Paying down debt and buying a home often make it difficult to save for retirement.
Many workers are saving for retirement in individual retirement accounts. At the end of 2014, $7.4 trillion was invested in IRAs, up from 2.6 trillion in 2000, according to the Investment Company Institute. IRAs may prove even more essential for younger generations of workers who change jobs often and too quickly to become vested in employer-sponsored 401(k) plans.
However, funding an IRA can be difficult to balance with other competing financial goals. These goals may include paying down debt, buying a home or funding workplace retirement accounts such as a 401(k) plan. Here are several factors to consider as you decide when to start saving in an IRA.
Paying off debt. Some workers want to pay off all non-mortgage debt before saving for retirement, but this could be costly. Low rate student loans may take years or even decades to pay off. Putting off retirement savings during this time could permanently short change your retirement.
For low-interest debts, you are likely to be better off investing while you make payments on the debt. A 401(k) match and investment returns in the plan might be worth more than the interest rate you are paying on low-interest loans. For high-interest debt, first determine if you can refinance to a lower rate. If you're paying more in interest on debt than you can earn investing, you should focus on these debts before saving for retirement.
401(k) versus IRA. If debt isn't standing in the way of retirement savings, the next consideration is whether to save in a 401(k), IRA or both. There are several things to consider.
First, if a 401(k) offers an employer match, saving in the 401(k) should be the first priority. At a minimum, contribute enough to the 401(k) to take full advantage of the match. Second, evaluate the investment options in your 401(k), paying particular attention to the costs. If your employer doesn't offer low cost investment options, an IRA is the better choice if there is no employer match or you've already contributed enough to take advantage of the match.
Finally, if you've maxed out your contributions to a 401(k), an IRA is the next step. You'll want to make sure you understand the contribution limits for a deductible IRA or a Roth IRA before opening an account.
Consider a HSA. You should consider maxing out your health savings account before opening an IRA. If your health insurance plan allows it, you can put up to $3,350 into the account for the year as an individual. If you carry your spouse or children on your plan, you can contribute up to $6,750 to your HSA for the year. This account also has a $1,000 catch-up provision for those age 55 and older.
HSAs are also a good avenue for retirement savings. Similar to a 401(k), HSA contributions are tax-deductible and grow tax-free, so long as they're used for qualified health care expenses. Since most people have significant health care expenses in retirement, a HSA can be a good investment.
Buying a home. Buying a home is an important financial goal for many people. But saving for a down payment adds yet another financial goal to a long list of priorities. Because home ownership and saving for retirement are both worthy objectives, there is no one "right" answer as to which one should take precedence.
However, you can use funds from an IRA as a down payment on a house without paying the penalty for early withdrawals. Retirement savers can withdraw up to $10,000 ($20,000 for couples) penalty-free from an IRA for a first home purchase. Of course, there are rules that must be followed and income tax will be due on the distribution, but it's an option worth considering.
Starting a business. If you're launching your own venture in 2016, consider opening a SEP or SIMPLE IRA. These are great for business owners and solo entrepreneurs who need to invest more than the maximum of $6,500 for an IRA. A solo 401(k) is another option. Be sure to check out all the retirement saving options for entrepreneurs before you decide to go with an IRA.
Contact us today for all your tax and retirement planning needs!