Don't Mess With Taxes

You don't need a golden goose to have a great nest egg for retirement. You just need to contribute to one or more tax-favored retirement accounts. (Photo by 401(k) 2012 via Flickr)

Congratulations to America's newest billionaire, the owner of the ticket bought in South Carolina that matched all the Mega Millions lottery numbers. That person is $1.537 billion richer, or more probably an $878 millionaire, since that's the cash payout amount.

That lucky lottery player won't have to work another day or worry about retirement as long as he or she isn't a total spendthrift.

Most of the rest of us, though, gotta keep grinding away. And socking away cash for when we finally call it career quits.

My post earlier this week about the tax treatment of the most common retirement plans got me thinking about all the options here.

Apparently, more people also need to consider how they, too, will pay for their post-work years.

Not enough golden years savers or savings: A National Institute on Retirement Security (NIRS) report issued last month found that the retirement savings of U.S. workers are woefully inadequate.

How woeful? NIRS points to analysis of U.S. Census Bureau data from 2013 that reveals almost 60 percent of a working age individuals that year did not have any money in a retirement account.

That's right. Zero. Zilch. Nil. Nada. Nothing. Not a red cent.

Even when folks are given a way to save at their job, they're not taking advantage.

NIRS' aptly named Retirement in America: Out of Reach for Most Americans? analysis also reports that 57 percent, or more than 100 million, of working age individuals do not own any retirement account assets in an employer-sponsored 401(k)-type plan, individual retirement account or pension.

And those that have saved aren't doing that well. Four out of five working Americans, says NIRS, have put away less than one year's income in retirement accounts.

Why we don't save: The lack of retirement savings probably is because too many of us need every dollar we earn to cover our current daily expenses. That's a blog post for another time on asking for raise, looking for a new job and/or budgeting.

Also, for many, retirement seems so, so far away. Trust me. It catches up with you pretty darn fast!

But another reason folks don't save for retirement often is because they are overwhelmed by the options.

I get it. Too many choices frequently produce paralysis when it comes to picking one. You don't have the time or feel confident enough to evaluate all the possibilities.

To help a little bit, here's a look at 5 popular retirement savings options and, of course, the tax benefits each offers.

1. Traditional IRA: An IRA is a tax-favored retirement account into which you put money that grows until you're ready to use it in retirement. With a traditional version of an individual retirement arrangement (and yes, that's official name, not individual retirement account), your contributions tax deferred. That means you don't pay any taxes on your investment earnings. 

Depending on your income and whether you have a retirement account at work (or, if you're married, your spouse's workplace retirement option comes into play here, too), you might be able to deduct your IRA contribution from your annual taxes.

You are limited in how much you can put into your IRA each year, with older savers getting to make a $1,000 catch-up contribution.

And eventually you do have to pay tax on your retirement money when you withdraw it at 59½ or older. And when you turn 70½ you must take a required minimum distribution (RMD). As the name indicates, this is at least as much as Internal Revenue Service calculations say you must take out of the tax-deferred retirement account so that Uncle Sam can finally get his tax cut.

2. Roth IRA: A Roth IRA also allows you to put an annual amount into this tax-favored retirement account, again with older folks getting to add more. But the money that goes into a Roth is already taxed. That means no tax deduction on the contributions.

But the tax code makes up for that by allowing you to withdraw your Roth IRA money in retirement tax-free. Even better, you can take it out on your timetable. There's no RMD for a Roth.

Because of the tax-free component, Roth IRAs are great for young workers, who can sock away beaucoup bucks and never worry about paying tax on the retirement funds.

For more detail on the differences between the two IRA accounts, check out Time to choose between a Roth or traditional IRA. It's an older post, so the dollar amounts have changed over the years, but the tax processes and advantages are still the same.

3. 401(k) workplace defined contribution plans: The days of your boss totally taking care of your post-work needs with a pension are gone. Those retiree payouts, known as defined benefit plans, have largely been replaced by defined contributions plans. The name says it all: contributions, mostly yours, go into a savings account at work that gets tax benefits to encourage you to save for retirement.

