Saving for retirement is no easy task. Fortunately, we have several tools and strategies that can help us reach our retirement goals. Here are five ways to boost your retirement nest egg that you may be missing.
1. Maintain your asset allocation. When you begin investing you typically select an asset allocation that suits your risk tolerance and investment goals. However, your investments begin to deviate from that plan as soon as the markets open and the value of your investments changes. Retirement savers need to periodically shift back to that target asset allocation to avoid taking on too much or too little risk. Particularly given the rise in equity values over the past several years, a failure to rebalance can result in investments that deviate significantly from your asset allocation plan. By periodically rebalancing, an investor effectively sells high and buys low.
2. Open a Roth IRA. Doing at least some of your retirement saving in an after-tax Roth account will add tax diversification to your portfolio and help reduce your tax bill in retirement because you are pre-paying the tax now. As an added bonus, Roth IRAs do not have required minimum distributions in retirement.
For those whose income and workplace retirement plan disqualifies them from contributing to a Roth IRA, there is an alternative. A backdoor Roth IRA allows you to contribute after-tax dollars to an IRA, and then immediately convert it to a Roth IRA. The conversion involves after-tax dollars, so there are no taxes due from the conversion. The result is an investment that grows tax-free.
3. Convert an IRA to a Roth later. Another important retirement account strategy involves converting pre-tax retirement account balances into a Roth IRA. Unlike a backdoor Roth involving only after-tax dollars, conversion of pre-tax dollars to a Roth IRA will trigger taxes. So, it's important to do the conversion in a year when you have a particularly low income.
Individuals in higher tax brackets during their working years often get a big tax break by contributing pre-tax dollars to traditional retirement plans. However, their incomes may fall substantially as they near or enter retirement, which lowers their marginal tax rates. During these years of lower tax rates, strategic conversions of pre-tax retirement dollars to Roth accounts can significantly minimize the taxes that will be due later in retirement.
4. Hedge your bets. Many people wonder whether it's better to save for retirement in a pre-tax 401(k) or an after-tax Roth account. A logical way to decide is to compare your current tax rate to your best guess of your tax rate in retirement and choose whichever tax treatment results in lower taxes. As you might imagine, predicting future tax rates is a lot like trying to predict the stock market.
Another option is to hedge your bets. The IRS permits contributions to both Roth and traditional 401(k) and IRA accounts. It's not an all or nothing proposition. The contribution limits for 401(k) and IRAs don't change just because you open multiple accounts, but you can split your contributions between both Roth and traditional retirement savings options. Then no matter what happens to your tax rate, you will have options in retirement.
5. Start a business. One of the biggest surprises when I started my online business was the retirement benefit. Unlike 401(k)s and IRAs, retirement plans for the self-employed offer significantly higher contribution limits. Both SEP IRA and individual 401(k) plans enable a business owner with sufficient earnings to contribute up to $52,000 in 2014, and the limit adjusts each year to keep up with inflation. Defined benefit plans enable some small business owners to save even more.
Rob Berger is an attorney and founder of the popular personal finance and investing blog, doughroller.net. He is also the editor of the Dough Roller Weekly Newsletter, a free newsletter covering all aspects of personal finance and investing, and the Dough Roller Money Podcast.
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