Category: 401(k)

$1.3 Trillion sits in orphan 401(k)s.

Once upon a time workers left school and went to work with the intention of working their way up the ladder with the company of their choice. Times have changed.

Today, it’s not unusual for someone in their 40s to have worked for two, three, four or more companies. The COVID-19 pandemic saw many workers seeking out better opportunities with new employers. Some may even have had “gig” jobs to supplement their income. And many of these companies offer 401(k) plans designed for retirement.

A research firm estimates that there are about 24.3 million abandoned 401(k) accounts, not a small number when millions have virtually no savings at all.

If you have left 401(k) plan assets behind at previous employers and don’t know how to gather them up and invest them for your retirement, we can help. We’ll show you how to gather them up and grow them for your retirement. Call us for a free, no obligation, consultation. We specialize in retirement plans.

Roth IRA vs Roth 401(k)

Retirement accounts, such as Roth IRAs and Roth 401(k)s, are confusing for most people. Whether you are preparing for retirement or are newly retired, it is important to make the right choices. It is essential to work with professionals who can explain all your options and help you weigh the pros and cons of each one. A financial planner provides the support and knowledge needed to guide you on the benefits of a Roth IRA vs a Roth 401k. Understanding these unique options can help you make the best personal finance decisions.

Korving & Company can help you understand your investment accounts to make informed choices. Call 757-638-5490 or use our contact page to discuss your investments with one of our experienced financial planners.

Roth IRA vs. Roth 401(k) – Understanding Your Options

Examine the differences between Roth IRA and Roth 401(k) plans to understand how they affect your retirement savings.

What Is a Roth IRA?

Roth IRA, named after William Roth, a senator from Delaware, is an individual retirement account (IRA) that allows you to take tax-free withdrawals when you meet certain conditions. First established in 1997, Roth IRAs are now a familiar retirement tool for millions of Americans. Roth IRAs resemble traditional IRAs in many ways. Both allow your retirement accounts to grow tax-deferred.  The difference is when you get a tax benefit.  Roth IRAs are funded by after-tax dollars, so you do not get a tax break from making a contribution. Instead, you do not pay taxes on qualified distributions when you take money out. That differs from traditional IRAs, which are funded with pretax dollars. Traditional IRA withdrawals during retirement are subject to income tax.  This tax-free withdrawal feature is the key tax benefit of Roth accounts.

Roth IRAs protect earners from future tax increases. When you contribute to a Roth IRA, it does not affect your income tax refund or payment for the current year. However, it could save you money during retirement. Savings in a Roth IRA do not have to be withdrawn at age 72 while traditional IRAs and 401(k)s require you to begin taking money out via Required Minimum Distributions (RMDs) and paying taxes on those withdrawals.

You can fund a Roth IRA as part of a personal retirement plan. There are three ways to do this, as follows:

  • Open a Roth IRA account and contribute to it directly.

  • Convert or partially convert a traditional IRA to a Roth IRA.

  • Rollover funds from your employer’s retirement plan.

Income limits apply to Roth IRA accounts. In 2021, single tax filers making more than $140,000 become ineligible for Roth IRAs [3]. For 2022, the income limit increases to $144,000. The limit for married couples that use the tax status married filing joint is $208,000 for 2021 and $214,000 for 2022. If you are below those income eligibility qualifications, the Roth IRA contribution limits are $6,000 for those under age 50 and $7,000 for those 50 years old or older.

It is important to partner with the right investment management team to open a Roth IRA or other individual retirement account. With a Roth IRA, you are contributing money that you’ve already paid taxes on, but you do not have to pay money on future withdrawals. If you want to reduce your taxes after retirement, you will want to consider a Roth IRA. If you are in a lower tax bracket today than you will be in the future, a Roth IRA makes sense.

To open an IRA, you will need to go to a brokerage firm, bank, credit union, savings and loan association, or other authorized institution. Additionally, if your employer has a retirement plan that offers a Roth 401(k), you need to understand how Roth 401(k)s work to determine whether it’s a better option for you than a Roth IRA.

What Is a Roth 401(k)?

Roth 401(k)s are retirement plans sponsored by your employer and funded through payroll contributions. Under certain circumstances, you can make tax-free withdrawals from your Roth 401(k). With a Roth 401(k), when your employer takes money from your paycheck to deposit into the 401(k) account, you have already paid taxes on it. Roth 401(k)s differ in this way from traditional 401(k)s, which are funded with pretax deferrals. With a traditional 401(k), your employer deducts the money from your gross income, and you pay taxes on it when you withdraw the funds in retirement.

