This is the second part of a two-part article on 401(k) Tax Mistakes
In the first part of this article on 401K mistakes (here), we discussed the fact that overdoing your 401k contributions can cause you tax troubles down the retirement road. Because this is not an obvious mistake, it tends to sneak up on you.
By way of review, in a typical pre-tax retirement plan, you benefit from laws providing a deduction when you make a contribution. You actually experience a double benefit: whatever you contribute serves as a deduction from your normal income and your savings and investments are tax-deferred earnings. Your money grows unscathed by taxation each year until you want it or need it (after age 59 1/2), and then you pay taxes at prevailing tax rates.
The problem arises when you’ve created a retirement plan that is out of balance; and, you do not have sufficient retirement resources in after-tax investments. When all your savings are in tax-deferred accounts, you’ve just sentenced yourself to pay taxes each and every time you need income or a withdrawal!
Don’t misunderstand, I am a proponent of saving taxes, but I believe even more in utilizing solid principles and planning to make sound financial decisions. Taxes are only one aspect of that process. So often I see the tax tail wagging the financial dog.
To retire with one million dollars in an IRA you rolled over from your employer is fantastic. However, a less than perfect retirement income plan is one where every dollar you need/want to maintain your lifestyle has a tax bill associated with it.
Here are Five Key Tips to Help You Avoid Making These Mistakes
- If your employer has a matching program, you should certainly contribute at least that amount in your 401k. Above the matching amount, consider your overall financial balance and consider a Roth 401k option if offered.
- After age 50, you can make “catch-up” contributions of up to $6,000 to your 401k. I’d urge you to consider saving this money in regular investment accounts, or in a ROTH IRA, if you qualify and depending on your situation.
- Wise financial decisions have more to do with options provided than with taxes or financial products.
- Build liquidity and flexibility into your retirement program by paying some tax now in order to provide yourself options later.
- Develop a coordinated retirement income plan that addresses the longevity of typical retirees.
The best advice I can offer is that you invest time into putting the retirement puzzle pieces in place. Our firm of fee-based, independent financial advisors provides a complimentary retirement planning review for readers. If you’re serious about making sure you’re headed in the right direction with clear direction, please call us to schedule a complimentary consultation.
Wootton Financial Group does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstances.