Rich Cawthorne is in his forties with three school-aged children, and you know what his biggest regret is? Not putting enough money in his retirement account 20 years ago.
“Wow. Boring,” someone in their twenties might be thinking. Well, here’s another important detail about Rich: he’s the President of HUB Retirement and Wealth Management, in New England. While he is unsurprisingly focused on managing his personal finances, he’s giving the gift of professional hindsight: roughly half of Americans between 55 and 66 have no retirement savings, according to the most recent U.S. Census Bureau data.
At a time in life when medical expenses are increasing and your ability to work is decreasing, not having savings is a precarious financial place where no one wants to be. “We don’t know what the future holds, either in our own world or the world at large,” Cawthorne said. “So, whether interest rates fall or there’s some doomsday Social Security situation, we need to prepare and take care of ourselves with our own retirement savings.”
If you are still decades (or even just a decade) from retirement, you can give your future self a hand: maximize retirement savings as soon as you can because the longer your money sits in a retirement account, the more it tends to be worth.
Retirement savings are like science fiction
Retirement accounts are the “Back to the Future” franchise of personal finance. (Hopefully, that’s still an intergenerational reference.) They provide the opportunity for a time-traveling gift of compound interest to invest in your older self’s health, happiness and well-being.
“For me, compound interest is like the eighth wonder of the world,” said Rich Cawthorne. “Because now, it doesn’t really matter what percentage of your income you’re setting aside for retirement each year. It’s about when you start saving, and typically the earlier you start the better.”
Here’s how it works: for an account, such as a high yield savings account, you make money each year from the interest your money accrues. That’s called capital gains. In most scenarios, you must pay taxes on that money because the IRS considers it as part of your annual gross income.
For a qualified retirement account, any gains are reinvested back into the account. By reinvesting or compounding interest, your retirement account will continue to receive deposits whether you are actively contributing that year or not. You won’t pay annual taxes on any contributions or investment gains in the accounts as long as you do not take any of the money out of the accounts.
Build a personal tax management strategy
Reducing taxable income is a general personal finance strategy. The ultra-rich may have offshore accounts, you have retirement accounts.
A traditional IRA is a pre-tax account: the money you put in there does not count towards your annual gross income and, thereby, reducing your tax bill. For example, someone who is self-employed could deposit a few thousand into their retirement account to reduce their income. This could drop them into a lower tax bracket and the opportunity to pay a lower effective tax rate for the year.
The tax bill arrives on the other end of the account’s lifespan. When you withdraw from a traditional IRA at age 59-and-a-half or later, you will pay taxes on the original contributions and on interest and investment gains. But the same logic about tax brackets applies. If this is your only source of income, you will presumably be in a lower tax bracket and pay less in taxes.
Choose an employer who helps you
Cawthorne notes that you have a lot of employment options in your twenties and many employers offer their employees a way to save for retirement.
401(k) accounts are funded with an authorized direct deposit from your paycheck. This is where young adults typically first access a retirement investment account. A common employee benefit is for an employer to match a percentage of what you set aside. Here’s a key piece of information from Cawthorne: Even if you do not plan to make additional contributions, never leave money on the table and meet as much of the match as you can.
The Roth IRA is a post-tax account. You have paid taxes on the money deposited. So when you withdraw from your Roth account, you typically do not pay taxes.
Cawthorne expanded: in your twenties, at the beginning of your career, you’re presumably not at your full earning potential. Many individuals probably have student loan payments that are already helping reduce the taxes and, therefore again, your gross income usually has you in a lower tax bracket. “So you could take the tax hit now,” he said. “And when you withdraw from that account, that money is 100% yours.”
Why would you want more than one retirement account? There are income restrictions and deposit limitations to Roth accounts, and there is a predictably unpredictable risk: while you can draw down without penalty after the account is five years old, you must make it to 59-and-a-half years of age to receive the full tax benefit of a Roth account.
Every day is a new day to start saving
Now, let’s say you are not in your twenties and starting to feel dread about your small to zero balance retirement accounts. Cawthorne said, “Don’t worry too much. Those ‘You should have this much by this age” articles are meant to shake you up and get you to pay attention.” He observed. “Maximizing savings in your 30s, 40s, and 50s usually pays off.”
If you are starting from scratch and do not have a 401(k) option, he shares you may want to contact a well-known investment firm such as Charles Schwab, Vanguard or Fidelity. “These organizations have resources that will guide you to accounts for your individual situation,” Cawthorne said. Another alternative would be to find an experienced investment advisor. For an example, the local HUB office in Cumberland, Maine has advisors that work with individuals to build retirement and financial plans.
Conventional wisdom for everyday investors is to focus on Index Funds, which nearly all major investment firms provide access to. These funds invest in a wide array of publicly-traded companies, and strive to keep you diversified and stable in the long run.
Control your destiny
Like many financial advisors, Cawthorne lamented how personal finance is not widely taught in school, often leaving young people to repeat what they learn from family. “These basic strategies are not ingrained in us, so we must take control of our own money. No one is going to do it for us,” he said.
No need to necessarily monitor your retirement accounts like TikTok and Instagram accounts, but Cawthorne said, “You must check in at least once or twice a year. I still ask myself, ‘Did I budget appropriately for this year? Did I save everything I could save? Am I simply getting better with my money?’”
Money cannot buy happiness, but it does provide you with options. So, young and not-so-young folks: live in the moment, try new things, and every year, consider putting as much money as you can into a retirement account.
To learn more, reach out to Hub International.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advisory services offered through Global Retirement Partners, LLC (GRP), DBA Alpha Pension Group, a registered investment advisor. Insurance services offered through HUB International. Alpha Pension Group, a division of HUB New England, GRP, HUB Retirement and Wealth Management and HUB International are separate entities from and not affiliated with LPL Financial. Alpha Pension Group, HUB New England, GRP, HUB Retirement and Wealth Management, HUB International and LPL Financial are not affiliated with any other referenced entity.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
Traditional 401(k) and IRA contributions may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
Roth 401(k)s offer tax deferral on any earnings in the accounts. Withdrawals from the account are tax-free, as long as they are considered qualified. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Savings accounts are FDIC insured to specific limits and offer a fixed rate of return, whereas investing in securities is subject to market risk including loss of principal.
ETFs are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF’s net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.
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