Withdrawals of the contributions and earnings in your account remain tax-free as long as your withdrawal meets the following qualifications:

  • You have had the Roth 401(k) for five or more years and

  • You withdraw money due to the account owner’s death or have expenses related to a disability.

  • The account holder reaches or exceeds age 59½.

If you are at least 72 years old, you must make a minimum withdrawal from your Roth 401(k) account each year. There are exceptions to this rule. For example, if you still work at the company that manages the 401(k) and do not own more than 5% of the company, you do not have to make a minimum withdrawal. Otherwise, it would help to take out the first required minimum distribution by April 1st following your 72nd birthday. Note that you can take out more than the minimum distribution amount.  For this reason, many people choose to do a tax-free rollover from their Roth 401(k) account to a Roth IRA upon leaving their employer for retirement since Roth IRAs are not subject to required minimum distribution rules.

Not all companies sponsor retirement plans that include a Roth 401(k) option. According to the Transamerica Center for Retirement Studies, 43% of retirement savers choose a Roth 401(k) versus a traditional 401(k). Further, millennials are more likely to choose a Roth 401(k) than baby boomers or Gen Xers [7].

Roth 401(k)s have contribution limits based on your age, set annually by the IRS. For example, in 2021, the maximum contribution was $19,500, while the 2022 limit increases to $20,500. However, those aged 50 and above have higher contribution limits and can add another $6,500 as part of a catch-up contribution. Additionally, Roth 401(k)s don’t have a taxable income limit to prevent high income earners from using them.  This is a key difference between the Roth 401(k) and the Roth IRA.

How Are Roth IRAs and Roth 401(k)s the Same?

Both Roth IRAs and Roth 401(k)s are funded with post-tax dollars and do not require you to pay taxes on withdrawals. Neither will reduce your gross income since contributions are not deductible, but both do have Roth contribution limits. Take an in-depth look at some of the similarities between these two types of retirement accounts:

  • Tax-Sheltered Growth: Once you contribute money to your Roth IRA or Roth 401(k) and invest it, it will continue to grow tax-free. So, your money will grow more efficiently because you don’t have to pay taxes on the growth every year.

  • Compensation Required: You need to have earned income to contribute to either a Roth IRA or a Roth 401(k). You can use taxable alimony or earned income to fund a Roth IRA, which you can set up on our own or with the help of a financial advisor. The company you work for administers your Roth 401(k). If your job pays you $12,000 per year, you cannot contribute more than $12,000 to your Roth 401(k) with that company.  If your job pays you $120,000 per year, per our explanation above, you can not contribute more than $20,500 to your Roth 401(k) with that company (or $27,000 if you are age 50 or older).

  • Contribution Limits: Both of these accounts have annual contribution limits. The contribution limits appear in the individual sections above, but both include catch-up amounts that allow savers over age 50 to put aside more money for retirement. While Roth IRAs require individual contributions, your 401(k) plan will accept contributions from you or your employer.

  • Early Withdrawal Penalties: Knowing and understanding early withdrawal penalties can save you a lot of money. If you withdraw funds early, you face a 10% penalty on top of income taxes. So, if you are in the 15% income tax bracket, you would pay 25% of the money you withdraw when you prepare your federal taxes. The early withdrawal penalties for a 401(k) plan ends when you reach age 59 ½. The early withdrawal penalties for a Roth IRA ends at age 59 ½ or after you hold the account for at least five years. Additionally, you can take up to $10,000 out of a Roth IRA to purchase a first home. We typically recommend that you can hold off on taking any money from your Roth accounts if you can and wait to take and withdrawals after age 59 ½ penalty-free and tax-free.

  • Penalty Exceptions: Most of these retirement accounts also have early withdrawal penalty exceptions. If you have a permanent disability, inherit the funds in a retirement account as a beneficiary, or have considerable medical expenses, you may qualify for a penalty exception on both accounts. Early withdrawals from a Roth IRA to pay for higher education do not result in a penalty, and you can take advantage of a waived penalty for those leaving a job after age 55.

How Are Roth IRA and Roth 401(k) Plans Different?

When comparing key differences between a Roth IRA vs Roth 401(k), you also need to know how these accounts differ. For example, some people consider a Roth IRA a better choice because it typically has more flexible investment options than a Roth 401(k), which usually has a limited investment menu. However, if you have a high income, you may not qualify for a Roth IRA. In that case, if you want to save as much money as possible and take advantage of an employer match, a Roth 401(k) might make sense.

