Personal Financial Plan – Phase 4 – Saving For Your Future

by RJ

in Money Management


“For all long-term investors, there is only one objective— maximum total return after taxes.” – Sir John Templeton

I wish I could tell you that the 15% taken out of your paycheck, about 7.5% from you and 7.5% from your employer, will support you when you’re old.

The concept of Social Security taxes, or FICA taxes as we painfully see it on our paychecks,  sounds like a great idea.. However, as many of our grandparents found out, a check from the Government once a month was not nearly enough.

As a member of Generation Y, we’re pretty lucky. We don’t have to live until our 40′s and 50′s to find out that Social Security isn’t enough. We can start being proactive today to take care of our future. In Phase 4 of your personal financial plan, you will concentrate on saving for retirement.

Due to our ever changing tax laws, there are hundred of books published each year on investing for retirement. Unfortunately, many of them give some very confusing advice. More importantly, they forget the one aim of investing that Sir John Templeton kindly reminded us at the top of this page.

In order to maximize total return after-taxes, use a combination of  your employer-sponsored plan and an IRA. These accounts were specifically set-aside for you to save for your future. If you use them wisely, they will be your greatest allies towards achieving the maximum-after tax return.

Step 1 – Invest In Your Employer Sponsored Plan

If you’re looking to put money away towards your future, there is no shortage of options. Choices include employer sponsored plans such as 401K/403Bs, IRAs, life insurance, individual brokerage accounts, and unfortunately many more. Your goal – to start invest with the account that gives the greatest after-tax return

Out of all your options, only one, the employer sponsored plan provides an immediate and guaranteed return on your investment. That guaranteed return comes from the employer’s option to match a portion of your contributions.

A typical employer match sounds something like 50% of contributions up to 6% of pay. In other words, for every $1 you contribute, your employer contributes $.50 up to 6% of your yearly salary.

Amazingly, Annika Sunden explains to us in her book Coming Up Short: The Challenge Of 401(k) Plans, that about half the people do not  contribute enough to get the full employer match.

I’m not sure why, nearly 50% of people don’t take advantage of the only “free lunch” there is in the investment world. Just make sure you’re not on the wrong side when it comes to contributing up to your employer’s match.

Cutting matching contributions has been very popular in the current economy. Therefore, consider yourself very lucky if your employer still provides a matching contribution.

Last, if your employer matches your contributions and offers a Roth option you have hit the jackpot. A Traditional 401K/403B lets you deduct your contributions from your taxable income for the current year. Your contributions and earnings are then withdrawn and taxed as ordinary income after you reach 59 1/2.

Roth 401K/403B contributions are not deducted from your current year gross income. However, money accumulated in a Roth account is tax-free once you reach 59 1/2. Therefore, if you plan on your tax rates increasing, it’s logical to pay taxes now while your tax bracket is low by investing in a Roth account, than to pay taxes later by investing in a Traditional account.

Step 2 – Maximize Roth IRA

Once you have invested enough to achieve the full employer match, the following step is to find the next investment that will give you the highest after-tax return. For young adults, that investment is known as a Roth IRA.

IRA stands for an individual retirement account (The Roth part comes from Senator William Roth if you must know). Instead of investing through your employer, you invest in a Roth IRA on your own. You choose everything from the provider to the investments.

The biggest benefit of investing in a Roth IRA is that the money contributed grows and is withdrawn tax-free after you reach 59 1/2. In a Traditional IRA, your contributions are tax deductible in the current year but taxed as ordinary income when withdrawn. However, just like your Roth 401K/403B, investments in a Roth IRA compound and are withdrawn tax-free.

The tax advantage is extremely helpful to your goal of the highest after-tax return.

For more information on the Roth IRA, I did a 3-part series that should cover any questions that you have.

Moving Forward

There are many variables to investing in retirement accounts. For example, your employer might match returns but not offer a Roth option. While your another employer might not match returns, but have a Roth option. Another scenario is that your employer offers a Roth 401K, but it has poor investment options compared to what you can get from a Roth IRA. Choosing between what accounts to start first isn’t so simple.

In deciding the starting point, remember that your goal is to get the highest after-tax return. The most efficient way to invest your money is different depending on your circumstances. Understand the fundamentals of each account and make the best choice for your circumstances.

Tips To Maximizing After-Tax Return

  • An employer match will outperform any other investment
  • Choose low cost index funds for your investments
  • Link your bank account to Roth IRA for automatic contributions
  • Don’t rebalance more than once a year
  • Maximize Roth accounts if you think your tax bracket will rise

Last, you probably want to know when you can move on to the next phase of your personal financial plan. You’re ready to move on once you have 15% of your income invested in employer-sponsored plans and/or Roth IRA.

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