Planning Ahead

Sprout member: Can you explain what a retirement plan or account is and what are the different types? 

Mr. Scalzitti: Ok so a retirement account can be anything you’re saving for retirement. However, traditionally there’s tax advantaged ways to save for retirement. So, a very common one would be if you have an employer at work that’s offering a 401(k) or 403(b). 

If you work in the public sector, that allows you to pull money out of your paycheck and then the employer will match that. That allows you to save tax deferred because the money comes out before you pay taxes, so the money that you would be paying taxes that year is now growing because it comes out pre-taxed…Often the employer will match a percentage of what you put in, and that’s a way for employers to help people to save for retirement. And that’s a very very common, probably the most common, way the average person saves for retirement--through these plans through work. 

However, if you work with a financial professional and you want to go beyond that, depending on how much money you make, you can do two other kind of plans that are typical. One of them would be a traditional IRA, and depending on your income, if it’s not too high, you can put money away and be able to deduct that off your taxes on your own, through a financial investment person, or through your own fidelity. You can put money away pre-taxed, same way it’s invested in stocks or bonds or what have you to grow for retirement. And all those plans you have to wait until you're 59 and a half to be able to draw out that money because you got that tax advantage without a penalty. 

And then one way that’s really good that I use a lot is what’s called a Roth IRA, and you don’t get the upfront deduction on your taxes with a Roth IRA, but anything you put in, as long as you keep it until 59 and a half, grows completely tax free. And you have a higher income threshold to do that--you can make up to 200K per year for a couple. You can do that every year. It’s tax free growth, 100% tax-free. Whenever you take it out at 59 and a half, all the gains are tax-fee; you don’t get the upfront deduction, but all the future gains are tax-free. And that is a very very popular way to save because it’s a tax-free investment. For under 50 years old, there’s a maximum of about $6500 that you can put in every year for either of those plans. You can also save money in a nonretirement account that could be used for retirement. 

Sprout member: For a Roth IRA or an IRA in general, would you say that it’s beneficial for teenagers to start contributing, and when would you say is the best time to start contributing to a retirement account?

Mr. Scalzitti: So in general, the earlier the better, and one of the reasons is compound interest, which Albert Einstein called the eighth wonder of the world.

Let’s say you start with $10,000 and you’re able to double it in 10 years. You double it once from 10K to 20K and you double it again from 20K to 40K. Over 20 years, your $10K turned to $40K because of compound interest. If you wait 10 years--you double it once--your 10K turns to only 20K. So it’s a significant difference, and this just gets crazier and crazier the more years you have…If you started 10 years earlier, someday instead of being 160K, it might double again to 320K. So you can see how much money that would be as you double it every ten years, in theory. The earlier you start, the more the magic of compound interest benefits you, and that’s why it’s very important to start as early as you can. When people start later, they have a tough time having enough to retire on. 

Sprout member: Can you give a ballpark of how much money someone should have saved up by the time they’re 59 and a half to have a successful retirement without too much stress?

Mr. Scalzitti: If inflation is 3%, you’ll need double or triple this amount. Right now, if you retire with a million dollars for example, we have what’s called the 4% rule. Now, I’ve actually had clients take 5%, but generally if you retire and you’ve got 30 years in retirement, you want to try to limit the amount you withdraw from your account to anywhere from 4% to 5% per year so that you don’t run out of money in your later years. So you want to just basically live off of as much of the interest as possible and not dip too much into the principal, especially early into retirement because you may need it for a long time or for end-of-life care. 

So, let’s say 5% and be a little aggressive; having a million dollars means that you can take out 50K per year to live on. So if you have 50K per year to live on plus let’s say 3K per month from social security, you have a pretty nice income to live on. And not everybody has that, and they struggle because maybe they can’t draw out 50K, maybe they can only draw out 25K and their social security is a little tight. But, I would say a million now; By the time you (teenagers today) retire, it’s probably going to be closer to 3 million because of inflation. 

The important thing to remember is you want to draw 4% to 5% a year, especially in early years. Later on I am not as worried because you’re at the end-of-life. But those early years, you don’t want to draw out more than 5% because you want the money to last--you want to live on the interest off of the money, not on the money.