Long-term savings questions to consider

By Tim Hawkins/Consulting

Financial professionals often follow two rules of thumb when providing clients with financial advice.

First, they suggest clients save as much as possible in qualified retirement plan accounts, such as 401(k) plans and Individual Retirement Accounts (IRAs).

Second, they advise that retirees delay taking distributions from qualified accounts for as long as possible because no taxes are owed on qualified accounts until distributions are taken.

As with many rules of thumb, these principles are not accurate or reliable in every situation. It is important to work with an advisor to evaluate your specific circumstances and determine the best plan of action.

Here are some issues that should be considered:

  • Should I save for retirement in taxable or tax-deferred accounts? From a financial planning perspective, it is beneficial to have a blend of qualified and non-qualified assets. This provides more opportunity to balance and potentially minimize income tax liability over time.
  • Do you receive company matching contributions? If your company’s 401(k) plan offers matching contributions, it is providing an automatic return on your investment. A company match of 50 cents on the dollar represents a 50 percent return on investment from day one, assuming you are 100 percent vested. When a matching contribution is available, it may be a good idea to contribute enough to the plan to receive the maximum match every year.
  • Should more qualified plan savings be set aside by an older spouse or a younger spouse? The answer to this question depends on the couples’ goals and expectations. In general, an older spouse will be able to access qualified plan savings sooner than a younger spouse; however, a younger spouse will have more years to invest tax-deferred, which may mean that he or she accumulates more savings. If the younger spouse saves and accumulates more, his or her Required Minimum Distributions (RMDs) may be greater at age 70 1/2. Since RMDs are taxed at ordinary tax rates, the long-term tax consequences should be considered.
  • Should I draw assets from a taxable or tax-deferred account first? Many people assume it is best to let qualified plan accounts grow tax-deferred for as long as possible; however, when you take a distribution from a qualified account, it will be taxed at your ordinary income tax rate. It may be advantageous to use a combination of non-qualified and qualified account assets to moderate taxable income over time. In addition, higher qualified plan distributions may affect the taxability of your Social Security benefits.

There are many considerations when structuring retirement savings and retirement income plans. When combined, federal and state income tax rates often total 30-45 percent. It is essential to plan carefully and understand the tax implications of your decisions.