When you think of retirement planning, a 401(k) account is probably the first thought that comes to mind. A 401(k) retirement plan is arguably the most popular employer-sponsored retirement savings plan. However, is it a complete retirement plan strategy?

To ensure you’re able to spend your retirement years with optimal income flexibility and tax efficiency, we want to look at a variety of investment options. It’s never too early to start planning with a Capstone Wealth Advisor to ensure you’re not overwhelmed and set up for success.

What Is a 401(k)?

Chances are your employer gives you an option to contribute a portion of your wages to a 401(k). A 401(k) is a type of profit-sharing plan that gives employees the ability to contribute a percentage of their pre-tax wages to an individual account under the company plan. This investment vehicle has many advantages. It’s a very convenient way to pay yourself first with an added advantage of receiving an employer match on some or all of your contributions. By deferring pre-tax dollars, you’re reducing current taxable income. Also, there is no income tax on dividends, interest or capital gains since all the income grows tax deferred. By all means, we recommend contributing as much as affordable to a 401(k) to maximize these benefits, but what else could you be doing?  

Why saving beyond a 401(k) is important to retirement planning.

Combining investment vehicles is ideal situation for success in retirement. This gives you the most flexibility to manage your assets and control tax efficiency. In your working years, you’re most likely in your highest earning years and thus a 401(k) works well to reduce your current taxable income. However, when retired, we still want to look for ways to reduce your taxable income. As soon as you start taking funds out of the 401(k), it is all taxed at ordinary income tax rates. Non-retirement brokerage accounts and Roth IRAs have their own tax benefits. Let’s take a look.

The tax advantages of a fully diversified brokerage accounts.

A fully diversified brokerage account has some great tax advantages. When it’s time to withdrawal funds, only your earnings are taxed. When held longer than one year, the tax is at favorable capital gains tax rates, which are much lower than ordinary income tax rates. Also, while the account may earn taxable income, such as dividends and interest throughout the year, you can choose more growth-oriented funds verses income-producing funds, reducing the potential for taxable income. Municipal bond funds are also an excellent diversifier and defensive strategy, as well as exempt from federal income tax.

Roth IRAs for the optimal tax efficiency.

Roth IRAs are an excellent tax-efficient account. Roth IRAs are funded with after-tax dollars, the earnings grow tax-free, and qualified withdrawals are tax free. There are several different Roth IRA planning strategies to build into your retirement plan. Some employer-sponsored 401(k) plans offer Roth deferrals. There are also Roth IRA contributions, conversions, and a strategy called a backdoor Roth IRA. Each planning strategy is used for a specific financial situation and best talked through with a Wealth Advisor to determine which strategy is right for you.

Other tax-efficient accounts to consider in retirement planning.

There are a few more tax-efficient accounts that are great ways to accumulate wealth in different investment vehicles.

If you participate in a high deductible medical plan, a Health Savings Account takes the best characteristics from a 401(k) and Roth IRA. It has the pre-tax deferral like the 401(k), reducing current taxable income and your money grows tax free. Like the Roth IRA, the withdrawals are also tax free when used for qualified medical expenses.

A 529 plan is one of the best plans out there to fund a college education. Contributions to the plan also grow tax free and qualified withdrawals are tax-free. Some states even give an income tax deduction based on your annual contribution.

High-income earners may have the advantage to participate in a Deferred Compensation Plan. A Deferred Compensation Plan is one of the best ways to reduce your current taxable income while saving for your retirement particularly because you can save above and beyond the annual limits of a 401(k). By participating in a deferred compensation plan, you’re effectively deferring your current income, pre-tax, into a separate account where it can be invested and grow tax free. Once you separate from your company, the deferred income and growth is paid in either a lump sum or monthly installments, when it is then taxed at your federal and state tax bracket. Deferred Compensation Plans can be a very powerful and tax-efficient wealth building strategy; however, they are not without risk. Talk to a financial advisor to consider all the nuances of the plan before electing to participate.    

An experienced Wealth Advisor can guide you in all the various accounts and planning strategies to fit your overall retirement plan. Having a variety of accounts provides for the most flexibility in tax efficiency as well as control as to how to best utilize the accounts, all designed to protect your wealth in and out of retirement.

Disclosures:

This article is not a substitute for personalized advice from Capstone and nothing contained in this presentation is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed by other businesses and activities of Capstone. Descriptions of Capstone’s process and strategies are based on general practice, and we may make exceptions in specific cases. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.