Here is a closer look at the significant differences between these two types of retirement accounts:

  • If you choose a Roth IRA, you make your own contributions and select your own investments or hire a financial advisor to do that for you. In a Roth 401(k), you usually have a limited menu of investment options, typically mutual funds chosen by your employer.

  • A Roth IRA makes early withdrawals slightly easier. Do you plan to retire before age 59½?  If this is a consideration, a Roth IRA may best meet your future needs.

  • A Roth 401(k) has higher contribution limits. If you want to invest more than $6,000 per year in a Roth account to fund your retirement, a Roth 401(k) might be the best option.

  • Roth 401(k)s offer paycheck deduction options and potential employer matching. Both of these options make a Roth 401(k)s attractive. Many employees choose to save at least the amount that their employers match. Also, having the amount taken out of your paycheck and never even hit your bank account makes it easy to save for retirement before you even miss the money.  (Keep in mind that any employer contributions to your Roth 401(k) savings will be made in a pre-tax account and will be considered traditional 401(k) savings.  Still, employer matches are essentially free money and are always a nice benefit that employees should take advantage of.)

  • Roth IRAs may offer more investment variety. If you want to diversify your retirement portfolio and you know a lot about investing or work with a financial advisor that you trust, a Roth IRA might give you more options and control.

Taxpayers can benefit from both types of Roth retirement accounts. If you can manage it, you might want to have both a Roth 401(k) and a Roth IRA. You can put enough into your 401(k) to take full advantage of your employer’s matching contributions limit. Then, put any additional funds into a Roth IRA. If you still have money available to invest after maximizing the Roth IRA, you can contribute even more to the Roth 401(k) sponsored by your employer. It is important to note that maxing out your contribution to either a Roth 401(k) or Roth IRA does not keep you from contributing to the other.  For example, if you are under age 50 and are able to save the full $20,500 in a Roth 401(k) in 2022, you can open a Roth IRA and save the max $6,000 this year, too.  If this is a consideration, it is important to review the income limitations on a Roth IRA we reviewed above to confirm that you don’t make too much to contribute directly to a Roth IRA.  Remember, there is no income cap to be able to contribute to a Roth 401(k).

Which Is Best?

Roth 401(k)s and Roth IRAs both give you an option for tax-deferred savings. If your employer offers a match for the company’s 401(k), it makes sense to contribute up at least up to the percentage they will match. While you don’t get any tax deduction for Roth IRA or Roth 401(k) contributions, you can withdraw them without paying taxes when you retire, which will be a long-term tax savings if you expect tax rates to be higher in the future than they are now.

So, which type of account is best for you between Roth 401(k) vs. Roth IRA? That answer depends on your investment goals and how much money you make. Therefore, it is essential to work with a financial advisor who can help you understand the differences between these two accounts and how each will affect your personal income now and in the future.

In reality, most investment strategies involve both Roth IRAs and Roth 401(k)s, assuming both are available to you. Your investment advisor can help you make the right decisions for you and your family. Whether you are a first-time investor or want help looking at your current retirement strategy, you can benefit from speaking with an experienced financial planning advisor.

If you are self-employed, Roth IRA contributions allow you to save for retirement, even if your company doesn’t offer a 401(k).

Talk to the professionals at Korving & Company who will help you evaluate your options and maximize your retirement savings plan.

Six Charitable Moves to Consider Before Year-End

The tax changes in the Tax Cuts and Jobs Act (TCJA) are extensive and far-reaching.  The standard deduction will be raised starting in 2018, which means that going forward taxpayers will need to provide more itemized deductions in order to receive the tax benefit of excess deductions.  If you are charitably inclined, you should to consider these six charitable planning moves before the end of the year given the impending changes to the tax code.