These commonly are called 401(k) plans if you work for a for-profit company. If you're employed at a nonprofit or are a teacher, this type of workplace retirement account typically is referred to as a 403(b). Similar accounts for government workers are called 457(b) plans.

Regardless of the tax-code section that provides these retirement options with their names, these accounts let you contribute a portion of your pay before taxes are taken out each pay period. That helps lower your tax bill since there's less money to be taxed. That 401(k) money then grows tax-deferred.

While you are primarily responsible for shoring up your 401(k), many employers match their workers' plan contributions, typically up to 6 percent. Make sure you contribute enough to get your company match. If you don't, you're basically throwing away free retirement money.

Some companies offer a Roth 401(k). As with IRAs, the money you put into a Roth workplace plan is already taxed, meaning its earnings grow tax-free. But, as with the Roth IRA, as long as you meet the withdrawal rules, your earnings in a Roth workplace retirement plan are tax-free.

Regardless of which type of workplace defined contribution plan you have, check out these 7 ways to make the most of your 401(k).

4. Self-employment retirement plans: If you work for yourself, you probably are focused on making your business or freelance effort a success. But you also need to look to the day when you won't be the boss any longer. That means opening and contributing to a self-employed retirement plan.

One of the easiest options for a sole proprietor is a SEP (for simplified employee pension) IRA. A SEP IRA operates essentially like a traditional IRA for tax purposes. You contribute a portion of your income to your retirement account and fully deduct them from your income taxes. The maximum annual contribution limits are higher than many other tax-favored retirement accounts. Plus, once created, SEP IRA administrative responsibilities are minimal.

Other popular self-employed retirement plane include SIMPLE (for Savings Incentive Match Plan for Employees) IRA and a solo 401(k).

My earlier post 3 popular retirement plans for the self-employed has more on these retirement saving options, how to open them and how much you can contribute to each.

5. Health savings account (HSA): Yes, this is a savings account connected to your medical insurance, specifically a high deductible health plan (HDHP). But this health-related account can provide another way to save for retirement.

Those with certain high-deductible policies can save money tax-free in an HSA. These funds help you cover the larger deductible portion of the associated medical coverage. The HSA is yours to keep even if you no longer have the HDHP or make contributions to the account.

Why hold onto an HSA? From a medical perspective, you can still use the HSA money to reimburse yourself tax-free for qualified medical expenses until the account is empty.

And once you turn 65, it essentially becomes a retirement account. You can withdraw your HSA money for any reason without penalty. You will, however, have to tax income taxes on money.

Finally, don't confuse HSA with FSA, a flexible spending account. Although both are related to medical expenses and offer tax breaks to the account owners, they are different.

Inflation factors into retirement accounts: In most cases where you get a tax break for contributing to your retirement, the IRS sets limits on how much you can put into the accounts. 

The amounts are adjusted each year, usually in the fall, for inflation. The 2019 figures should be released by the IRS soon.

This year's retirement plan inflation changes were issued before the Tax Cuts and Jobs Act (TCJA) was enacted, but luckily for us and the IRS, those 2018 amounts weren't affected by the tax reform law. 

The HSA inflation information is on a different schedule, usually coming out in the spring. Still, new TCJA revisions forced the IRS to change, then change back, the 2018 HSA and HDHP limits. Shortly after that tax pas de deux, the IRS issued the 2019 HDHP and HSA inflation adjustments. 

Yeah, despite my railing on the horrors of too much information when it comes to retirement options, this still is a lot. Sorry.

But it's worth sorting through. If you need help, a tax professional will be happy to walk you through the retirement plan that's best for your situation, finances and taxes.

And by picking a plan (or two or more!), you'll know you won't have to worry about how to fund the kind of retirement you want.

You also might find these items of interest:

• 5 things to consider in choosing workplace benefits
• Rethinking retirement as traditional 3-legged stool wobbles
• Tapping retirement accounts early is a dangerous trend among young savers

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