Establishing Clear Direction for your Retirement Plan

Retirement planning is an exercise in imagining your future.  We all posses the ability to think ahead and plan for the future; whether it is making plans for tomorrow, arrangements for a trip next year or planning ahead for retirement in 5 years, 10 years or even longer. Thinking ahead allows us to carefully arrange our financial lives to align with our future vision.

Be Ready to Adjust Your Plan

Like life, adjustments will be necessary along the way.   It is more common than you may think for couples to approach retirement with an agreed upon plan, only to have divergent thoughts surface before reaching the goal.  Financial planning and thoughtful conversation can help to reestablish clear direction and a workable plan to follow together. Here is a simplified case study to help illustrate crucial planning steps leading to retirement.

Try 3 Action Steps to Jumpstart Your Plan

When Jack and Sally began to think about retirement, they had more questions than answers.  Sally was looking forward to relaxing and spending time in a warmer climate, while Jack couldn’t imagine moving to another state away from his volunteer work and grandchildren.  This is not a unique situation.  With a goal of retirement in 5 years, we established these three action steps:

• First they needed to review assets, future income sources and anticipated expenses to determine how much money they will need to live their retirement plan.  Increased longevity is factored into the financial analysis.

• They were in agreement to be debt free and have enough assets and income sources that cash flow would not be a limiting factor in retirement.  That gave them a clear picture of how much they needed to save and invest leading up to retirement.

• Jack and Sally agreed they would downsize their home to accommodate the goal of renting in a warmer climate for 5 months during the coldest part of Michigan winters.

Test your pre-retirement plan by laying out your unique objectives to see if you have a clear direction and workable plan to follow together.  The most successful transitions hold the promise of retiring to something, not away from something.  Contact me if you need help getting started or making adjustments along the way to your retirement goals.

Laurie Renchik, CFP®, MBA is a Partner and Senior Financial Planner at Center for Financial Planning, Inc. In addition to working with women who are in the midst of a transition (career change, receiving an inheritance, losing a life partner, divorce or remarriage), Laurie works with clients who are planning for retirement. Laurie was named to the 2013 Five Star Wealth Managers list in Detroit Hour magazine, is a member of the Leadership Oakland Alumni Association and in addition to her frequent contributions to Money Centered, she manages and is a frequent contributor to Center Connections at The Center.

Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James. C14-034237

A ROTH IRA Strategy for High Income Earners

Do you have a 401k Plan from your current employer?  Does it allow you to make after tax contributions (these are different than pretax contributions and Roth 401k contributions)?  If the answer to both is “yes”, a recent IRS notice may present a welcome opportunity.  IRS Notice 2014-54 has provided guidance (positive guidance) allowing the splitting of after tax 401k contributions to a ROTH IRA. Although I believe that ROTH IRAs are used in many less than ideal situations, this is one strategy that can make sense for higher income earners; tax diversification and getting money into a ROTH without a big upfront tax cost. 

After answering “yes” to the first two questions, the next question is, “Are you making maximum contributions on a pretax basis?”  That is, if you are under 50 years old, are you contributing $17,500 and if you are over 50 (the new 30) $23,000? If you are making the maximum contribution, then a second look at after tax contributions should be considered.  Whew – that’s three hoops to jump through – but the benefits might just be worth it.

Putting Notice 2014-54 to Work

For example, Teddy, age 50 has a 401k plan and contributes $23,000 (includes the catch up contribution) and his employer matches $5,000 for a total of $28,000.  Teddy’s plan also allows for after tax contributions and he may contribute $29,000 more up to an IRS limit of $57,000. 

The new IRS Notice makes it clear and simplifies the process allowing this after tax amount at retirement to be rolled into a ROTH IRA.

The bottom line:  It is more attractive to make after tax contributions to your 401k with the flexibility of converting the basis to a ROTH at retirement or separation of employment without the tax hit of an ordinary Roth conversion.

As usual, the nuances are plentiful and your specific circumstances will determine whether this strategy is best for you.  To that end, we are here to help evaluate the opportunity with you.

Timothy Wyman, CFP®, JD is the Managing Partner and Financial Planner at Center for Financial Planning, Inc. and is a frequent contributor to national media including appearances on Good Morning America Weekend Edition and WDIV Channel 4 News and published articles including Forbes and The Wall Street Journal. A leader in his profession, Tim served on the National Board of Directors for the 28,000 member Financial Planning Association™ (FPA®), trained and mentored hundreds of CFP® practitioners and is a frequent speaker to organizations and businesses on various financial planning topics.

