The average American worker has less than $25,000 in retirement savings, and over a quarter of us have nothing: no IRA, no 401(k), no pension. This is a crisis of the first magnitude, as entitlement programs are already straining and Baby Boomers are pouring relentlessly into retirement. Today we take up a few additional ideas for confronting the shortfall.
Christopher Hopkins
Obviously, the first stop should be your employer's qualified plan. But one third of workers have no access to a plan at work, and must maximize alternative strategies to prepare for the end of their careers. Previously, we looked at traditional and Roth IRAs as powerful tools. Today we take up additional options for retirement saving.
If you are self-employed and do not have a plan, you should get one started. Your financial adviser or accountant can help you sort through the options, including SEP and SIMPLE IRAs as well as solo 401(k) plans that allow you to fund retirement savings accounts on a tax-favored basis much like a plan offered by a large employer. This should be a top priority if you work for yourself.
Traditional brokerage accounts do not offer tax deferral, but can be reasonably tax efficient with a sufficient time horizon in mind. Appreciation in the value of stocks in your account is not taxed until the position is sold, potentially many years hence. And the rate of taxation on long-term gains (at least today) is generally lower than the tax rate on ordinary income. Dividend distributions are taxed as received, but also typically at the lower capital gains rate. Realized losses may be used to offset gains, which is not the case within tax-deferred retirement accounts. And at your death, the cost basis of appreciated holdings is reset to the price at your death, effectively erasing any tax liability for your heirs, within the limits of the estate exemption (currently $5.49 million).
While anathema to most financial advisers with a fiduciary duty, variable annuities could make sense in very limited circumstances. Those products are frequently expensive and opaque and can carry punitive surrender charges if you decide you want out (annual expenses in excess of 3 percent are common, as are surrender fees of 5 to 8 percent or higher). They generate large up-front commissions, which have often led to abusive sales practices and inappropriate recommendations (for example, inside an IRA).
But a new class of low-cost, zero-commission annuities that carry no surrender fees is now offered by many of the discount brokers as well as some insurance companies through direct sales. For workers in relatively high income tax brackets, the additional cost and inefficiency of a variable annuity could be outweighed by the tax deferral over many years. Consult your tax adviser to evaluate the trade-offs.
If you have a high-deductible health insurance policy, don't overlook the potential of using your HSA to enhance retirement savings. Contributions are tax-deductible up to the annual limit ($3,400 for 2017 plus a $1,000 catch-up if you're 55 and up). The funds can be invested, and the earnings compound tax-free if used for qualified medical expenses. If you can afford to cover your annual deductible out-of-pocket, your HSA can grow indefinitely to be used in retirement for copays and Medicare premiums. And there is no minimum required distribution.
More important than the specific vehicle is the decision to take action. Most of the channels we have discussed can be funded through a regular payroll deduction or systematic electronic transfer to make the process automatic. And the sooner you get started, the more you will benefit from the wonders of time and compounding.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.