6 things to do after maxing out retirement contributions
You've made the maximum possible annual contribution to your retirement account. Now what?
First of all, congratulate yourself. This is kind of a big deal.
According to a 2013 University of Missouri study, just 3% of Americans maximize their tax-advantaged retirement savings. That makes you a thrifty rarity.
Should you stop there? Good question. There's no reason to stop saving just because you've done as much as the IRS or your employer say you can. But there's also no reason to starve now in order to feast later.
As you consider what happens next, ask yourself these six questions:
Question 1. Have I truly contributed the maximum amount the law and my employer will let me put into this retirement account?
How Much Are We Saving?
In 2012, Fidelity measured the average combined retirement contributions of people with both a workplace savings plan like a 401(k) and an IRA.
|Age group||Average contribution|
|Source: Fidelity Investments|
Rules can change over time. Employers add options. Make sure you're making your maximum contribution and, most important, setting aside the biggest sum your employer will match. Matching funds are free money and guarantee a return of 100%, so don't pass them up. (Find the 2013 IRA and 401(k) contribution limits here.)
Question 2. As I think ahead to retirement, will my current level of savings fund the lifestyle I anticipate?
The subject of how much money you'll need or want in retirement is a complex one. For now, though, get a sense of how much money your maxed-out account might provide when you stop working. The 4% rule is a good way to measure your financial security.
Can you live comfortably on that much money, given your hopes for how you'll spend your retirement?
Not everyone wants a private island, but no one ever regretted having just a bit more money. Unless you're really sure that you'll have enough savings, you're probably wise to keep putting money aside.
Question 3. Do I qualify for other kinds of tax-advantaged retirement accounts?
There's nothing inherently wrong with putting your money in your employer-sponsored IRA or 401(k) and calling that good. If you can afford to fund them, though, you are probably eligible for multiple tax-advantaged retirement accounts. You can have a 401(k) or an IRA and add a Roth IRA, for instance. If both you and your spouse work for someone else and moonlight for yourself, you can put away a percentage of your self-employment income in a SEP plan.
If you have multiple types of retirement accounts, however, you should still manage them as a whole. Develop a master asset allocation that considers your combined assets and your goals for them.
Maybe you want to put 10% of your retirement funds into emerging markets stock and debt, for instance. Look at all your accounts to see where the best possibilities for that investment might lie. If the best emerging markets vehicles are through your Roth IRA, then putting 10% of total assets in emerging markets might mean that 25% of your Roth IRA is in emerging markets, depending on the size of your Roth.
As time goes on, rebalance across your entire portfolio — not just within each account.
Question 4. Could I benefit from a nondeductible IRA?
A nondeductible IRA allows an after-tax $5,000 annual contribution. What you earn isn't taxed until you withdraw it. At that point, you pay taxes on your investment gains, but not on your contributions, because you contributed after-tax dollars. That's not as good as a Roth or a 401(k), but a nondeductible IRA has no earnings limit and is still an available choice for investors who have maxed out other options.
Even if you are earning too much to contribute to a Roth IRA, you can still convert a nondeductible IRA to a Roth every year, no matter how much money you make.
There is no mandated waiting period between beginning a nondeductible IRA and converting it to a Roth. If you move fast, you won't have time to generate much in the way of investment returns, so you'll be paying little to nothing in conversion taxes.
Question 5. What about other tax-advantaged savings?
If you're sure you've got enough money for retirement, it may be time to turn your attention to other opportunities. A 529 plan lets you put aside after-tax dollars for educational expenses while still maintaining control of the money. Use the funds to pay for tuition and other recognized costs for college, graduate or professional school, and the investment earnings aren't taxable.
If one child doesn't go to college, you can switch beneficiaries and let the account educate another child, help a niece or nephew or grandchild, or even pay for you to attend classes.
Most financial planners tell clients to save for retirement first and then for children's college, because you can borrow money for college but not for retirement. If you can save for both, though, a 529 account is a good addition. Tax-free bonds and health savings accounts (HSAs) are two other potential options.
Question 6. What about savings that aren't tax advantaged?
Taxable savings vehicles, whether a brokerage account or a certificate of deposit, can be great ways to save for things that you'll buy before retirement. If you know that you'll use the money for retirement, though, you're probably better off with a nondeductible IRA (or other tax-deferred account), because these accounts let you pay taxes on investment income when you're in retirement and therefore in a lower tax bracket.
Maybe significant investment income means that your tax bracket will be higher in retirement, not lower. A taxable account might make sense in that situation. Maximize a taxable account by thinking of it as just one part of your overall portfolio.
Put low-fee, low-turnover assets such as index funds in the taxable account to minimize your annual capital gains taxes. Mutual funds that trade more and therefore produce higher capital gains, on the other hand, belong in your tax-deferred retirement accounts.