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James.

The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. C14-033701

Retirement Spending: Is My Savings Goal Too High?

 Determining how much you actually spend each month is really the first step in dialing in on how much money you need or want in retirement. (If you missed it, check out my last blog on this!) With so many payroll deductions (taxes, 401k savings, medical premiums, insurance, etc.) it can be pretty staggering when you crunch the numbers and see what you’re truly spending each month. It’s probably much less than you thought!  The good news is that several of these payroll deductions will disappear or be significantly reduced when you retire.  Let’s dive in and take a look at some of those items to shed some light on what might be your “number” for desired retirement spending.

The Good News on Taxes

There’s a good chance your tax liability will be lower in retirement.  Two items that go away upon retirement are Social Security and Medicare tax (FICA).  As an employee, you are responsible for kicking in 6.2% to Social Security and 1.45% to Medicare – a total of 7.65%. Think about it, that’s $7,650/yr if you earn $100,000 annually.  Kiss those taxes goodbye on your last day of work. 

When you begin to receive your Social Security benefit, the benefit may or may not be taxable, depending on your adjusted gross income (AGI).  However, most clients see at least some taxation of benefits. Per SSA.gov, the maximum amount of your benefit that can be subject to federal tax is 85%. Meaning if you were receiving $35,000/yr in benefits, the maximum taxable amount that would be included in your AGI would be $29,750 ($35,000 x 85%).  In addition, most states, including Michigan, do not tax Social Security benefits.

Pension , IRA, qualified retirement plan (401k, 403b, etc.) distributions will be included in your income for the year on the federal level – these income sources are treated as ordinary income.  This is why being cognizant of your current and future tax bracket is so important in proactive tax planning.  A few years ago, Michigan began taxing these income sources on the state level, but the amount that is included in taxable income for the year is dependent on your age and total benefits.

Forget Saving for Retirement

One of the many benefits of being retired is that you no longer have to save for retirement!  The maximum 401k contribution for someone over the age of 50 in 2014 is $23,000. We commonly see clients saving the maximum while in the latter half of their working years.  For a couple who both maximize their retirement plans at work, we are talking about a $46,000/yr outflow that will no longer exist upon retirement.    

Getting Rid of Debt

The goal of many is to be debt free (or close to it) upon retirement.  If your mortgage (not including taxes and insurance – unfortunately those items never go away) is $1,500/mo, this is $18,000/yr in savings … a huge amount if you are able to eliminate your house payment prior to retirement.  With rates as low as they have been, it often makes sense to keep the mortgage because it’s “cheap money”.  However, being debt free in retirement is a very personal decision and is typically more of a “what makes you sleep better at night” decision rather than a strictly “numbers” decision.

Adding it All Up

When you factor in what you are saving for retirement, taxes, and having a mortgage, many clients are shocked to realize that those items can eat up close to 50% of total gross income.  So, if a client has joint income of $200,000 we may propose $100,000 in retirement spending (when we do, they often look at us like we’re crazy).  But if we back out their total 401k savings of $46,000, Social Security and Medicare tax of $15,300 ($200,000 x 7.65%), their $1,500/mo or $18,000/yr mortgage and a total tax reduction of approximately $10,000 because less total dollars are being generated, that is a total of almost $90,000 that will no longer exist in retirement.  So what does that mean?  It means the couple can live the equivalent of their current $200,000 lifestyle on $110,000 in retirement – pretty close to the suggestion of $100,000 in retirement spending! 

For this reason, I cringe when I hear advice like, “You need $2,000,000 to have a fighting chance at retiring,” or, “You will spend 70% of your current income in retirement.”  Everyone’s situation is different and many folks are probably living on a heck of a lot less than they actually think.  If you’re retiring in the next 10 years, I urge you to walk through this process. Really start thinking about what you want to spend when that time comes.  It will help you plan accordingly and will hopefully significantly improve the chances of you reaching your retirement goals.

