Today we’re exploring solutions to a very common question I hear from clients and potential clients alike:
"WE'RE MAXING OUT OUR RETIREMENT ACCOUNTS AT WORK AND WE WANT TO SAVE MORE MONEY. WHAT ARE OUR OPTIONS?"
First, if this sounds like you - congratulations. You’re probably saving at a pretty high clip relative to your income. And second, you're probably getting that employer match which means you're taking full advantage of your compensation.
In the Metro DC area, the median household income is $82372. So if your spouse and you are simply "average" earners and you're maxing out your retirement accounts at work, you're saving 23% of your gross annual income.
This is pretty sweet as you may remember from The Great Chase that rate of savings is a far better measurement for financial success than rate of return.
I imagine some of you reading this might make more than that. And you might be able to save more money than what you're allowed to sock away in the 401(k). Here's an example: we have an annual household income of $300,000 and both spouses work. And they're good savers, saving 18% of their gross annual income ($54,000). Both are maxing out their 401(k) plans at work to the tune of $38,000 ($19k x 2, right?). This leaves another $16,000 of money we can (want?) to do something with.
So what can we do? Let's take a look…
GET THAT PILLOW FULL OF MONEY
That's my way of saying make sure your emergency/rainy day fund is full. I call it pillow money because while google will tell you anything from 3 months to 12 months of living expenses, I've found that measurement doesn't work for everyone. Everyone has different cash flow needs. Remember, this stuff is personal!
FUND AN IRA
The IRS allows everyone to open and fund an IRA. If you can contribute to a 401(k) at work, your ability to deduct your contribution is limited by the amount you make. However, everyone can still fund it up to $6000 (2019) and $6500 for folks age 50 and older. The contributions are post-tax however the funds grow tax deferred and when you take the money out in retirement you are only taxed on the gains, or the amount of money that grew over time. Since we're already participating in the 401(k) and IRA's require you take money out during retirement, this isn't my favorite option for super savers. It also locks money up since IRA's have penalties for taking money out before age 59.5.
*we won't get into this today, but another option here is to execute what's known as a "backdoor" ROTH IRA. Again, since ROTH IRA's have lower income thresholds this move offers high earners the opportunity to fund a ROTH IRA.
OPEN A TAXABLE BROKERAGE ACCOUNT
Another option is to open a taxable brokerage account. These can be jointly owned or separately owned. Since we've already maxed out our tax-deferred employer plan and maybe the IRA option, the taxable brokerage account is a good choice here. The only tax-advantage here is growth inside the account can be taxed at capital gains rates. Capital gains rates are typically lower than what an individual might pay in "ordinary" tax rates, but not always. Another advantage here is the funds are semi-liquid. You typically won't pay any fees for needing the money before retirement. The only caveat here to liquidity is the risk associated with having money invested in the market.
EMPLOYER PLAN AFTER-TAX OPTION
I’ve come to really like this next option. Maybe even love it. For some of you, your employer will allow you to contribute to your 401(k) plan above and beyond the $19,000 maximum. Any funds contributed in this case go in as after-tax dollars similar to the IRA example above. We also get the tax-deferred growth similar to the 401(k) and IRA option. This is an advantage over the taxable brokerage account. However, we also lose the liquidity advantage. The biggest advantage to this strategy is this: when we leave our employer and/or retire and choose to roll that money out of the plan, we can roll it into a Roth IRA. When it comes to contributing to a Roth IRA, they have pretty low income thresholds. By implementing this savings strategy, we can effect what's known as a "mega Roth" option since we can typically put 25% of income or up to $56k/year (for 2019) into the Employer's plan. Roth IRA's are great because again we get the tax-deferred growth while we're working and saving. Even better, ALL of the growth and contributions come to us TAX FREE during retirement. One added bonus of the ROTH IRA is we don't have to required distributions during retirement.
529 PLAN
College education. It's a hot topic these days. Or maybe since like forever. Setting money aside for your child(ren)'s college education is important to many of us. Over 30 states + DC offer a state tax deduction for contributing to your state's 529 plan. So obviously there's a small tax benefit to contributing to these plans. Another added benefit is obvious to me - setting money aside for your kid's education. 529 plans work much like a ROTH IRA in that contributions are made with after-tax dollars, the money grows tax-deferred, and, when used for qualifying education expenses, is TAX FREE. The laws around 529 plans used to only cover college expenses. Today, you can even use your 529 plan to fund private school grades K-12. The drawbacks to 529 plans: again, money is not liquid. In fact, it's not even yours anymore. It belongs to your kid. If your kid is fortunate enough to earn a scholarship, you might be able to gift the funds to a sibling or relative. Rules around this and other distribution options apply. Be sure to understand them before starting this or any other investment plan.
PERMANENT LIFE INSURANCE
For the right situation, permanent life insurance can be an option for extra savings dollars. The first benefit here is the permanent death benefit. As long you pay the premium the death benefit will never disappear, unlike term life insurance which only covers you for a specific period of time. Guaranteed rates of return and protection of principal are another plus. Most permanent life insurance policies like whole life insurance will never go down in value. In addition, you might have access to money income tax free and policies can offer liquidity in certain situations. High earners seeking a permanent death benefit can use the right life insurance policy as an added bonus to their asset allocation and retirement plan.
HOME DOWN PAYMENT OR RENTAL PROPERTY
If you're looking to move into a new house or are wanting that vacation home, socking money away for this exciting event is always an option. Or maybe you want to get into owning a rental property. Both of these are options for super savers looking for another place to stash their cash.
BUSINESS OPPORTUNITY
Maybe you're curious about private equity or a startup company via a friend/colleague/crowdfunding website. Or you might want to start your own business. While this option carries quite a bit more risk, the rewards can be much greater than what you might reap investing in a typical stock market investment. Not always, but sometimes. That's a big advantage. The drawback? Obviously the risk of seeing your entire investment go to $0. In addition, these investments are rarely if ever liquid so your funds are often tied up until a liquidation event.
This list is by no means an exhaustive list and in no particular order - nor are they recommendations. Again, your personal financial situation is different from mine, which is different than the person next to you. My advice: meet with a financial planner and see what would be the best option(s) for your personal situation before taking action on any of these options.
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