Developing a Long-term Savings Plan
So many opportunities and dreams are lost and just never happened because there is no means, no capital, no way to finance the change or take a risk. The notion that it gets easier to save, invest, and make things happen as you grow older is crazy. As a young couple responsible only for yourselves, you’re at the best stage of your life to learn how to build capital. Develop each of your skills and talents, prepare for the future, and internalize personal disciplines and habits that will last a lifetime. There is no reason to think it will get easier with children, mortgage payments, and the challenges of growing older.
Many middle-age couples wait too long to figure out that they need to start a serious savings program. They are staring squarely at the triple trial: college education for children, support for aging parents who are about to outlive their money, and the need to save for their own retirement. Their estate consists of a modest home equity, a few cars in the garage, and an anemic savings program.
A great majority of these couples have no real hope of pulling it off. They don’t have the money and they don’t have enough time to accumulate the money. They are going to join the great mass of Americans – a mass that is growing everyday who knows that they’re going to outlive their money. Their plan and only real hope is to continue to work often at jobs they’re bored to tears with until they drop. The saddest part of this scenario is not what lies ahead but it’s looking back at the lost opportunities — opportunities that could have changed everything. A better quality of life, more interesting and rewarding work, less worry and stress, serious support of children, exciting hopes for the future. Opportunities that were lost because there was never any serious financial priorities, never any capital or means to make real positive changes, and always that “not now but later” approach to money. So the bottom line, don’t procrastinate starting your savings and investment program.
Now the government offers some tax savings vehicles to jumpstart and maintain long term savings programs. These are savings untaxed vehicles or SUVs for short. Understand an SUV is not an investment itself; it is a vehicle that allows you to save taxes by saving money long-term. The most popular SUV is a 401(k) plan — an employee savings program that a company can easily adopt. Its counterpart SUV for nonprofit organizations such as schools or hospitals is a 403(b) plan. These plans allow an employee to contribute an amount each year on a tax-free basis.
Income taxes are deferred on the earnings that are contributed. The employee then can choose from a number of investment options offered by the plan, typically mutual funds. No income taxes are paid while the money is in the plan. When an employee starts withdrawing money out of the 401(k), income taxes are then paid on all amounts that come out and accepting very limited circumstances if the withdrawals occur before age 59 ½, an extra 10% penalty for early withdrawals must be paid. A 401(k) plan is a long-term tax deferral SUV. There are limits on how much an employee can contribute to a 401(k) plan each year. In some 401(k) plans, the employer agrees to match a portion or all of the amounts contributed by the employee.
Dave’s employer, for example, promises to contribute $0.50 to the employee’s account for every dollar contributed by the employee. This provides a huge incentive to invest in the plan. The employer’s portion usually is contingent on the employee remaining with the company invests over time.
There are other types of SUVs’ that an employer can offer. This includes simple plans, set plans, key plans for unincorporated businesses. There are many different types. For an employee, they all offer the same tax deduction and tax deferral benefits of a 401(k). But the rules relating to participation, maximum contributions, and other items vary.
Suppose your employer does not offer an SUV, is there an SUV for you? As a couple, you have a few options. The first is a traditional individual retirement account, an IRA for each of you. There are limits on the amounts that can be contributed to an IRA each year. Amounts contributed are tax-deductible and earned on a tax-free basis, but are fully taxable when they start coming out. Like the 401(k), there’s a 10% penalty for withdrawals before age 59 ½, but the penalty does not apply to certain withdrawals used to purchase a home and to fund various educational expenses.
The second individual SUV is a Roth IRA. Here you get no tax break, no tax deduction for what you put into the plan. But earnings in the Roth accumulate tax free, and so long as you play by the rules are never taxed. And here’s the real kicker. At any time and any age, you can withdraw the amounts you put in, not the earnings, and pay no tax, and you can withdraw the earnings completely tax-free after 59 ½ or to buy a first home. You give up the upfront deduction but pick up a real permanent tax break, not just a deferral, and always have the ability to get your hands on the money you’ve put in with no tax and no penalty.
There are limitations on how much that can be contributed to a Roth IRA each year. A traditional IRA or a Roth IRA can easily be set up at almost any financial institution or brokerage firm. One caution on these SUVs: As previously explained, often they impose a penalty for withdrawals before age 59 ½. Understandably, this may be a real turn-off for a young couple that doesn’t like the idea of tying up their savings in a tax deferred vehicle that will trigger an added penalty if and when they want and need access to the funds.
If that’s your situation and even the Roth IRA doesn’t provide enough flexibility, then just pass on the SUV opportunity, but do not abandon your savings program. Above all, stay with the savings program even if there is not an SUV that appeals to you and fits your situation.
Well, that completes our discussion. We hope that you have found it to be informative and that it helps you in your efforts to protect your family long-term. Thanks for your time.
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