Nick Defenthaler, CFP® is a Certified Financial Planner™ at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

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Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. Any example is hypothetical in nature and is used for illustrative purposes only. Individual cases will vary. Every investor’s situation is unique. Please consult with your financial advisor about your individual situation. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. Investors should consult a tax advisor about any possible state tax implications. C14-026884

Retirement Spending: Finding Your Actual Cost of Living

 When you’re approaching retirement, it can be hard to determine how much you would like to spend when you stop working.  It’s a scary thought for most.  You wonder: Have I saved enough?  Is what I want to spend reasonable and safe?  It can seem a bit overwhelming, but hopefully part one of this two-part blog series will help to simplify that discussion. 

How much does my lifestyle really cost?

Start the conversation by figuring out your current cost of living. To illustrate, look at an example of how this figure might be much less than you think.  Tom and Mary are both age 58 and plan to retire at age 62.  The discussion of retirement planning is becoming increasingly important to them as they near retirement.  Tom works for Ford and earns $100,000/yr and Mary works as a teacher earning $55,000/yr.  Tom and Mary are great savers and each contribute the maximum to their 401k each year ($23,000 each, $46,000 total for 2014).  They have health insurance through Mary’s work and pay $400/mo for excellent coverage – they also save $200/mo towards a Health Savings Account (HSA) to be efficient with their out-of-pocket medical expenses each year.  They each pay into a group disability policy that costs $100/mo in total.  Of course, we can’t forget about taxes.  In 2013, they paid $12,000 in federal tax and $4,000 in Michigan state tax. Social Security and Medicare (FICA) cost them $11,858 (7.65% on their income).  Below is a breakdown of these payroll deductions on an annual basis:

Assuming no additional dollars are saved beyond the 401k, Tom and Mary are actually living on $72,742/yr ($155,000 – $82,258) – only 47% of what they are earning.  This is a great starting point but this is where we start to explore a bit by asking questions like: 

• Are they happy with their current lifestyle? 
• Do they feel constrained right now and want to spend more on things like travel in retirement?
• Or, do they already travel and do the things they love on their $72,742/yr lifestyle? 
• What personally meaningful things do they want to accomplish once they are retired? 

These kinds of questions open the discussion surrounding retirement spending and goals.  It is also worth mentioning that there will be several expenses and payroll deductions that will ultimately disappear or significantly reduce upon retirement.  I will go into detail on these items and show how things change in retirement in part two of this blog series – stay tuned!

Nick Defenthaler, CFP® is a Certified Financial Planner™ at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

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Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. Any example is hypothetical in nature and is used for illustrative purposes only. Individual cases will vary. C14-026770

Richard Marston on Investing for a Lifetime

 What does a financial planning geek do for fun? He visits the Wharton School of the University of Pennsylvania for a day of lectures! The first part of the day was spent hearing from Professor Richard C. Marston. Professor Marston is the James R.F. Guy Professor at Wharton, a graduate of Yale, MIT, and Oxford (on the east coast they would call him “wicked smart”). Moreover, he has taught asset allocation for over twenty years and in 2011 wrote the book Portfolio Design: A Modern Approach to Asset Allocation (Wiley, 2011). Needless to say, it was a thought-provoking and worthwhile day.

In two lectures -- the first taken from his new book, Investing for a Lifetime” Managing Wealth for the “New Normal” and the second titled “Investing with a Fifteen Year Perspective: Past and Future” – Marston shared what he believes to be some “best practices” in savings and investing. He talked about choosing an asset allocation focusing on stocks when you are still years from retirement. You then gradually shift towards a 50/50 portfolio while saving 15%-20% of income during the accumulation period. And once you reach retirement, he discussed spending 4% of accumulated wealth. My sense is that these are consistent messages that our clients have heard from us over the years. 

During one of the wicked smart professor’s lectures, he shared that as he gets older, he has a greater appreciation for the role that investor and advisor behavior plays in ultimate investment success.  For example, he believes in using active managers. He also believes that selecting the right investments is important (and he is paid by several family offices to do so), but behavior such as letting fear or greed control actions plays a critical role as well.

Professor Marston’s recent work also focuses on determining a savings goal for retirement. A common rule of thumb is that investors must save 8 times their income before they retire.  So, if you earn $100k, then you need $800k saved at retirement.  Professor Marston was intrigued by the simplicity of the general rule and decided to put it through his own analysis. In the end, his analysis suggested that 8 times income is probably too low for most people.  His own conclusions, obviously depending on the exact assumptions, ranged from 11.5 to 18.4 times income. In his opinion, your savings goals will vary widely depending on two main factors:

• If you are single: Your savings must be higher because a couple will receive more in social security benefits at the same earnings (consider it a marriage premium).
• If you earn much more than $100k: Your savings rate needs to be higher because social security plays a lessor role in your retirement income.