If you itemize your taxes:

  1. Donate highly appreciated stocks or mutual funds. The stock market has been on a terrific run, and you may have highly appreciated stocks or mutual funds that you are holding on to because you do not want to pay capital gains taxes.  By donating appreciated investments, you avoid paying the capital gains tax and can take a deduction for the fair market value of the investments.  If you are considering gifting mutual funds, do so before they declare their year-end dividends and capital gains and you will save on taxes by avoiding that income as well.  While your deduction is limited to 50% of your Adjusted Gross Income (AGI), you can carry the unused portion to future tax years.
  2. Consider bumping up this year’s contributions: essentially, make contributions that you would have made in 2018 before the end of 2017. The rationale here is that your tax rate is likely to be lower next year than it is this year due to the TCJA, so every additional dollar given this year is deducted against your higher current 2017 rate.
  3. If you want to create a legacy or are unsure of where to contribute, use a Community Foundation or Donor Advised Fund (DAF) to max out your contributions. For example, if you give $50,000 to a DAF, you can deduct the entire amount now but designate your gifts and charities over time.  You can invest the portion of your DAF that is not immediately donated to a specific charity, creating the potential for even greater giving in the future.
  4. If you are considering an even larger donation, or are interested in asset-protection, you may want to consider creating either a charitable lead or remainder trust. With a charitable remainder trust, you get a deduction for your gift now; generate an income stream for yourself for a determined period of time; and at the expiration of that term, the remainder of the donated assets is distributed to your favorite charity or charities.  A charitable lead trust is essentially the inverse of the remainder trust: you get a deduction for your gift now; generate an income stream for one or more charities of your choice for a determined period of time; and at the expiration of that term, you or your chosen beneficiaries receive the remaining principle.  The deduction you receive is based on an interest rate, and the low current rates makes the contribution value high.
  5. Donate your extra property, clothes, and household items to charity. Make time to clean out your closets, spare bedroom and garage, and donate those items to one of the many charitable organizations in our area.  CHKD, Salvation Army, Purple Heart, ForKids, Hope House are just a few organizations that will take old clothes, appliances, household items and furniture.  Some of them will even come to you to pick up items.  Make sure to ask the charity for a receipt and keep a thorough list of what you donated.  You can use garage sale or thrift store prices to assign fair market values to the donated items, or you can use online programs (such as itsdeductible.com) to figure out values.

If you are over age 70 ½:

  1. Make a Qualified Charitable Distribution (QCD).  Essentially a QCD allows you to donate all or a portion of your IRA Required Minimum Distribution to a qualifying charity.  The donated amount is not included in your taxable income and also helps to lower your income for certain “floors” like social security benefit taxation and Medicare Part B and Part D premiums.  QCDs are very tax-efficient ways to make charitable donations.

Beware the Quirks of the TSP in retirement

The TSP (Thrift Savings Plan) is a retirement savings and investment plan for Federal employees. It offers the kind of retirement plan that private corporations offer with 401(k) plans.

Here is a little information about he investment options in the TSP.

The TSP funds are not the typical mutual fund even though the C, F, I, and S index funds are similar to mutual fund offerings.
The C Fund is designed to match the performance of the S&P 500
The F Fund’s investment objective is to match the performance of the Barclays Capital U.S. Aggregate Bond Index, a broad index representing the U.S. bond market.
The I Fund’s investment objective is to match the performance of the Morgan Stanley Capital International EAFE (Europe, Australasia, Far East) Index.
The Small Cap S Fund’s objective is to match the performance of the Dow Jones U.S. Completion Total Stock Market Index, a broad market index made up of stocks of U.S. companies not included in the S&P 500 Index.
The G Fund is invested in nonmarketable U.S. Treasury securities that are guaranteed by the U.S. Government and the G Fund will not lose money.

One advantage of the TSP is that the expenses of the funds are very low.  However, if you plan to keep your money in the TSP after you retire you need to understand your options because there are traps for the unwary.

The irrevocable annuity option.  

This option provides you with a monthly income.  You can choose an income for yourself or a beneficiary – such as your spouse – that lasts your lifetime or the lifetime of the beneficiary.  The payments stop at death.  Once your annuity starts, you cannot change your mind.

Limited withdrawal options. 

You can’t take money out of your TSP whenever you want.  When it comes to taking money out you have two options.

  1. One time only partial withdrawal. You have a one-time chance to take a specific dollar amount from your account before taking a full withdrawal.
  2. Full withdrawal.   You can choose between a combination of lump-sum, monthly payments or a Met-Life annuity.

Limited Monthly Payment Changes

If you take monthly payments from your TSP as part of your full withdrawal option you can change the amount you receive once a year, during the “annual change period” but it takes effect the next calendar year.  If you choose this option, make sure that you know how much you will need for the coming year.

Proportionate distribution of funds

When you take money out of your TSP you have no choice over which fund is liquidated to meet your income needs.  It comes out in proportion to which your money is invested.  This means you can’t manage your TSP and decide which of the funds you will access to get your distribution.

