Whether your retirement unfolds as a beautiful dream or a scary nightmare depends largely on the financial decisions you make today. But if retirement planning is brand-new to you, you’re not alone.
The average working household has very little cash saved for retirement and about 45% of working-age households have no retirement savings at all, according to the National Institute on Retirement Security.
However, you still have time this year to start building a retirement fund and gain a tax advantage in the process.
Calculate Your Target
How much will you actually need for retirement? Chances are, quite a lot. Retirement may last anywhere from 15 to 20 years or more, and you’ll need somewhere between 70% and 90% of your pre-retirement income annually to live comfortably.
Don’t count on Social Security to cover this; many people experience some shortfall. To determine yours, contact the Social Security Administration online or call 1-800-772-1213 for a benefit estimate. Factor in retirement accounts you already have, as well as how expenses might change after retirement. To close your gap, you’ll need to save $15 to $20 for each annual shortfall dollar. So an annual shortfall of $25,000 means you’ll need to save between $375,000 and $500,000 before retirement.
Tax-Advantaged Retirement Strategies
There are various types of savings plans that let you save on your taxes while you get ready for retirement.
IRAs: Individual retirement accounts come in many forms, including CDs and mutual funds. In any case, two basic structures apply:
- Traditional IRAs: Contributions aren’t taxable until you withdraw funds during retirement, which can dramatically reduce what you owe the IRS this year. By the time you withdraw cash, you’ll likely be in a lower tax bracket.
- Roth IRAs: If you won’t owe much to Uncle Sam this year, consider a Roth IRA. The money invested remains taxable as income this year, but then grows tax-free.
Both IRA types have a basic contribution limit of $5,500 annually (with the exception of qualified reservist repayments and rollover contributions). If you’re 50 or older, however, you’re allowed to make additional catch-up contributions of $1,000 each year.
401(k) plans: These employer-managed plans often match employee contributions up to a set limit, which translates to free retirement money for you. Unless your plan is specifically a Roth 401(k), your contributions are deducted from your federal income, resulting in a nice immediate tax break. Like traditional IRAs, when you make retirement withdrawals, the money is taxed as income. When planning your retirement savings, make sure to take full advantage of any employer 401(k) match that’s available before putting money into other types of plans.
Health savings accounts: HSAs don’t generally come to mind during retirement planning, which is a shame because if you’re enrolled in a high-deductible health insurance plan, they can provide a tax break today and help to make retirement more comfortable down the road. Payroll deductions for HSAs are pretax, and individual contributions are tax-deductible, up to the annual limits of $3,350 for individuals and $6,750 for families. Then, to sweeten the deal, any interest earned on these accounts is tax-free, and you can make tax-free withdrawals anytime for qualified medical expenses.
If you’re wondering what this all has to do with retirement, there’s no limit on carry-overs or when you have to withdraw funds. This means you can invest annually in an HSA, receive a tax break right away, and reserve the funds to use tax-free for medical expenses during retirement.
Once you’ve reached the contribution limits for tax-advantaged retirement investment options, you can explore alternative retirement savings options, including money market accounts, CDs and cash-value life insurance, to make sure your shortfall is covered. With the right planning and discipline on your part, you can achieve your best possible tax outcome this year while ensuring a comfortable tomorrow.
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I found out when entering tax information that HSA’s are not allowed if you have Medicare. I have contributed to one for the last 2 years – unaware of this rule. What are my options for avoiding taxes and penalties? (I just turned 70 in October. Can I switch the money to an IRA for 2019 taxes?)
Beverley: Thank you for reaching out. You will need to check with a certified Tax Professional to find out your options for your HSA account.