Retirement Planning
I am neither a financial advisor or tax professional. Verify anything you read here before you act.
Equities and Cash Allocation
Financial advisors agree that you should not have money in stocks that you will need in the next few years. And also, the older you are the safer your investments should be such as more bonds and less equities. Here is the approach I take.
Fully invest in TQQQ or cash based on the Timing Pundit Ultimate signal up to an account value of $1,000,000. Then every $100,000 gain after that, I set aside $20,000 (20% of the gain) as cash forever more. When the account value hits $1,200,000, I set aside another $20,000 for a total of $40,000 and so on.
I set a “Good Till Canceled – Extended Hours Limit Order” at the appropriate limit price and number of shares. I am always selling at a high that way and taking some profit. In a year with significant market gains, you would be skimming a lot of cash off the top. In a down year you wouldn’t take any cash. This is better than a common system of taking a fixed amount out on a fixed time frame where you may be taking cash out at a market low or mid-point. Here is a spreadsheet you can download that calculates the shares and limit price.
Roth vs Traditional IRAs and 401K
Every situation is different, but my general rules of thumb are as follows. In the 1st half of your career when your tax rate is lower, contribute to a Roth IRA or 401K if it is available to you. The number 1 thing is to take advantage of a full 401K employer match if offered, even if a Roth is not offered. If you think you will be in a higher tax bracket when you retire than you are in now, Roth is the best choice. If you will be in a lower tax bracket in retirement, traditional is best. If you will be in the same bracket, Roth is still the choice because of flexibility. No minimum distributions and you can withdraw contributions before retirement without tax or penalty if needed.
Investment Ranking for Retirement Savings
Not every option is available to everyone. This is the ranked order of retirement investment vehicles:
- Pay off high interest credit cards.
- Roth 401K if you are young and in a lower tax bracket only up to full employer match. IRAs have better investment options that 401Ks so that is why we only invest enough to get the employer match in the 401K at this point.
- Traditional pre-tax 401K if in the 2nd half of your career and in a higher tax bracket only up to full employer match.
- HSA (health saving account). The best tax treatment available. You deduct the money going in and you don’t pay Social Security or Medicare on it. It grows tax free. If you take a distribution for a qualified medical expense, that is tax free also. If you take a distribution for any other reason, you pay tax just like a traditional IRA. If possible, pay medical expense out of your pocket and keep the money in the HSA.
There is no time limit on when you can claim a qualified expense. If you pay a Doctor bill when you are 25 you can pull that money out tax free when you are 75. You just have to keep records. HSA providers have a section on their web sites where you can keep the records for future use.
If your employer offers a high deductible plan and HSA, they may have a default HSA provider which may not offer the best investment options. You can have more than 1 HSA provider. I set up a second account with Lively.com. Once a year I transferred funds from my employer’s stodgy HSA to Lively. In Lively, you can keep all your funds in an TDAmeritrade account and invest in TQQQ. Then when I retired I closed the old account and put everything in Lively.
- Roth IRA if you are young and in a lower tax bracket. If your income is too high you cannot directly contribute to a Roth IRA.
- Traditional pre-tax IRA if in the 2nd half of your career and in a higher tax bracket. If your income is too high you cannot deduct the contribution. You can then transfer it to a Roth (back door Roth) or move on to the next step.
- If you still have more money to invest after the 6 options above, max out the 401K. In 2020, the max is $19,500 or if you are over 50, $26,000. If you hit income limits mentioned in steps 5 and 6, there are no such limits with the 401K. Then, when you are 59-1/2 you can do an in-service rollover to IRAs if your company allows it (most do). If not, you can do that rollover when you retire or change jobs.
When I first discovered this, I thought there had to be a catch. If you are not eligible to take a deduction on a $7,000 IRA contribution, you can put $26,000 in a 401K, deduct it, and transfer it right into your IRA when you are at least 59-1/2.
The Roth Advantage
Roth 401K. Grows tax free and can be withdrawn tax free. There is no Required Minimum Distribution. You can pull your contributions (not earnings or company match) out anytime without tax or penalty after a typically 5 year vesting period depending on your company. Ideally you won’t pull any out until you retire but it is available for major emergencies or purchases like a house or college.
Having said that, I raised 6 kids on a single income which made it challenging to save a lot. I always contributed enough to my Roth 401K to get the full employer match but would often have to withdraw much of that contribution back out later. Most of the seed money in my IRAs today is from employer match, not contributions. Yet the balance has grown substantially using the Ultimate timing model with TQQQ.
Roth IRA. Better investment options than a Roth 401K. Same commentary applies except there is no employer match.
Traditional to Roth Transfer
You may want to transfer traditional funds to a Roth if you may have a higher tax bracket in the future or want to avoid required minimum distributions. This is a good time to do that since tax rates have been temporarily lowered until 2025. Each year transfer as much as you can without going into the next tax bracket.
Charity
Do you give to tax deductible charity? If so, you will want to keep some money in a traditional IRA. Once you reach age 72, you will have to take RMDs. You can transfer money direct from your IRA to the charity. It counts against the RMD and it is deducted from your taxable income. Most people giving to charity now get no tax advantage because they still don’t have enough deductions to itemize. With the IRA to charity transfer, you get the deduction.