Tuesday, September 30, 2008

(Guest Post): Missing Out on The Tax Benefits of Retirement Savings

This is a guest post from LAL at "Living Almost Large." LAL is a twenty-something woman in a dual income no kid (DINK) household. As a scientist, she enjoys blogging about finances after hours and looks forward to one day having enough money to do what she really yearns, be her own boss. I wish her luck and hope she gets to own that book store she referenced in her original post or find enjoyment elsewhere.

Many people talk about saving for retirement. Yet I have found very few people actually maximize their retirement contributions. What does that mean? It means very few people actually contribute $15,500 to a 401k annually or $20,500 to a Roth 401k, as well as $5000 to a Roth, Traditional, or Non-deductible IRA.

Instead I hear from a lot of people, I am saving for retirement 10% or 15% and now I want to pay off my mortgage. I think it’s a huge shame! I mean it’s great, but do you realize that once you pay off your mortgage you cannot go back and stuff money into your IRA or 401k for previous years contributions? This is an opportunity that can never be regained. You only have one year to make your contributions to a retirement plan and you cannot contribute after the deadline passes. But they forget about the tax benefits of investing in a retirement plan.

If you invest in a Roth IRA, you can draw out the earnings tax free when you retire. No other plan gives you that benefit. But what if you don’t qualify? Then you should contribute to a non-deductible IRA still. Why? For a couple of reasons, the earnings are tax deferred until you withdraw them similar to a 401k. And while not tax deductible it is tax sheltered.

As for investing the maximum into a 401k, why should you do it? Well you have a 6% mortgage, but you are saving off the top 15% at a minimum on taxes, more likely 25% +! How can you compare paying 6% interest to saving 15% in taxes? That’s a 9% immediate gain, not to mention your mortgage is tax deductible! Personally my DH contributes the maximum annually to a 401k because it saves us 25% federal taxes and 6% in state income taxes. That’s 31%! Yes when we retire, who knows what the tax rates will be, but what if we live in a state without income tax? Or rules changes? Or we draw from our 401k only up until the 15% federal tax bracket and then we use our Roth IRAs? There are many scenarios, but given a chance I’d rather avoid taxes that I know I will occur. So, for these reasons, try to maximize your retirement savings annually. It’s the best return on your money.

Here's a link to the fabulous site "Living Almost Large."


Anonymous said...

People who don't even earn $15,500 per year can hardly be faulted for not saving $15,500 in a 401(k) plan.

Finance Junkie said...

Yes, that's correct.

But, you should be developing yourself professionally so you get promotions, increased job responsibilites and higher income year over year... Eventually, you'll get to the point where you can heavily participate in a 401k, IRA, etc.

Living Almost Large said...

Hi FJ, thanks for allowing the guest post. I greatly appreciate it.

To anonymous, how can you survive long term on $15.5k/year unless you are getting help from the government? I don't think that's a long term solution to living.

Any my point was if you can earn enough to prepay the mortgage