Saving for retirement can be intimidating and overwhelming. It can often feel like a huge and unattainable goal. It’s crazy how many 20 and 30 somethings are already panicking about retirement, and the result is that they are saving pretty damn aggressively.
And this year you’re eligible to contribute $500 more to your 401(k) than you were last year. But should you?
When clients come to Stash Wealth, it’s not uncommon that we run into HENRYs™ that are over saving for retirement. Sounds crazy, but the media has made us think that we’re never going to be ready, so many of us are stashing too much away. And when we save too much for retirement in our 20s and 30s, we sometimes end up sacrificing our other goals that fall between now and those golden sunset years – like buying a home, upgrading our lifestyle, traveling, and going back to school. Remember, once you put money into a retirement account, chances are you are going to have to pay a fee if you want to get it out early. And you should absolutely not EVER borrow from your 401(k).
It turns out that HENRYs™, like many millennials, are actually over saving for retirement. Now we’re not saying you shouldn’t be putting any money away for retirement, hell no! You definitely should be saving, but we’re trying to get to the heart of what the sweet spot is for you.
The two most common ways to save for retirement are IRAs and 401(k)s. Here’s a quick explanation of the difference before we jump into the new contribution limits.
IRA, 401(k), What’s the Difference?
IRAs and 401(k)s are both retirement accounts.
A 401(K) IS…
always established by an employer. You can’t set one of these up on your own (unless you’re your own boss, in which case you may be eligible to establish a solo 401(k)). This piece isn’t going to get into all the different types of 401(k) plans, but if your employer is offering one, particularly if they’re offering to match your contributions, you should definitely take advantage.
IRA STANDS FOR…
Individual Retirement Account. There are traditional and Roth IRAs. The big difference here is when you pay taxes on the money. With a Roth IRA, you pay taxes on the way in, and can withdraw without paying taxes on the money in retirement (after you’re 59 ½ years old). With a traditional IRA you can add money now, before paying taxes, but you will be required to pay taxes on the money when you withdraw it in retirement.
Taxes and retirement accounts can be complicated, but here are the very basics of what you need to know this tax season and what changed between 2019 and 2020.
New Contribution Limits in 2020
The contribution limit for most 401(k) plans increased by $500, from $19,000 for 2019 to $19,500 for 2020. The max amount you can now contribute to your employee sponsored 401(k) for the year 2020 is $19,500 (if you’re under 50).
The IRA limit did not change from 2019 to 2020. It is $6,000. That means your total combined contributions to a traditional and/or Roth IRA cannot exceed $6k for the 2020 tax year.
But should you be aiming for these limits? Maybe not if your salary is still around $100k or less and you have other big things to save for in the meantime. Many HENRYs™ and future HENRYs™ are maxing out their 401(k)s and IRAs when they’re on track for healthy retirements without having to do so.
Hold the phone.
Did you read that right?
When you’re a high earner, you may not need to max out your retirement account to be on track.
How do you know if this might be you? We have a retirement calculator linked at the end of this article, but…
Here’s a handy hypothetical:
Say you’re 30 years old making $80k/year with at least $25k already stashed in retirement accounts. You’ll hit $1,000,000* at age 65 if you’re contributing 5% to your 401(k)!
Is $1 million enough to retire? It depends.
BUT TAKE NOTE, THIS DOESN’T TAKE INTO CONSIDERATION…
-That your salary will go up!
-That you may receive social security!!
-That you are probably getting an employer match!!!
-That you may have an SO that’s also contributing to retirement!!!!
So there’s a good chance you’ll actually end up with more than $1 million.
Are there salary limits for a Roth IRA in 2020?
To contribute to a Roth IRA for future tax benefits, you need to fall under a certain income threshold. As a HENRY™ or future HENRY™, it’s likely a day will come when you can no longer contribute to this account because you make too much money! So, we encourage you to use it while you can.
The income threshold also went up this year, a bit. If you’re rocking the single life and filing alone, you can now make up to $124,000 and contribute the full $6k to a Roth IRA. If you make more than $124k but less than $139k, you can contribute a reduced amount. If you’re filing jointly, the new limit is $196,000. Between $196k and $206k and you can contribute a reduced amount. For the specifics, check out the IRS’ website.
Hello, HENRYs™, we see you contributing to your Roth IRA while you still can! Living that HENRY™ life can mean that these limits will soon be in your rearview mirror, so you might want to contribute while you still can.
And real quick, let’s clear up a common misconception about retirement contributions, shall we?
Are IRA contributions tax deductible?
Your IRA contributions aren’t always tax deductible. Roth IRA contributions are never tax deductible, point blank. For traditional IRA contributions, the amount you can claim as a deduction depends on if you (and/or your spouse) are offered retirement plans by your employer, and your income level. You can find more details here.
Are you over saving for retirement?
How do you know if you’re saving enough? How much should you contribute this year? Should you max out your IRA and your 401(k)?
We get it. It’s hard to know what you want your retirement to look like when it’s still so far away. Hell, sometimes it’s hard to know what you want next year to look like, nevermind 30 or more years from now. For now, we suggest you mess around with a retirement calculator, take a guess at how much you might want for retirement. This can help you figure out how much you actually need to be stashing now to get on track for your goal.
If you have no idea where to start when using a retirement calculator, focus on figuring out how much you’d need to save to be able to replace your current annual salary for a 30 or 35 year retirement. Fiddle around with the calculator until it shows what you’d need to save today to be on track for your current salary for 30+ years.
Here’s an example: Let’s say you’re 26 years old, making $65k/year, and you want to retire by the time you’re 60 (you think). If you’re just starting to save for retirement, you’d need to save about $1k each month to make sure you have enough for retirement. Note, “enough” in this case means enough money for you to live off of 70% of your current income for the 35 years of your expected retirement. Notice this means you’re only contributing $12,000 a year! Which is much less than the new 401(k) limit of $19.5k!
What other common mistake do millennials make when saving for retirement?
FYI, the biggest mistake we see people making when it comes to retirement accounts is investing as if you’re already retired. Translation: lot’s of y’all are being way too conservative with your retirement portfolios. If you’ve invested in a diversified portfolio you should be looking at a return of about 8% on average. This doesn’t mean 8% consistently every single year, markets fluctuate, but when you take the average over several years, it falls around 8%. This means you have to have some moderate, or even aggressive investments mixed in there!
Then remember to check in with this each year as your income gets stronger. But don’t forget the other goals you have along the way! Weddings, trips, continued education, buying a home…these are all important goals. Remember that saving for retirement is only a piece of your financial puzzle.