As a quick aside, I was pleased to hear Professor Marston include and emphasize the importance of social security in the retirement planning analysis.  Without it, the savings rates above would need to be increased significantly.  I invite you to read our many previous posts on social security and let us know if we can help answer any questions.

On the flight home from the lectures, I read Professor Marston’s newest book Investing for a Lifetime (Wiley, 2014). It’s about making saving and investing understandable to the investor.  Probably the most important statement, that occurs early and often, is SAVING IS MORE DIFFICULT THAN INVESTING. Meeting your life goals, such as retirement, is much more dependent on our savings than getting another 1% from investment portfolios.  As I have written in the past, saving is much more than dollars and cents; it takes discipline and perseverance.

For our long-time clients, the book would provide a good refresher on many of the concepts we have discussed and encouraged over the years.  If you have a family member or friend starting their career or looking to take more control of their finances, Professor Marston has the ability to make the complex simple and I think his books would be a wonderful gift.

The second part of my Wharton School visit was spent hearing from Professor Christopher Geczy, Ph.D., another wicked smart guy.  I will leave that review for another post.  If you like Alpha, Beta, Correlation coefficient, Standard Deviation, R Squared, Systematic risk, and Idiosyncratic risk…well you are in for a treat!

Timothy Wyman, CFP®, JD is the Managing Partner and Financial Planner at Center for Financial Planning, Inc. and is a frequent contributor to national media including appearances on Good Morning America Weekend Edition and WDIV Channel 4 News and published articles including Forbes and The Wall Street Journal. A leader in his profession, Tim served on the National Board of Directors for the 28,000 member Financial Planning Association™ (FPA®), trained and mentored hundreds of CFP® practitioners and is a frequent speaker to organizations and businesses on various financial planning topics.

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The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Center for Financial Planning Inc. and Richard C. Marston and not necessarily those of RJFS or Raymond James. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or a loss regardless of strategy selected. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Asset allocation does not ensure a profit or guarantee against a loss. C14-026186

Factoring the Cost of Living in a Post-Retirement Relocation

Your retirement plan may involve a move. You could be moving some place warm so you don’t have to put up with the wonderful Michigan winters or perhaps moving to be closer to your kids and grandkids.  Whatever the motivation, there is always a financial component in the decision-making process.

Paying for what you want vs. what you need

The cost to live in other areas of the country can be higher or lower, but some people don’t know the specific figures you will probably pay after you make the move.  Is a dollar in Michigan the same as a dollar in California or Utah? A recent conversation with a client evaluating relocating placed focus on this specific issue. His thinking was that it didn’t matter where you lived, you can always find a way to spend money.  While I certainly have to agree with him on that point, I think the bigger point is that there is a difference between spending money on things you want versus spending money on things you need.

Comparing Expenses

Let’s take a look at the cost of different goods and services in the two cities. These figures were taken from www.costofliving.org and they are an average estimate taken from people who live in Salt Lake City and San Francisco. The list of goods and services has more than 75 commonly purchased or used items but we’ll look at just a sampling of expenses.

As you can see, everything in San Fran is more expensive except the T-Bone steak. Unfortunately, after you pay for your basic living expenses, you might not have any money left over for that T-Bone! According to the living expense calculator on www.costofliving.org someone living on $70,000 of net income in Livonia, Michigan would need approximately $120,000 net in San Francisco.  In Salt Lake City, that same person would only need $69,000 to maintain the same standard of living. 

If you think a move might be in your future, talk to your financial advisor to weigh the costs associated with the new location and make sure it fits within your retirement income goal.

Matthew Trujillo, CFP®, is a Certified Financial Planner™ at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.

Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. C14-022592

The 50/50 strategy turns your next raise into lifelong savings

 Ever wonder how much you should be saving? We hear it from a lot of clients who want to make sure they’re putting away enough each paycheck towards retirement.  We typically suggest saving at least 10% of your before-tax income and for those approaching retirement within 10 – 15 years, we like to see that number closer to 20%.  Although we never like to make blanket statements in financial planning, those savings rates are typically what most should be striving for while still maintaining a balance to live a full life now.  But is there a better strategy that could be more efficient?

