.
Under certain conditions, some people will have access to their Traditional 401k at age 55. The Rule of 55 allows them to start pulling money out penalty-free.
But, most people won’t be eligible to take withdrawals until they’re 59 ½. If they do take early withdrawals, they’ll pay a large penalty. This punishment discourages most employees from reaching early financial freedom!
Traditional 401Ks have Required Minimum Distributions (RMDs). The IRS demands that you start taking money out of 401Ks at age 72. These withdrawals can increase your future tax liability and are required regardless of whether you need the money or not!
Roth 401k
Roth accounts get funded using post-tax money. The taxes get paid upfront and then the capital grows tax-free.
Roth 401k contributions aren’t deducted from your earned income. Instead, the gains inside the account grow and get withdrawn tax-free!
Roth 401k’s have RMDs, too. But, these accounts can get converted to a Roth IRA to avoid them.
The amount you can contribute to a Traditional 401k and a Roth 401k are the same. The current limits are:
Both a Traditional and a Roth 401k offer some flexibility. They allow you to take early withdrawals penalty-free in some situations. Also, they can be rolled over into an IRA when you leave an employer.
Most 401k based retirement accounts have limited investment options. But, IRAs give you more possibilities. They allow account holders to own most products that Wall Street offers.
Everyone that has earned income in a given calendar year can fund an IRA. You can contribute to an IRA even if you put money into an employer-sponsored plan!
The current IRA contribution limits are:
The two main types of IRAs are Traditional and Roth.
Everyone that has earned income can contribute to a Traditional IRA. Under certain situations, the contributions you make to it are tax-deductible, too.
But, in most circumstances, Traditional IRAs are tax-deferred and get funded using pre-tax money. The account grows tax-free and will get taxed when money gets taken out.
The rules for pulling money out of a Traditional IRA are like those of the Traditional 401k. They have a 10% penalty on withdrawals made before age 59 ½. Also, all money that’s taken out of it is subject to ordinary income taxes.
Traditional IRAs have RMDs, too. Distributions must start at age 72. If the account holder fails to take them, they’ll pay a 50% penalty of the amount they didn’t withdraw!
There are some situations where these funds can get taken out early and penalty-free. Check out this list of special circumstances on NerdWallet to find out more.
The main difference between a Traditional and a Roth IRA is taxes. A Roth gets funded using money that is taxed upfront. These funds grow and get withdrawn tax-free!
You must qualify to contribute to a Roth IRA. It has income limits which affect the amount you can put in it. The current Roth IRA income limits are:
If you make these amounts or higher, you’re not eligible to make Roth contributions.
Roth IRAs are one of the most flexible retirement accounts. They don’t have RMDs and they give individuals access to their money well before retirement age!
Owners don’t have to wait until they’re 59 ½ to withdraw their principal investment. They can withdraw their capital penalty-free once it has been in the account for 5 years!
There are even some instances where you can access this money earlier. A few of these examples include paying college expenses, buying your first home, and more!
Roth IRAs are helpful when you’re planning for the future, too. They can be used as part of your early financial freedom strategy and they allow individuals to pass their legacy on in a tax-efficient manner. In most cases, beneficiaries of these accounts won’t pay taxes on the contributions or earnings when they’re withdrawn!
Another reason you should consider Roth accounts is future tax rates. No one knows for sure what will happen. But, if the government continues deficit spending it could be a good sign that they’ll be higher!
Most people don’t consider this account as a way to grow their nest egg. But, it can be the most powerful retirement account of them all!
An HSA helps to grow your nest egg because it’s tax efficient. The contributions get made using pretax money. Then it grows and gets taken out tax-free! The only stipulation is that withdrawals must be used for eligible products and qualified expenses.
Many people use an HSA to pay for their medical expenses. But, it can also act as an investment account. An HSA allows you to use the money inside it to buy and hold assets!
This retirement vehicle is like a Roth IRA in that you must qualify for it. Account owners must have a high deductible health insurance plan to be eligible to contribute to it. If you’re unsure if you do, contact your HR department or health insurance provider.
Some people confuse an HSA with a Flexible Spending Account (FSA). The latter requires that you spend all the contributions each year. But, an HSA allows you to roll money over from one year to the next.
Many of my coaching students contribute to an HSA. They use it as an investment account and choose to pay their medical expenses out of pocket. It allows their nest egg to grow and compound tax-free!
Two great companies that offer HSAs are Lively or Fidelity. Both allow you to buy securities and they have zero monthly fees!
A great benefit to the HSA is that you don’t pay penalties for early withdrawals. But, the money must get used on a qualifying purchase.
Individuals that need to access this account for ineligible expenses are subject to a 20% penalty and will pay ordinary income taxes. But, once you turn 65, the 20% penalty gets eliminated.
HSAs are one of the most underused retirement accounts. Not only will they allow your nest egg to grow in the most tax-efficient way possible. They’ll also help reduce one of most people’s biggest fears as they age, rising healthcare costs.
Most people only invest in their employer-sponsored plans to grow their nest egg. One drawback of these accounts is that they limit your investment options and keep you confined within Wall Street.
Self Directed accounts give you the most investment options. They allow you to invest in almost anything. You can use them to buy stocks, businesses, real estate, mortgages, and more!
All my retirement accounts are self-directed. They give more control and freedom to invest in assets that I know and understand. I’m not forced to buy products that are confusing, I have limited control over, and have high total expense ratios!
If you want more options to grow your nest egg, then contact your IRA provider. Find out if they offer self-directed retirement accounts. If they don’t, contact NuView Trust or Millennium Trust and get yours set up!
The best way to grow your nest egg is to contribute to several retirement accounts. They provide tax benefits now and in the future. These plans help your money to grow efficiently and compound into larger amounts.
Start planning for the future and growing your nest egg today. The sooner you begin, the quicker and easier it will be for you to reach your financial goals!
What are you doing today to grow your nest egg? Comment below.
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