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Welcome to the 18th edition of the Tech Financial Planning (TFP) newsletter.
Most people are making the same mistake.
The vast majority of their saving and investing is in their traditional 401k.
In this newsletter we’ll breakdown why that can be an issue and a couple alternatives.
TL;DR
Most people are only saving in pretax retirement accounts
You probably have some big goals and big expenses in the next 10-20 years
Your future self will thank you for putting money into after tax (Roth) accounts
What most people do
Most people put the vast majority of their savings into their traditional 401k.
To clear up any confusion, here’s what that means:
Traditional = before (pre) tax. It means that it will help you in taxes now. It reduces your income by the amount you put away. So if you make $200,000 but put away $10,000 before taxes, you will get taxed on $190,000 of income.
401k = retirement plan offered by your employer. If you or someone you know works for a non-profit or government, you may see terms like 457 or 403b.
People do this because they
a) want to save for retirement and
b) save money on taxes now.
Not necessarily bad things by any means.
Here’s why that’s a problem
Saving for retirement and saving on taxes today are both good things.
But it can get problematic if that’s your ONLY thing.
And that’s the case for most people I talk with.
Here’s why that’s a problem:
You can’t touch it
In general, you shouldn’t / can’t withdraw from your 401k until your 59.5. There are exceptions & ways around it, but we’ll ignore that for today.
So what about all the “big things” in your life before then? Things like:
Sabbatical
Kid’s college
Early retirement
Dream trips
Investment property
How do you pay for that? Hint: your savings account probably isn’t the best avenue.
You will Owe taxes in retirement
With traditional retirement accounts, you save on taxes now, but you have to pay taxes when you take the money out in retirement.
Contrary to popular belief, many diligent savers can find themselves in a higher tax bracket in retirement than during their working years.
If you only have money in traditional accounts, you don’t have any “tax diversification” aka control over your tax bill in retirement (that’s for another discussion).
2 Alternatives
Here’s two different ways to invest that you should look into.
Taxable accounts
Some like to call this “non-retirement” money.
I like to call if your bucket of money for everything before retirement (although you can certainly still use it in retirement
We trade tax benefits for access.
You lose the tax benefits of retirement accounts, so when you make money (through capital gains, dividends, or interest), you’ll pay taxes on it.
But you gain access.
You can use that money whenever you’d like.
Roth accounts
Future you loves this account.
This is another type of retirement account, and you might be able to put money into a Roth 401k.
All “Roth” means is that you won’t save on taxes today when you put the money in. But when you take it out in retirement, you won’t pay any taxes (provided you follow all the rules).
Pay taxes now, save later
Putting it all together
As we close out the year and enter 2023, think about what you’re working toward and your plans for saving and investing.
Make sure the two are aligned, and if not, tweak accordingly.
In Q1 I’ll meet with my clients to review their plans for saving & investing for 2023 and make sure we make the appropriate adjustments.
But again, it all goes back to making sure that your spending and saving are in line with your goals.
Do that and you’re on the right track.
See you again next week.
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