Retirement Assets Bucket

The third bucket is retirement assets . These are 401(k)s, Individual Retirement Accounts (IRAs), pension accounts and the like . For the most part these retirement assets accumulate during your working career . For our purposes we also group Social Security into this bucket as for most people social security begins to pay out once they stop working . On an annual basis they increase from contributions (made by either you and/or your employer) plus the annual growth in value. They could have a “tax-free” aspect if you use the ROTH IRA feature . For most people this bucket will grow gradually over time, and depending on your age and how close you are to retirement age and your risk profi le, the asset allocation will change from more risk in your younger years to less risky as you get closer to retirement .

There are some required distributions that need to be made based on your age and the balance in the account .

The Retirement Bucket can grow quite large and be a major component of your net worth and a large contributor to your after work cash fl ow. Your CPA Shovel should work with you to calculate distributions over a long period.

The Retirement Assets Bucket contains assets that are specifi cally intended for use during retirement. During your working career, these assets are allowed to accumulate over time in the Retirement Assets Bucket, before being transferred into your Liquid Assets Bucket at retirement age .

Essentially, during retirement the assets in this bucket will replace the monthly paycheck you earned during your working career, thus making it critical to begin growing the assets in this bucket early .

The diff erent types of assets in this bucket grow and appreciate, both through your own contributions (and those of your employer if your retirement plan is employer-sponsored), and the annual growth in the value of the assets .

For most people, this bucket will grow over time . Growth occurs because, depending on your age, how close you are to retirement, and your risk profi le, the asset allocation will change from mostly equities and little fi xed income bonds to less equity and more bonds .

The picture to the right is a simple way of looking at retirement savings . The picture shows a mountain called “Mt . Retirement” . On one side it shows a person climbing the mountain with their skis . The skis represent a person’s leisure life in retirement . The person is sweating climbing up Mt. Retirement; it is not easy to save for retirement, but every dollar you save means that the skiing down the other side of the mountain will be a longer and more enjoyable ride .

There are a variety of diff erent

types of retirement plans and assets and we will discuss the variety of options below.

Types of Retirement Assets: Employer-Sponsored Plans: There are a variety of retirement plan types if your employer offers a retirement plan. Like medical insurance, employers will often use these plans as an employment benefit. The type of plan your employer offers is dependent on a number of factors, including the size of the organization, if it is a for-profit or non-profit firm, and other factors. We will discuss some of the most common plan types.

401(k): A 401(k) plan is the most common retirement plan offered by employers. Essentially, a 401(k) allows you to choose to defer a percentage of your paycheck to an account within the plan. Typically, those plan contributions are invest ed into a portfolio of mutual funds, but can include a variety of other investment options like stocks and bonds. The amount that you defer is not taxable until it is taken out of the account or withdrawn from the plan.

It is very important to be aware of how your employer contributes to the plan. 401(k)s are defined contribution plans, meaning that your account balance is determined by your contributions to the plan and the performance of your investment portfolio. Your employer is not required to make contributions to the plan (similar to pension plans, as discussed below), but many choose to match your contributions up to a certain percentage. Some employers may make a profit-sharing contribution based on the performance of the company throughout the year.

For 401(k)s, it is important that you strive to contribute enough from your paycheck to receive the maximum amount available from your employer.

Roth 401(k): Your employer may offer a Roth 401(k) retirement plan, which is similar in structure to a regular 401(k) plan, but is funded with after-tax deductibles from your paycheck. This is a great option if you’re young and intend to be in a higher tax-bracket by the time you reach retirement age. Once you reach 59.5 years of age, any withdrawals you make on the account (including any investment earnings) are tax-free. It also has no income limitations for those who want to participate (unlike Roth IRA, as discussed on page 45) and you can invest up to the allowable contri bution limits.

Pension Plans: Your employer may offer a pension plan, a type of retirement plan in which your employer makes contributions toward a pool of funds for your future benefit. Essentially, your employer is contributing to the retirement account on your behalf. These employer contributions are often tax-exempt.

There are two types of pension plans (like many other retirement plan options), defined-benefit and defined-con tribution. In defined-benefit plans, your employer promises you a set amount when you retire, regardless of how the investments perform. In defined-contribution plans, your employer makes a set contribution on your behalf, but the amount you receive on retiring depends on the performance of the investments.

