Think about the money you're counting on for retirement. If you're still working, you may be participating in a 401(k) plan. You have a pension plan benefit, and an IRA or two on the side. If you've been thrifty over the years, you may have some savings or investments in a brokerage account. And oh, yes, there may be some Social Security money coming in…if you can claim it before the system goes broke. (It won't, but that's for another blog.)
So, you add it all up and generate a number. It may look pitifully small, on-target, or you might feel pretty good about how well-prepared you are. Before you get too complacent, let's consider how different retirement dollars can be, one from the other. Sort of like friends—some friends have your back, some are fair-weather friends, and some “friends” owe their loyalty to someone else. How "friendly" are your retirement dollars?
To begin with, you don't actually own all the dollars you're counting on. Before-tax money in an IRA or a 401(k) will be taxed as ordinary income when you take a distribution. If you're in the 25% tax bracket when that happens, you could say that the IRS "owns" one-fourth of your IRA or your 401(k). Reduce what you think you have by the tax rate you expect to pay when you finally take cash out of the account. Apply the same discount to that pension benefit or any non-tax qualified benefits you may be entitled to at retirement. Those retirement dollars are friendly, but they actually may be more buds with Uncle Sam than with you!
Those dollars tucked away in your savings account—well, they're tax-paid, so they don't owe any allegiance to Uncle Sam. But those little fellows aren't likely to grow very much over the duration of your retirement. If you leave them in the bank, they're available when you need quick access to cash, but over time, inflation will erode the degree to which they can help you lead the life to which you aspire. Think of them as good friends, but without a robust ability to withstand the ravages of inflation.
Those dollars you've invested in a brokerage account may become very good friends over the years. Invested properly, they can grow, help you overcome the effects of inflation, and perhaps demonstrate only a marginal allegiance to Uncle Sam. The problem with those dollars is that the boldest of them may grow or shrink at inconvenient times. If you need to access those funds and the market's in one of its inevitable but temporary declines, you may be hesitant to call upon those friends when they seem to be hurting. And recognize that when the market is rising and you're feeling flush, it's hard to sell an investment for fear you're leaving more friendly dollars on the table--like ditching friends after they've helped you out of a bind.
Dollars in a Roth IRA can be exceptionally good friends. They're tax-free when you need them (if you meet certain requirements), so Uncle Sam has no call on them at all. Their growth over time is also tax free. That means they may be among the most robust of your dollar friends in fending off the effects of inflation. You can even pass them along to your kids income tax-free, ensuring the friendship continues beyond your lifetime. But for many of us, there are costs associated with acquiring these friends--we have to pay taxes when we convert dollars from an IRA into a Roth IRA or when we contribute to them each year.
Finally, consider those lowly Social Security dollars. Most of us don't think much of them. And while they likely won't be as significant in number as all your other retirement dollars, they will last as long as you do (and generally for your spouse's lifetime, too). They’ll grow with inflation. They enjoy a slight tax advantage (only 50% or 85% of them will be subject to income tax). And they are NOT subject to the ups and downs of the stock market. Good friends to have.
Getting your retirement dollar friends aligned and working together is part of what wealth management is all about. Give us a call if we can help you make sure your group of retirement dollar friends will stand with you through retirement!