Saving for retirement is an essential financial goal, but there are certain circumstances in life when it may be best to push pause on retirement contributions. By recognizing these situations, you can better allocate resources and make informed decisions. Below we discuss the times in life when slowing or pausing retirement savings goals could be the right call.
Debt and Financial Stability
If you are burdened with high-interest debt, such as credit card debt or student loans, it’s important to allocate more funds towards debt repayment before saving for retirement. Reducing debt obligations will improve your financial stability and free up resources for retirement savings in the future.
Job Loss or Career Transition
If you’ve lost your job, it’s a good idea to pause retirement contributions temporarily until your financial situation has improved and you are once again steady in the workforce. When you decide to restart retirement savings, be sure to take advantage of any 401(k) matches that your new employer may provide.
Likewise, when you are in a career transition, whether that be changing your career path or starting a new business venture, it might be necessary to redirect funds to supporting your career goals or acquiring new skills in your industry.
The above situations might call for a pause on retirement savings, but not a full stop. If you are in a position of needing to pause retirement savings, it’s essential to have a plan to resume saving once the transition is complete and you are back on your feet.
Major Life Events and Unforeseen Circumstances
Life happens, and sometimes we’re faced with a financial hardship. Unexpected medical expenses and major life events, such as having a child or making a cross-country move, can impact your finances. During these times you may need to adjust your retirement savings strategy to meet these needs. Pausing or slowing down retirement savings temporarily can provide flexibility while protecting some financial stability. Once you’re back on your feet, you can revisit your retirement savings strategy and make adjustments accordingly.
The above examples are all valid reasons to readjust your financial priorities and push pause on saving for retirement. By recognizing these situations and making informed decisions, you can maintain a financial balance and step up your retirement savings game once you’re in a less financially tumultuous phase of life.
A key approach to minimizing taxes, especially as you near retirement, is to implement tax planning strategies that can help you save money and maximize your retirement savings. Here are some tax-efficient strategies to consider.
Contribute to Tax Advantage Retirement Accounts
When you contribute to a retirement account such as a 401(k), IRA, and Roth IRA, you can lower your taxable income in the year you make the contribution. With a traditional 401(k), you defer income taxes on contributions and earnings, which means you won’t pay taxes on them until you withdraw the funds in retirement. With a Roth IRA, your contributions are made after taxes and your earnings may be withdrawn tax-free in retirement.
Utilize Catch-Up Contributions
Workers over the age of 50 are eligible for an additional tax break when they make catch-up contributions to retirement accounts. In 2023 individuals can contribute an additional $1,000 to an IRA (up to $7,500 in total). For 401(k) plans, individuals can contribute an additional $7,500 for a total tax-deductible contribution of as much as $30,000. Catch-up contributions help to save more for retirement and reduce taxable income.
Consider a Health Savings Account
A Health Savings Account (HSA) is a tax-advantaged savings account that can be used to pay for qualified medical expenses. If you have a high-deductible health plan, you may be able to contribute to an HSA. The contributions are tax-deductible, the earnings grow tax-free, and you can withdraw the funds tax-free in retirement to pay for qualified medical expenses.
Make Use of the Saver’s Credit
In order to be eligible for the saver’s credit in 2023, you must contribute to a 401(k) or IRA and earn up to $36,500 for individuals, $54,7500 for heads of household, and $73,000 for married couples. You can claim the saver’s credit on retirement account contributions of up to $2,000 ($4,000 for couples). Depending on your income, it is worth between 10% and 50% of the amount contributed (bigger credits go to lower-income savers). The saver’s credit may be claimed in addition to the tax deduction for traditional retirement account contribution.
Refrain from Triggering the Early Withdrawal Penalty
You could be subject to a 10% tax penalty if you make IRA withdrawals before age 59 ½ and 401(k) withdrawals before age 55. The penalty may be avoided for certain specific purchases such as:
Up to $10,000 for a first home purchase
College costs
Extensive health care costs
Health insurance following a layoff from your job
If a Roth IRA is at least five years old, you may be able to withdraw funds that you contributed, but not the earnings, without prompting the early withdrawal penalty.