Retirement Plans for the Self-Employed: Virtually any retirement plan that is available to a large organization or business is available to you if you are selfemployed. Deciding on a plan may seem difficult (talking to your CPA Shovel, as discussed on page 54, may help), so it may make sense for you to focus on the plan features that best suit your needs. You may choose a plan that minimizes the amount of taxes you will have to pay. You may choose a plan that simply allows you to save as much

as possible for retirement. For some people, it may be important to take into account plan flexibility if you are unsure whether you want to maintain the same contribution amounts or if you don’t want to make a plan contribution at a specific time.

We will discuss some of the most common types of retirement plans for the self-employed in further detail.

Individual Retirement Arrangement (IRA): Don’t worry - if you’ve always thought that IRA stood for individual retirement account, you aren’t the only one.

An IRA retirement plan allows you to contribute all of your income from self-employment, up to a set maximum dol lar amount. It may be tax-deductible based on your income, your tax-filing status, and any other coverage that you may have through an employer-sponsored retirement plan. With an IRA (unlike a Roth IRA, as discussed below), any withdrawals that you eventually make from the plan are taxed as income, including any gains you may make on investments.

Since your income might be lower after the liquid cash flow from your paycheck slows or stops and your retirement assets take their place, the income tax rate on those withdrawals could be lower than while you were working.

Roth IRA: A Roth IRA is very similar to a Roth 401(k) except it is not an employer-sponsored plan. However, the same rules apply that once you make the after-tax contributions, your account grows and you are able to take distributions from the account after age 59.5 tax free.

Pretend that there are three brothers named Saver, IRA, and Roth. Each brother saves the same amount for retire -

ment beginning at age 21, but each one chooses to invest in the account that they are named

Saver IRA Roth

Total Dollars Saved $ 940,748 $ 940,748 $ 940,748

after. Assuming that each brother faces the same tax rates and their investments grow at the

Less Taxes Paid Upfront $ 355,477 $ 131,571 $ 355,476

Net To Invest $ 585,002 $ 808,907 $ 585,000

same rate, Roth is the brother that comes out on top. Even

Total Distributions/Balance $ 2,554,538 $ 5,115,981 $ 6,836,203

though he was being taxed more

After Tax Net Profit

$ 1,969,536 $ 4,307,074 $ 6,251,203

initially than IRA, the money that he invested was able to grow for

Total Taxes Paid $ 1,355,439 $ 2,263,895 $ 355,476

years and he removed it tax-free upon retirement. The story of

Each person will start saving when they are 21 years old. Tax rate will change from 25% to 30% to 40% and back to 30%. All investments earn 6%. People will invest until they are 65 years old. Distributions will go from 66 to 102 years.

these three brothers is illustrated on the right and shows that saving for retirement in a Roth IRA can be the best choice if you are young and have a long career ahead of you.

SEP-IRA: If you are self-employed you can create a retirement plan called a Simplified Employee Pension (SEP-IRA). A SEP is very easy to set up and doesn’t need to be filed with the IRS. This makes it a lower cost option, especially if you don’t have any employees. If you do have employees, then a contribution would need to be made for them as well. For example, if you contributed 10% of your income to the SEP, then you would need to contribute 10% of your

employee(s) compensation as well. Investing in a SEP-IRA can also be beneficial since contributions to a SEP are tax deductible.

Social Security: If you are a U.S. citizen, a permanent U.S. resident, or if you work in the U.S., a percentage of your payroll-tax deducted every payroll cycle is collected by your employer and placed in the Social Security Trust Fund. It is a federally-operated social insurance and benefits program that includes not only retirement income and disability income, but also Medicare, Medicaid, and death and survivorship benefits.

Social Security planning should be updated as part of your overall financial plan. Your CPA shovel can help you figure out the best time to begin drawing these benefits. Currently you can begin to draw your social security ben efits when you are age 62, but if you wait until you are age 66, you’ll receive 100% of your benefits and each year you wait will benefit you roughly 8% more. So, if you wait until age 67, you’ll get 108 percent of the monthly benefit because you delayed getting benefits by 12 months. If you wait until age 70, you’ll get 132 percent of the monthly benefits because you delayed getting benefits by 48 months. If you continue working during that time, that extra income can help your retirement savings.

Source: https://www.ssa.gov/planners/retire/1943-delay.html