Posted on 25 October 2012
By Mark Miller
Ed Slott is one of the nation’s top experts on IRAs and retirement saving. An author, public speaker and CPA, he emphasizes the importance of strategies for minimizing the tax burden on retirement saving.
Ed recently published a brief book laying out fundamental principals for young retirement savers, called Fund Your Future: A Tax-Smart Savings Plan in Your 20s and 30s. I posed five questions to him about the challenges facing young retirement savers; while I don’t agree with his pessimistic view of Social Security’s future, read on for his valuable advice on managing the saving process, developing a “blueprint,” Roth IRAs and more.
Q: How has the challenge of saving for retirement changed for today’s young people, compared with the challenges their parents faced?
A. It is more challenging. Their parents and grandparents had more of the saving, investing and retirement functions taken care of for them through their job and Social Security.
Today’s young people need to be more involved in the process than their parents were. They have to start saving earlier and save more for two main reasons: They will live longer and they may not be able to rely on Social Security. Young people need to plan to fend for themselves. They should only consider Social Security as gravy – an extra they did not count on.
They generally cannot count on their employers either. Many companies have moved from pension plans (where companies put money away and guaranteed you a retirement income) to 401(k) type models where employees contribute the lion’s share of the money to their company retirement plans. They also take on the risk and management of those funds, so they must be more diligent and involved in planning for their retirement than their parents and grandparents had to be.
Q: You talk in your book about developing a “savings blueprint.” What is that?
Like a home blueprint, savings blueprints will help you build a solid foundation and keep you on track to build a healthy retirement account. It means sticking with that plan. The three key components of that plan are to contribute, convert and collect. Your goal should be to keep the tax man away so you can keep more of your savings.
Q: A big theme in all your work is the impact of taxes on retirement saving. What do you tell young people just starting out about how to be smart about taxes?
A. Tax Free. Tax Free. Tax Free. Tax Free is better.
When saving for retirement, it is essential that young people take advantage of their most powerful planning tool: time. They should consider the long-term tax impact on their retirement savings from the first day they put their first dime into a retirement account.
Taxes will be the single biggest factor that will separate people from their retirement dreams. Young people need to focus on building tax-free retirement money, so that taxes will be minimal or even eliminated when they come to collect in retirement. Young savers can accumulate amazingly large retirement savings when those savings don’t have to be shared with the government.
Saving tax free also means that you don’t have to worry about future high tax rates consuming your life savings. Saving tax free removes the uncertainty of what future higher tax rates could do to your retirement plans.
Q: With regard to Roths, are young people best advised to use a Roth IRA, or a workplace Roth if that’s available?
Most workers are eligible for both. Do as much Roth as you can afford. This is all building tax free, and that is powerful wealth building. It will never be eroded by future taxes. There are income limits for contributing to a Roth IRA (but they are very high so most young people will qualify). There are no income limits for contributing to a Roth 401(k) and you can contribute much more to a Roth 401(k) than you can to a Roth IRA.
In 2013 for example, the most you can contribute to a Roth IRA is $5,500 but you can contribute up to $17,500 to a Roth 401(k). Of course your company must have a Roth 401(k) option on their 401(k) plan in order for you to contribute.
For a Roth IRA, anyone with earned income (under those high income limits) qualifies to contribute, even if you do not have a Roth 401(k) at work. If you can afford to do both, first max out your Roth 401(k) at work and take advantage of any company matching – but that matching amount cannot go into the Roth 401(k). It must go into your 401(k) part of the plan. But that’s still your money and it’s free money so you never want to walk away from that. Then if you can afford to, start filling up your Roth IRA (up to the $5,500 maximum for 2013).
Q: Many young people worry that Social Security won’t be there for them when their retirement rolls around. What do you tell young people about the future of Social Security, and it’s value as part of a retirement plan?
A. As I said in answer number one, and as we say in New York . . Social Security for young people . . . Fugetaboutit!
Young people have to face reality and math. You’ll have to build your retirement savings on your own. Anything that might come from Social Security will be an extra surprise. That’s why you need to take charge now, start early and create your own plan to build tax-free retirement savings.
While you might not get Social Security like today’s retirees received (even if you are paying for it out of your paycheck – I know that sounds unfair) you have a bigger advantage than people collecting Social Security now. Young people have time and time is the greatest money making asset anyone can posses.
You have it and you need to capitalize on it immediately. Every lost day could means thousands less at retirement. Compounding over time is the eighth wonder of the world and the amount you can amass will amaze you! Then imagine all of that tax free! Not too shabby.