Retirement Planning for Young Professionals
*Updated to reflect 2019 Increases
It is never too early to start saving towards retirement. As the new year approaches everyone is setting their goals and intention for the coming months. A main focus for many of us will be our money management and long term goals(retirement planning). It is imperative to have some knowledge of compounding interest to fully understand the benefits of starting early. In this post I will cover some basics of retirement planning and hopefully compel every young professional to start saving towards retirement(if you haven’t already).
Before moving forward, I must remind you that retirement planning is a long term investment. In most cases you will not be able to access these funds until around age 59 1/2 without severe ramifications (taxes + penalties). So, if you are investing and need to access your funds sooner than this, you may have to think of other types of investments, which we will talk about in a subsequent post.
There are many different accounts and plans available and choosing the right one is very important as they each have different benefits and advantages, especially when it comes to tax planning. Here are a few to help you get started.
Simple IRA (Saving Incentive Match Plan for Employees)
For the year 2018, participants can make employee contributions of up to a maximum of $12,500 per year if you are under 50 years old and $15,500 if you are older than 50. Both employee and employer contribute to this account. Contributions are non tax deductible.
Anyone can open a traditional IRA account - but honestly, if you are a dentist or physician (like most of my colleagues are), then there really is no use for this type of account. During residency you have the option to open a Roth IRA (more on that below) because your lower salary allows you to stay within the income restrictions. Later as you start your career and your salary increases you will most likely surpass the income caps and will have the ability to deduct your traditional IRA contributions. However, it’s worth understanding as it forms the framework for all other types of retirement accounts. A Traditional IRA is set up by you (not an employer) and the maximum contribution to this type of account is $6,000 if you’re under 50 years old and $7,000 if you’re older. The contributions are tax deductible and grows tax-free. If you withdraw the money prior to age 59 1/2, there will be ramifications of a 10% tax (penalty) as well as any income tax which would be owed on the money. After age 59 1/2, you just have to pay the income tax based on your tax bracket at that time. At age 70, you will be required to start withdrawing part of the money each year, the “Required Minimum Distribution (RMD).” This is age based and starts out at about 3.6% and increases to about 8.8% at age 90.
I absolutely love a Roth IRA. However, there is a contribution income limit. If you make more than $120K (single) or $179K (married), you cannot contribute to a Roth IRA. However, there are ways to get around that with Roth IRA conversions, which we will discuss in a subsequent post. Anyone with earned income can open a Roth IRA and contribute up to $5000 per year. If income is sufficient, one can also open a Spousal Roth IRA and contribute another $5000. If you’re over 50, those limits are raised to $6000 per year.
The reason I love a Roth IRA is because you contribute with after-tax money, but it is never taxed again! You don’t pay taxes on capital gains and dividends as the money grows, and it comes out tax-free in retirement. You generally can’t access the money before age 59 1/2, but unlike a 401K or Traditional IRA there are no required minimum distributions beginning at age 70.
If you are an employee of a company and your employer offers a 401K retirement plan, there’s absolutely no reason why you should not be participating. It is even more important that you participate if said company is offering a match. A match is basically free money! Do not leave free money laying on the table. The contribution maximum for the year 2019 is $19,000 and the great thing about a 401K is that you are investing pre-tax dollars. The not-so great thing is that when you go to retrieve your money (after age 59 1/2), you will be taxed on this (unlike with a Roth IRA).
If you're an Independent Contractor (not a W2 employee), you’re considered to be “running your own business.” In this case, you can also make an employer contribution of 20% of your net income up to $55,000.
SEP IRA (Simplified Employee Pension)
If you have your own practice, a SEP IRA may be a good option. This allows you to contribute 25% of your business profit or $55,000 per year, whichever is less. The contributions are tax deductible, and investments grow tax deferred until retirement.
This is not a comprehensive list of retirement vehicles but it’s a great place to start. Everyone, as early as possible, should start contributing to one of the above. Speak with your financial planner or accountant for more clarification about which plan is best for you. Hope this helps in getting started.