Building Your Retirement Savings

A generation or two ago, workers relied on the “three-legged stool” for their retirement income. The three legs — Social Security, employer pension and personal savings — supplied a steady retirement income. Now, with Social Security retirement benefit formulas changing and many employers shifting away from traditional pension plans, workers must depend more on their own savings for retirement income. Also, Americans are living longer and health care costs continue to climb — which increases the need to save even more for retirement.

Put time on your side

Start saving for retirement early in your career to give your money a chance to grow over time. But, even if other commitments have prevented you from starting, it’s never too late to save.

Determine how much you will need

The general rule of thumb is that you will need 80% or more of your pre-retirement income or more each year to achieve a comfortable lifestyle in retirement. Next, you should project how long you think your retirement may last. Make an educated guess, starting with the average life expectancy and factoring in knowledge about your personal health. Although the average life expectancy for Americans is 79*, as you age you prove your ability to live longer, and your life expectancy increases. For example, the life expectancy for those who reach age 65 is 88**— seven years beyond the average life expectancy.

Saving through your employer’s plan

There are several good options for accumulating savings for retirement, but contributing to an employer-sponsored retirement plan, such as a 401(k) or 403(b) plan, should be at the top of your list. These plans offer important benefits:

  • Your earnings compound tax-deferred. You may also be able to contribute to a Traditional or Roth account, which gives you the flexibility of saving pre-tax or after-tax, whichever is most advantageous.
  • You can contribute more to employer-sponsored plans than is allowed by individual plans.
  • Your employer may make matching contributions to your account. If so and you do not participate, then you are passing up free money.

IRAs offer tax advantages and flexibility

An Individual Retirement Account (IRA) is another good choice to help you save for retirement. Like a 401(k) account, IRA earnings compound tax-deferred. But IRAs have some attributes and tax benefits that are different from a 401(k) plan:

  • Depending on the type of IRA you choose, your contribution may be tax-deductible.
  • IRAs are not linked to your job. You can make IRA-to-IRA exchanges or transfer your IRA from one investment company to another at any time.
  • A Roth IRA allows you to make tax-free withdrawals which gives you additional flexibility in deciding how best to draw down your total mix of retirement accounts.

Consider using a 401(k) plan account as your primary retirement savings account. Contribute as much to your employer’s savings plan as possible — at least make sure you contribute enough to collect the maximum matching contribution your employer offers.

Then, once you’ve “maxed out” your employer plan contributions, contribute to an IRA to complement your employer account. That gives you greater flexibility in managing distributions for tax efficiency.

How a Traditional IRA compares with a Roth IRA

Use the table inside to see whether a Traditional or Roth IRA works best for you.

Traditional IRARoth IRA
Maximum contribution per year (to all IRA accounts)The annual limit is 100% of your earned income or $6,000 in 2022 and $6,500 in 2023, whichever is less. If age 50 or above, the annual limit is 100% of earned income or $7,000 in 2022 and $7,500 in 2023, whichever is less.Same
Tax/penalty at withdrawalDistributions from Traditional IRAs are generally taxed as income. If you take money out of a Traditional IRA before age 59½, you may be subject to a 10% premature distribution penalty.Distributions from Roth IRAs generally are not taxed as income provided you are age 59½ or older and the account has been open for at least five years at the time of withdrawal. Premature distributions of account earnings may be subject to ordinary income taxes and a 10% penalty.
Tax benefitsTax-deferred compounding and possibly a current-year tax deduction.

You may be able to deduct the amount of your annual contribution from your taxable income, depending on your modified adjusted gross income and whether you or your spouse participates in an employer-sponsored retirement plan. See note below. Unlike a Roth IRA, distributions from Traditional IRAs are generally taxable as income when received.

If you participate in an employer-sponsored retirement plan: Single filers who have a modified AGI of less than $68,000 in 2022 and $73,000 in 2023. Joint filers who have a modified AGI of less than $109,000 in 2022 and $116,000 in 2023. If your income is higher, you may be able to receive a partial deduction.
Tax-deferred compounding and tax-free distributions.

Amounts withdrawn from Roth IRAs are not subject to income tax if you are at least age 59½ and the account has been open for at least five years at the time of withdrawal.

Unlike a Traditional IRA, Roth IRA contributions are not deductible.
Portability of account balanceYou can exchange balances directly from one Traditional IRA into another Traditional IRA or transfer these accounts from one investment company to another at any time.

When you retire or leave your job, you can move account balances from an employer-sponsored plan to a Traditional IRA. This is called a Rollover IRA.

You may also be able to transfer an account balance in a Traditional IRA into your plan at work.
You can exchange balances from one Roth IRA into another Roth IRA or transfer these accounts from one investment company to another at any time.

You may be able to move amounts from a Traditional IRA into a Roth IRA, but taxes would be due unless you are immediately converting non-deductible contributions from a Traditional IRA and don’t have any other contributions and earnings in the Traditional IRA. This is called a Roth conversion.

Account balances may not be rolled over into an employer-sponsored plan.
Required Minimum Distributions (RMDs)After age 72, you must start taking required minimum distributions from this account.There is no age at which you must take distributions from this account.
This account may be appropriate for you if…You are eligible to make a tax-deductible contribution.

You earn too much to contribute to a Roth IRA.

You do not need your savings until at least age 59½.

You have maxed out your 401(k) or 403(b) contributions.
You are not eligible to make a tax-deductible contribution to a Traditional IRA.

You think you may be in a high tax bracket at retirement.

You do not want to be forced to start taking RMDs.

You want to avoid the Roth 401(k) Required Minimum Distribution (RMD) rules by rolling your Roth 401(k) into a Roth IRA.

You intend for this account to be part of your estate. Assets from a Roth IRA can be passed on to heirs, free of income tax.

Contributions to Traditional IRAs may be tax-deductible

If neither you nor your spouse participates in an employer-sponsored retirement plan, your entire contribution to a Traditional IRA may be deductible. If you do participate in an employer-sponsored retirement plan, the deductibility depends on your annual income and tax-filing status.

Put your Homestead Funds account on autopilot 

If you open an account with Homestead Funds, our Automatic Investing Program allows you to start investing right away with no minimum amount required. You choose an amount and it’s deducted automatically — directly from your paycheck or bank account — as often as you like, such as monthly, quarterly or every payday. 

*Source: World Bank, 2020 data
**Source: IRS Publication 590 for Preparing 2021 Returns, Appendix B, single life expectancy

Homestead Funds does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.

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