Don’t Sleep on Required Minimum Distributions
After age 73, savers are generally required to take required minimum distributions (RMDs) from IRAs and 401(k)s, and income tax will be owed on each distribution. Should you withdraw the incorrect amount, you could be subject to a 25% penalty of the amount that should have been withdrawn. This is in addition to the income tax due. However, if you act quickly to amend the error, that penalty could drop to 10%. Your first RMD is due by April 1 of the year after you turn 73. All following distributions must be taken by Dec. 31 each year in order to avoid the penalty.
Put Off 401(k) Withdrawals if You’re Still Employed
If you are still employed in your 70s and beyond, you may be able to delay withdrawals from your 401(k) account until your retirement (provided you don’t own more than 5% of the company sponsoring the retirement plan). Just be aware that after age 75, you will still be required to take RMDs from IRAs and 401(k)s associated with previous jobs in order to avoid the 25% tax penalty.
Plan Your Withdrawals
When you start withdrawing funds from your retirement accounts, plan in a way that minimizes taxes. For instance, you can withdraw funds from taxable accounts first to avoid triggering taxes on Social Security benefits. During your 60s, you can take penalty-free withdrawals from your retirement accounts without being required to take distributions each year. You can also take advantage of tax-efficient withdrawal strategies, such as the bucket approach, which involves dividing your assets into different buckets based on when you plan to use them.
While the purpose of a retirement account is to fund your lifestyle in your golden years, certain situations in life might necessitate dipping into those funds early. Typically, withdrawing from an IRA before age 59 ½ will trigger a 10% early withdrawal penalty. However, there are some key milestones where that penalty is waived. Here’s when you can avoid the IRA early withdrawal penalty.
Medical Expenses
IRA funds can be used to cover unreimbursed medical expenses that exceed 7.5% of your adjusted gross incomes. For example, if your AGI is $80,000 in 2023, you can use a withdrawal to cover unreimbursed medical expenses this year over $6,000. You don’t need to itemize your taxes to take advantage of this exception to the early withdrawal penalty.
Health Insurance
If you are unemployed and have received unemployment compensation via a federal or state program for at least 12 consecutive weeks, you may be able to take IRA distributions without penalty in order to cover health insurance premiums for you, your spouse, and any dependents. The withdrawal must be made in the same year that you received unemployment, or the next year. You must also take the withdrawal within 60 days of being re-employed.
Costs for Higher Education
Penalty-free IRA distributions may be used to pay for some higher education costs for you, your spouse, your children, and grandchildren. Eligible costs include tuition, fees, books, supplies, equipment required for a student’s enrollment, and expenses for certain special-needs services. For students who attend school at least half-time, room and board may also qualify. Keep in mind that IRA withdrawals are considered taxable income and could lower the student’s qualification for financial aid.
Home Purchase
If you are funding a first home purchase with funds from an IRA, the withdrawal may be penalty-free. This doesn’t mean that you need to be a first-time home buyer. The IRS broadly defines a first-time buyer as someone who hasn’t owned a home in the last two years. If you fall into this category, you can withdrawal up to $10,000 ($20,000 for couples) without penalty. If the purchase or building of the home falls through, you have 120 days from the date of distribution to put the money back in your IRA in order to avoid the penalty.
Birth or Adoption of a Child
Parents are eligible to take a penalty-free IRA distribution of up to $5,000 following the birth or adoption of their child. The withdrawal must be made within one year of a child’s birth or legal adoption date.
Disability
Disabled retirement savers under age 59 ½ who are “totally and permanently disabled” aren’t obligated to pay the IRA tax penalty. In order to qualify, per the IRS, one must be unable to do “any substantial gainful activity” for a continued or indefinite duration due to a physical or mental condition, and a physician must certify the severity of the condition.