Give Your Savings a Raise

What do most people do when they get a raise?  Many people keep their savings rate the same but increase their standard of living.  Sure, the actual dollar amount is increasing because the savings percentage is now based on a larger salary; however, my argument would be that controlling your standard of living is what is most important, especially when approaching retirement.  So how do you keep your standard of living from getting out of control and far surpassing savings? 

Spend 50% of your raise and save the other 50% 

Let’s see how that strategy could impact our hypothetical client, Jack.  Jack is 30 years old and is earning $100,000/yr as a business consultant.  He is currently saving 10% towards his 401k ($10,000/yr).  Jack had a great year in 2013 and earned an 8% raise for 2014, increasing his base salary to $108,000.  Assuming Jack kept his savings rate of 10% the same, he would now be putting $10,800/yr into his 401k.  However, what if he took the “spend 50, save 50” approach?  After taxes and other payroll deductions, Jack actually realizes a “take home” raise of $5,000.  In the 50/50 strategy, Jack would tack on $2,500 to his annual 401k savings, increasing total annual contributions to $12,500 (from $10,000 prior to his raise).  By simply saving 50% of the money that didn’t exist the year prior, Jack has increased his total retirement savings to about 11.6% ($12,500/$108,000). He’s controlled how quickly his standard of living increases. 

As a young professional, I can certainly attest to the difficulty of looking down the retirement road to a goal that is 35+ years away.  However, committing to your goals and having a clear, simple strategy, such as the 50/50 savings approach, can help you reach the financial goals you set for yourself or family!

Nick Defenthaler, CFP® is a CERTIFIED FINANCIAL PLANNER™ at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

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Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. C14-025359

The Power of Compounding

 

When you’re just starting in your career, you can feel strapped, earning a small salary and trying to make ends meet.  You might not feel like there is any money left over at the end of the month and that’s why some people decide to wait to start saving for retirement. However, the power that time has on your money can’t be understated.

I recently had an opportunity to meet with a long-time client’s daughter.  The goal of the meeting was to give some timely financial advice as she embarks on her new career after college. One of the key points I made was the power of compounding dollars over time.    

Using Time to Compound Money

For instance, if a 25 year old were to save approximately $4,500 a year compounding at 7% she would have close to 1 Million dollars by age 65. But, if she decided to wait to start saving for retirement until she was making more money at age 45, she would need to save $21,904 a year to accomplish the same result. That’s a staggering 486% increase in the dollars she’d need to save compared with the 25-year-old saver.

Knowing Your Benefits

To help with your retirement savings, it’s very important to fully understand your employer benefits before you begin employment.  Many employers will offer qualified retirement savings programs like a 401(k) or 403(b). If these plans exist and the company offers a match on your contributions, you should do everything you can to make sure you at least get the matching dollars.  For instance, in the case of our 25 year old, we know the potential of a $4,500 a year savings and earning 7% on that money. Now, if we factor in an employer match of $2,250, that same 25 year old would have accumulated approximately $1,350,000 over that same time horizon.

The longer you wait to start saving, the more you are going to have to put away. In other words, the pain could be much worse the later you wait.

Matthew Trujillo, CFP®, is a Certified Financial Planner™ at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.

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This is a hypothetical illustration and is provided for illustration purposes only and is not intended to reflect the actual performance of any particular security. Future performance cannot be guaranteed and investment yields will fluctuate with market conditions. C14-022060

401(k) After-tax Accounts: Preparing your checklist

 In my last blog, I answered four common questions about an after-tax 401(k). If you’ve decided that this savings options might be right for you, your next step is to sit down with your financial advisor.

Getting ready: A checklist for the meeting

Your financial advisor can help you review your plan documentation to establish whether you have an after-tax contribution option; and, if so, whether it would make sense for you to set aside some of your pay on an after-tax basis. Before you meet with your financial advisor, you may want to gather some important information and documents:

• The most recent statement from your 401(k) plan
• Any plan documentation you may have, such as an SPD (your human resource department can provide a copy or you may be able to access it online)
• The telephone numbers of your current and former employer’s benefits administrators so you and your financial advisor can confirm information
• Any retirement income planning documents you may have accumulated
• The contact information for your tax advisor should you have any tax-related questions

First, review your plan documentation with your financial advisor to establish whether you have an after-tax contribution option. Then determine with your tax advisor whether you should make after-tax contributions to your 401(k) plan and/or proceed with a conversion. Be sure to discuss any potential tax and penalty implications, as well as expenses and sales charges that may result from your decisions.

