Retirement

Pretax, Roth, or After-Tax Contributions: Which Should You Choose?

 
Pretax, Roth, or After-Tax Contributions: Which Should You Choose?If your employer-sponsored retirement savings plan allows pretax, after-tax, and/or Roth contributions, which should you choose?
 

Pretax: Tax benefits now

 
With pretax contributions, the money is deducted from your paycheck before taxes, which helps reduce your taxable income and the amount of taxes you pay now. Consider the following example, which is hypothetical and has been simplified for illustrative purposes.
 

Example(s): Mark earns $2,000 every two weeks before taxes. If he contributes nothing to his retirement plan on a pretax basis, the amount of his pay that will be subject to income taxes would be the full $2,000. If he was in the 25% federal tax bracket, he would pay $500 in federal income taxes, reducing his take-home pay to $1,500. On the other hand, if he contributes 10% of his income to the plan on a pretax basis–or $200–he would reduce the amount of his taxable pay to $1,800. That would reduce the amount of taxes due to $450. After accounting for both federal taxes and his plan contribution, Mark’s take-home pay would be $1,350. The bottom line? Mark would be able to invest $200 toward his future but reduce his take-home pay by just $150. That’s the benefit of pretax contributions.

 
In addition, any earnings made on pretax contributions grow on a tax-deferred basis. That means you don’t have to pay taxes on any gains each year, as you would in a taxable investment account. However, those tax benefits won’t go on forever. Any money withdrawn from a tax-deferred account is subject to ordinary income taxes, and if the withdrawal takes place prior to age 59½ (or in some cases, 55 or 50, depending on your plan’s rules), you may be subject to an additional 10% penalty on the total amount of the distribution.
 
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Are federal employees eligible for phased retirement?

 

Are federal employees eligible for phased retirement?Yes, a phased retirement program is authorized by the Moving Ahead for Progress in the 21st Century Act or MAP-21. In 2014, the United States Office of Personnel Management (OPM) issued final rules relative to the program that provide guidance to agencies and employees about who may elect phased retirement, what benefits are provided, how the retirement pension/annuity is computed during and following phased retirement, and how federal employees may exit the phased retirement program.

Generally, each federal agency has the option of offering a phased retirement program–employees have no right to phased retirement. Otherwise, only employees who have worked full-time for the preceding three years–who meet certain age and years of service combinations for immediate retirement in either the Civil Service Retirement System (CSRS) or the Federal Employees Retirement System (FERS)–may be eligible. Employees subject to mandatory retirement (law enforcement officers, firefighters, air traffic controllers, etc.) may not participate.

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What is a phased retirement?

 

What is a phased retirement?In its broadest sense, a phased retirement is a gradual change in your work patterns as you head into retirement. Specifically, a phased retirement usually refers to an arrangement that allows employees who have reached retirement age to continue working for the same employer with a reduced work schedule or workload.

A phased retirement has advantages for both employees and employers. Employees benefit from the opportunity to continue active employment at a level that allows greater flexibility and time away from work, smoothing the transition from full-time employment to retirement. And employers benefit by retaining the services of experienced workers.

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Give Your Retirement Plan an Annual Checkup

 

Give Your Retirement Plan an Annual CheckupFinancial professionals typically recommend that you review your employer-sponsored retirement savings plan annually and when major life changes occur. If you haven’t revisited your plan yet in 2015, the end of the year may be an ideal time to do so.

 

Reexamine your risk tolerance

This past year saw moments that would try even the most resilient investor’s resolve. When you hear media reports about stock market volatility, is your immediate reaction to consider selling some of the stock investments in your plan? If that’s the case, you might begin your annual review by reexamining your risk tolerance.

Risk tolerance refers to how well you can ride out fluctuations in the value of your investments while pursuing your long-term goals. An assessment of your risk tolerance considers, among other factors, your investment time horizon, your accumulation goal, and assets you may have outside of your plan account. Your retirement plan’s educational materials likely include tools to help you evaluate your risk tolerance, typically worksheets that ask a series of questions. After answering the questions, you will likely be assigned a risk tolerance ranking from conservative to aggressive. In addition, suggested asset allocations are often provided for consideration.
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Think Twice Before Counting on a COLA

 
Think Twice Before Counting on a COLAThe rising costs of food, gas, electricity, and health care can strain anyone’s budget. The situation is even worse if your living expenses increase while your income stays the same, because your purchasing power will steadily decline over time. That’s why cost-of-living adjustments, or COLAs, are especially valuable to retirees and others living on fixed incomes.

 
A COLA is an increase in regular income you receive (such as a Social Security or pension benefit) that is meant to offset rising prices. It’s important protection because price inflation has occurred in most years during the last 40 years. However, a COLA may not be payable in years when inflation slows or declines.

 

How COLAs work

 
It’s easy to think of a COLA as a “raise,” but a COLA is meant to help you maintain your standard of living, not improve it. For example, let’s say you receive a $2,000 monthly retirement benefit, and the overall cost of the things you need to purchase increases by 3% during the year. The next year, you receive a 3% COLA, or an extra $60 a month, to help you manage rising prices.

 
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