Military Service
Members of the military reserves in the Army, Navy, Marine Corps, Air Force, Coast Guard, or Public Health Service may be exempt from the tax penalty if they were ordered or called to active duty after Sept. 11, 2001, and in duty for at least 180 days. The distribution must be taken during the active-duty period in order to avoid the 10% early withdrawal penalty.
An Inherited IRA
If you inherit a traditional IRA, you can take penalty-free withdrawals, even before age 59 ½. However, you will need to pay income tax on each distribution. If the original owner of the IRA account passed away after Jan. 1, 2020, you will be obligated to withdraw all assets from the inherited IRA within 10 years of the IRA owner’s death. The exception to this is if you are the surviving spouse or minor child of the original account owner, or if you are disabled, chronically ill, or up to 10 years younger than the original account owner.
For more information on individual tax planning, click here.
Retirees routinely withdraw cash from retirement accounts to cover basic living expenses, but selling low could negatively affect your retirement portfolio. If the economy experiences a downturn during your retirement years, you can use the strategies discussed below to minimize the impact to your long-term financial plan.
Before Making Any Withdrawals
While younger investors are generally advised to leave their cash invested and wait for the market to rebound, retirees typically rely on market withdrawals to create cash flow. In an effort to avoid or postpone withdrawals during tricky market conditions, try to find assets unlinked to the market that you can tap into until the market normalizes. Market downturns and steep inflation can be considered financial emergencies if you’re struggling to make ends meet, so you can certainly dip into emergency funds without feeling guilty. Just be sure to prepare a plan to replenish the funds as soon as possible. If you must withdraw from your investment accounts, it’s important to be strategic in your withdrawals.
Begin with Interest and Dividends
Before selling low, try to leave your original investment intact by only withdrawing the interest and dividends from your taxable accounts. This move could allow you to conceivably grow your income when the market rebounds in the future.
Sell Lower Volatility Investments
Short-term bonds and bond funds generally aren’t as affected by market unpredictability, and their values are ordinarily stable. Selling them in a down market can supply necessary cash and not cause too much damage to your retirement savings. They also favor smaller price fluctuations than stocks during stretches of market volatility.
Rebalance Your Portfolio
If your investment portfolio is out of alignment with your asset allocation goals due to market volatility, it’s an opportune time to look for opportunities to raise needed cash by rebalancing. In order to return your allocation to its original goal, sell assets where values have increased disproportionately in value relative to your desired allocation, and buy assets that may have dropped in value.
Make Tax-Smart Choices
If you’re forced to sell assets from taxable accounts for needed cash flow, be sure to make tax-smart choices. You can minimize your taxes owed by selling investments that you’ve held longer than one year. Those gains are taxed at the long-term capital gains tax rate of 20% and not at the federal ordinary income tax rate. Keep in mind that some gains may also be subject to state and local taxes.
Retirees are feeling the effects of soaring inflation, and it’s stretching their budgets. More than 70 million retired Americans depend on a Social Security benefit program as a source of income, especially during economic downturns, so annual changes to payouts are always expected. Read on to learn what’s in the cards for Social Security benefits next year, including a higher payout.
COLA Boost
Get ready for a historic increase to 2023’s cost-of-living adjustment (COLA). 2022 saw an adjustment of 5.9%, which was already uncommonly high, but in 2023 monthly checks will increase by 8.7%. That’s approximately $146 per month ($1,752 per year) for the average retiree. This is the highest COLA increase since 1981. All retirees currently receiving Social Security benefits will see this increase in January of 2023.
Maximum Taxable Earnings Will Increase
Due to an increase in average wages, Americans will see more Social Security taxes taken from paychecks in 2023 because more of their income will be liable for the tax. Maximum earnings subjected to Social Security taxes will increase from $147,000 in 2022 to $160,000 in 2023. This means that workers paying into the system are taxed on wages up to this amount, typically at the 6.2 percent rate.