Rolling after-tax savings into a Roth IRA

Explore whether a conversion of all or a portion of your after-tax account to a Roth IRA or designated Roth account would be a strategy that advances your retirement savings and income planning goals.

If you decide to make after-tax contributions and/or execute a conversion of all or a portion of your after-tax account, work with your financial advisor to execute the proper documentation and authorizations. And, as always, we’re here to answer any questions that may crop up as you consider making contributions to an after-tax 401(k) plan.

Matthew E. Chope, CFP ® is a Partner and Financial Planner at Center for Financial Planning, Inc. Matt has been quoted in various investment professional newspapers and magazines. He is active in the community and his profession and helps local corporations and nonprofits in the areas of strategic planning and money and business management decisions. In 2012 and 2013, Matt was named to the Five Star Wealth Managers list in Detroit Hour magazine.

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Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. You should discuss any tax or legal matters with the appropriate professional. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Converting a traditional 401(k) into a Roth IRA has tax implications. An investor should carefully consider the source of funds used to pay the taxes owed on a Roth conversion. Penalties and taxes may apply if the investor uses money from the 401(k) as the source for conversion taxes. Consult a tax professional for details. C14-016529

401(k) After-tax Accounts: The forgotten contribution feature

 Roughly half of 401(k) plans today allow participants to make after-tax contributions. These accounts can be a vehicle for both setting aside more assets that have the ability to grow on a tax-deferred basis and as a way to accumulate assets that may be more tax-advantaged when distributed in retirement.

As you discuss after-tax contributions with your financial advisor, you might consider the idea of setting aside a portion of your salary over and above your pre-tax salary deferrals. By making after-tax contributions to your 401(k) plan now, you could build a source of assets for a potentially tax-efficient Roth conversion.

Here are some questions to consider:

Does your plan allow for after-tax contributions?

Not all plans do. If an after-tax contribution option is available, details of the option should be included in the summary plan description (SPD) for your plan. If you don’t have a copy of your plan’s SPD, ask your human resources department for a copy or find it on your company’s benefits website. You can also talk to your financial advisor about other ways to obtain plan information, such as by requesting a copy of the complete plan document.

What does “after-tax” mean?

After-tax means you instruct your employer to take a portion of your pay — without lowering your taxable wages for federal income tax purposes — and deposit the amount to a separate after-tax account within your 401(k) plan. The money then has the ability to grow tax-deferred. This process differs from your pre-tax option in which your employer takes a portion of your pay and reduces your reported federal taxable wages by the amount of your salary deferrals and deposits the funds to your pre-tax deferral account within the plan.

Are there restrictions?

Even if your plan has an after-tax contribution option, there are limits to the amount of your salary that you can set aside on an after-tax basis. Your after-tax contributions combined with your employee salary deferrals and employer contributions for the year, in total, cannot exceed $52,000 (or $57,500 if you are age 50 or over and making catch-up contributions). Your after-tax contributions could be further limited by the plan document and/or to meet certain nondiscrimination testing requirements.

How does a 401(k) after-tax account help me acquire Roth assets?

When you are eligible to withdraw your 401(k) after-tax account — which could even be while you are still employed — you can roll over or “convert” it to a Roth IRA or a qualified Roth account in your plan, if available. A conversion requires you to include any pre-tax assets that you convert in your taxable income for the year. That means if you convert your after-tax account, only the earnings are included as ordinary income for the year. And if you have pre-1987 after-tax contributions, special rules allow you to convert just those contributions without including any of the associated earnings.

If your plan allows for after-tax contributions and you think they may be right for you, it’s time to talk to your financial planner. In my next blog, I’ll walk you through what you need to take to your meeting.

Matthew E. Chope, CFP ® is a Partner and Financial Planner at Center for Financial Planning, Inc. Matt has been quoted in various investment professional newspapers and magazines. He is active in the community and his profession and helps local corporations and nonprofits in the areas of strategic planning and money and business management decisions. In 2012 and 2013, Matt was named to the Five Star Wealth Managers list in Detroit Hour magazine.

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Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. You should discuss any tax or legal matters with the appropriate professional. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Converting z traditional 401(k) into a Roth IRA has tax implications. An investor should carefully consider the source of funds used to pay the taxes owed on a Roth conversion. Penalties and taxes may apply if the investor uses money from the 401(k) as the source for conversion taxes. Consult a tax professional for details. C14-016528