It’s no doubt that making these type of decisions can be nerve-racking and reviewing your benefits can be very complicated. Although capable, sometimes it’s hard to find the time to digest all your options and analyze all the various benefits. Making the wrong election can have financial consequences for you, either now or in the future, when you enter retirement. You could be paying more in taxes or missing out maximizing employer matches. As a financial advisor, the answer is always “Well…it depends” when it comes to making your elections, but below are a few areas you should hone in on when working with your financial advisor and tax professional.
Employer sponsored retirement plans-So Many options and variations!
Optimize Employer Matches
One of the first things I like to look at when reviewing employer retirement benefits are employer matches and vesting periods. Typically, you will see these take place with defined contribution plans such as 401(k) and 403(b)s, but there could be other types of benefits that may be subject to additional scrutiny that should be closely reviewed as well.
The general recommended retirement savings rate is 15%-20% of gross income, which makes it even more important to not leave “free money” on the table. If your employer offers matches, maximizing this opportunity means you are getting the most from your employer and you may be able to contribute less on your own, thereby freeing up your cash flow for other savings goals. –So, you may get to have your cake and eat it too!
Let’s be honest, no one likes to talk about their cash flow or budgeting, but when it comes to knowing what you can afford to save it is vital to review your cash flow (at least at the basic level). Although you may be able to change your savings rate throughout the year, you really do not want to get into a habit of changing it month to month. It complicates things and you are not setting up self-discipline for saving towards your retirement. Depending on income and cash flow restraints, one possible planning strategy is to increase your retirement savings rate by any salary increases, or at least 1% (just be aware of annual contribution limits). If you are managing your cash flow before the raise, you are less likely to feel the impact of increasing your contribution limit with your new raise.
Account variety -Tax Planning
For some, simplicity is key but depending on your situation, funding various types of accounts may be beneficial in helping you reach your financial goals. For example, funding both a pre-tax and post-tax 401(k) allows you to contribute the maximum benefit for each account type. By contributing to pre-tax accounts, your Adjusted Gross Income is reduced, thereby saving you money in taxes come end of year. While pre-tax retirement accounts’ distributions are taxable, you may have the opportunity to convert post-tax contributions to a Roth IRA which allows you to make distributions tax free. Further, if your employer offers 457 plans, this may be an additional tax-deferred savings strategy (if pre-tax, but post-tax may also be permissible) that is not subject to early withdrawal penalties. The flexibility this plan offers because it is a non-qualified plan may be particularly appealing if you plan on retiring before the age of 59 1/2, since most retirement plans are subject to early distribution penalties. However, to take distributions from the account, you must have either separated from service with the employer or experience some hardship per the plan rules.
Goal Sharing, Profit Sharing and other Incentive Packages
The last few employer benefits that are important to briefly mention are Incentive Packages that are based on company goals and performance. These benefits are extra perks, but can make incorporating them into your financial plan a challenge. As planners, we try maximize these benefits while being on the conservative side when making recommendations to our clients that may have significant tax and retirement income implications. That being said, we work closely with tax projections and discuss cash flow to insure that should these benefits be paid out, they are already incorporated into the plan as best as possible to.
Here at John G. Ullman and Associates, Inc., we make the complex understandable for our clients. This includes educating them on their employment benefits, walking them through the pros and cons of the options available and assisting them in making their decisions. We then re-evaluate these benefits on an annual or as needed basis when client circumstances change. While this article does not touch on all the nuances to various plans that may be available, nor their contribution limits which may impact planning strategies, we invite you to reach out to discuss your company’s employee benefits and what strategies can be executed to maximize those benefits as aligned with your financial goals.