Maximum Social Security Benefit Also Set to Increase
The maximum benefit for retired workers who claim Social Security at full retirement age — which is 67 for anyone born after 1960 — will be $3,627 in 2023, up 8.4% from $3,345 in 2022. Take note that the maximum benefit will be different for those who claim benefits before the full retirement age, and the same can be said for those who claim benefits after the full retirement age. For instance, if you begin claiming benefits at age 62, your maximum monthly benefit in 2023 will be $2,572. On the other end of the spectrum, if you begin claiming benefits at age 70, your maximum monthly benefit in 2023 will be $4,555.
Work Credits Will Be Harder to Reach
In order to earn retirement benefits, workers must accumulate at least 40 work credits during the whole of their careers. The maximum number of credits eligible to be earned per year is four, and the value of each credit fluctuates from year to year. In 2023, a single credit will be worth $1,640, up from $1,510 in 2022. Thus, workers will need to earn more income in order to collect the credits they need to retirement benefits.
Approaching retirement planning when you’re late in the game can be a daunting task, but with the right strategies, you can get on track to build a nest egg that will provide some support by the time you reach retirement. Read on for proven catch-up options for late starters.
Identify How Much Savings You’ll Need
You might tell yourself that you won’t need much in retirement, but you might be surprised to learn that even a life of simplicity could require $1 million in the bank once you step away from the workforce. Given that most financial experts agree on an annual withdrawal of 3% to 4% of your retirement portfolio, that’s $30,000-$40,000 per year with a $1 million portfolio. This scenario excludes Social Security income as well as pensions, rental properties, or other sources of income.
Thinking through how much money you’ll need to live comfortably with the lifestyle you plan to lead in retirement will help you determine how aggressively you’ll need to save.
Pay Down Debt
While it’s important to pay down debt, you don’t want to surrender retirement goals to do so. You’ll need to come up with a plan to pay off credit card debt, car loans, and other high-interest or non-mortgage debt while also saving for retirement.
As for your mortgage, how you handle this debt as you approach retirement depends on where you are in your repayment journey. If you’re closer to the early stages of your mortgage and most of your monthly payment is assigned to interest, it might make sense to pay down some of the principle. However, if you are closer to the later stages of your mortgage and your payments are generally assigned to the principal, you might think about investing that money for retirement rather than putting any additional funds toward mortgage payments.
Invest Your Age
You might think that in order to make up for lost time, you should take on more investment risk. But with more risk comes the potential for more loss to your principal. Your risk should correlate with your age. While investors in their 20s and 30s can afford more risk because they have more time to recover any losses, investors in their 50s or older don’t have that luxury. As you near retirement you might consider one of the following blueprints for asset distribution, depending on your personal level of risk aversion:
High (but acceptable) risk: Invest in stock funds a percentage of 120 minus your age. Put the rest into bond funds.
Moderate risk: Invest in stock funds a percentage of 110 minus your age. Put the rest into bond funds.
Conservative risk: Invest in bond funds a percentage equivalent to your age. Put the rest in stock funds.
Fund a Roth IRA
If you are able to max out your 401(k), consider opening a Roth IRA and fully funding that as well. Roth IRAs are an opportune way to save and grow investments. Contributions to a Roth IRA grow tax-free, and qualified withdrawals are tax-free. The yearly contribution limit for both traditional and Roth IRAs is $6,000 for 2022. The catch-up contribution for those 50 years and older is $1,000.
Be Sure You Have Sufficient Insurance
Fact: Unforeseen hardship is the cause of most personal bankruptcies. You have a greater chance of avoiding bankruptcy when you have adequate health, disability, home and car insurance in place. Further, if you have dependents, think about term life insurance. Note that, in general, term life insurance is recommended over whole life insurance. Be sure to look for insurance agents who have a fiduciary duty to you, meaning the agent must legally and ethically act in your best interest.
Put Your Retirement Saving Plan First
It’s typically agreed that draining retirement funds to send children to college is a bad financial move. Aside from the fact that your 401(k) may not permit you to take out a loan on your retirement account balance, consider that your children have their entire working lives ahead of them, and they can begin saving for retirement much earlier than you did. At this stage in the game, protecting your own financial retirement security will help to ensure that the burden doesn’t fall to your children in the future.