If you want to give yourself greater flexibility once you retire you have the option of rolling the TSP assets into a rollover IRA without incurring any income tax.

 

Is your retirement plan a ticking time bomb?

In your mind’s eye, how do you see yourself living retirement?  Does it include the activities that you enjoy now … without the time you spend at work?  When you have the time, do you see yourself seeing the world?  Retirement presents an opportunity for some life-changing experiences.

But there are a few things that can cause those retirement dreams to become nightmares.

If your retirement plan includes a pension, you may want to consider the risk.  It is a fact that many private and public pension plans are sadly underfunded.  Some public pension plans are the worst offenders.  As an extreme example, the Illinois General Assembly Retirement System is only 13.5% funded.

A long period of very low interest rates means that pension plans with large bond investments have generated low returns.  It has caused others to take greater risk.  At some point that can affect the pensions of those who believed their Golden Years were paid for.

Living longer than you expected is another risk.  In 1950 the average life expectancy was 68.  That meant that the average worker retired at age 65 and died three years later.

Sixty years later, in 2010, the average life expectancy was 79 and many people are living longer.  In 2010 there were 1.9 million people over age 90 and three quarters of those were women.  One of the biggest concerns that retired people have is running out of money as savings are eroded by inflation.    How would living past age 90 affect your retirement plans?

The third thing that is causing the average worker concern about retiring is insufficient savings.  Fewer people are covered by pension plans.  Many employers have replaced guaranteed pensions called “Define Benefit Plans” with 401(k)s and 403(b)s known as “Defined Contribution Plans.”  This transfers the responsibility for retirement from the employer to the employee.  Too few people are taking advantage of these programs, not saving enough, and making unwise investment choices.  This can result in insufficient savings when the time comes to actually retire.  One result is that more and more people continue to work well past the traditional retirement age of 65.

What is to be done?

We have to accept a greater responsibility for our own retirement.  We have to be honest about how safe those pension promises are, whether we work of a large corporation or for a government entity.  We have to start saving early and make wise investment choices.  One of the wisest things people do as they prepare for retirement is get the services of a competent retirement professional who will guide them to a safe haven at the end of the road.

 

Benchmarking Inverts the Basics of Investing

The problem with “benchmarking”  – that is measuring your investment performance against market indexes (known as “benchmarks”) – is that it often leads to buying into asset bubbles.

During the tech boom of the last 20th century, billions of dollars went into internet stocks whose values became wildly inflated.  People who participated in this as a way of reaching for high rates of return, found that no one rang a bell when the party was over.  Many lost their retirement savings and saw their 401(k)s devastated.

Certain stocks become wildly popular, industries become wildly popular and investing styles become wildly popular, all of which leads to wildly inflated values.  This almost inevitably leads to financial pain.

But this does not only happen in the stock market.  In the first decade of the 21st century, real estate seemed to be a way of making outsized profits.  Of course, when the housing bubble collapsed, many not only lost money, but their homes.

The focus of serious investors is to align your portfolio with your personal objectives.  The focus should be on long-term – multi-year – performance.  The only benchmark that should concern you is the one you set for yourself.

At Korving & Company we keep our clients grounded and work with them to meet their personal benchmarks.  Contact us to do the same for you.

Top 5 Tax Mistakes Investors Make

The tax laws are fairly complex and people make mistakes, but there are some mistakes that investors should not make.

  1. Taking short-term gains when waiting will turn the gain into a long-term gain.  Appreciated gains on assets held one year or longer are taxed at a lower rate than those held for less than a year.
  2.  Foreign stock investments held in a tax-qualified account.  Many foreign companies are required to withhold foreign taxes on dividends paid. U.S. investors can claim a tax credit on their tax returns, effectively recouping this lost dividend, but only if the foreign stocks are held in a taxable account.
  3. Failing to realize capital gains.  If you have a gain in a stock and believe that stock is now overvalued, do not allow fear of taxes to sell and lock in a gain.  That is the trap that many tech stock owners fell into in 1999, just before the tech bubble burst in 2000.
  4. Failing to take capital losses.  If you have a loss in a stock, the loss can be used to offset a realized gain in another stock, thus reducing your tax liability.  If you still like the stock you have a loss in, you can buy it back later as long as you observe the “wash sale rule.”
  5. Taking a direct distribution from a 401(k) or similar retirement plan.   Distributions from retirement plans should be done via a custodian-to-custodian transfer or you can be subject to taxes as well as potential penalties if you are under 59 1/2.

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