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How to Make Your Money Last

Take advantage of Uncle Sam's help to save at every age and stage

Jane Bryant Quinn's updated book

Jon Paterson, Ari Michelson

With 'How to Make Your Money Last,' you will learn how to stretch your savings through a long and vibrant retirement.

En españolThe following article is taken from the new book How to Make Your Money Last: The Indispensable Retirement Guide by Jane Bryant Quinn.

"Saved more money."

That's the number one response retirees and people nearing retirement give when asked, "Financially speaking, what do you wish you'd done differently?" This realization, of course, usually hits most of us after we've blown through Plan A (the retirement fairy who'll magically take care of everything) and Plan B (work till I drop). But since we can't count on our health or our jobs to see us through, those of us who are lucky enough to still be employed should proceed directly to Plan C: Squeeze that paycheck like a sponge to fund our retirement accounts.

Fortunately, the government has bestowed a great gift on all retirement savers, even those nearing the end of their working lives: the tax-favored retirement plan. The contributions to these plans, as well as their earnings, are tax-deferred and even, in some cases, tax-free.

Get retirement savings tips in the AARP Money Newsletter

Many people close to retirement see little point in funding these accounts. "Why put money in a retirement plan now?" they ask. "I'll be taking it out in a few years." Two crucial reasons. First, these could well be your highest-earning years, making the tax benefits especially valuable. Second, you'll be withdrawing the funds incrementally, not all at once. You may live another three decades — ample time for your preretirement contributions to grow tax-deferred. So be smart and get those tax breaks while you can.

Gimme (tax) shelter

Tax-favored retirement savings plans come in two types: traditional and Roths. The vast majority are traditional IRAs, 401(k)s and similar plans. The income taxes on your contributions, up to an annual limit ($18,000 in 2016, plus $6,000 for taxpayers 50 or older), are deferred, and the earnings grow tax-deferred as well. When you start withdrawing the money (which you cannot do before age 59 1/2 and must do by 70 1/2, unless you're still on a company payroll), it is taxed as ordinary income. That's the deal: No taxes now but definitely taxes later, when — the assumption goes — you'll likely be in a lower tax bracket.

Roths, on the other hand, are funded with after-tax dollars. But all the earnings grow tax-free, so when you take out the money, it doesn't count as current income and hence is totally tax-free. If you don't need the money, you never have to take it out; a Roth can grow tax-free for the rest of your life and be left tax-free to your heirs. (Another upside: If you do need the money, you can withdraw your own contributions at any age without penalty.)

But the contribution limits for IRAs, whether Roth or traditional, are fairly low: The 2016 maximum is $5,500, or $6,500 if you're 50 or older. There are also income limits, albeit generous ones: You can contribute the maximum if your adjusted gross income in 2016 does not exceed $117,000 or, for married couples filing jointly, $184,000.

Which plan is which?

The type of tax-favored plan you participate in is determined by your employment situation, so there's not much angst around that choice. What is absolutely vital is that you participate in whatever plan you qualify for and sock away as much as you can afford. The money you invest now will be your nest egg later. Here's a quick rundown.

  • If you work for a company with a tax-deferred plan, a percentage of every paycheck can be deducted automatically from your pretax salary and invested in the plan. It's typically deposited in mutual funds provided by investment firms, brokerages, banks and insurance companies. Many employers match a percentage of your contribution, a freebie no employee should pass up.

    In general, for-profit businesses offer 401(k)s; public schools, universities and other nonprofit institutions offer 403(b)s; and certain state and local governments provide 457s. (The names correspond to sections of the tax code.)

    According to Vanguard's 2014 study "How America Saves," workers in their mid-50s to mid-60s contribute an average 8.8 percent of their earnings to these plans. At 65 and up, they save 10.1 percent. As an annual goal, that may be too ambitious; still, try raising your current contribution by 2 or 3 percent (an amount that should be relatively painless when deducted automatically from your paycheck). Vanguard reports that women, mindful of their longevity, save a larger percentage of their pay than men at the same income level.

  • If you work for a company and meet certain income requirements, you can fund a personal IRA in addition to a company plan. The full IRA contribution ($5,500, or $6,500 if you're 50 or older) is tax-deferred if your modified adjusted gross income in 2016 does not exceed $61,000 or, for married couples filing jointly, $98,000. You can earn more than those amounts and still open a personal IRA in addition to a company plan if you have freelance income on the side and use it to fund the IRA.

  • If you have no employee plan, you can open a traditional IRA. The same contribution limits mentioned above make an IRA stingier than the 401(k), but the tax break it offers should not be left on the table. Moreover, if your spouse has no earnings, you can make maximum contributions in both your names — as long as the amounts are covered by your earnings. Tax-favored retirement plans cannot be funded with unearned income (Social Security, pensions, interest, dividends or rent). If your part-time job pays, say, $4,500 per year, that's where your contribution tops out.

  • If you're self-employed and earn a substantial income, you can start a SEP-IRA (simplified employee pension, handled like an IRA) with a maximum contribution of $53,000 in 2015. If you work with your spouse, you can each fund a SEP-IRA. However, any employees who've worked for you at least three of the past five years must also be included in the plan.
JBQ's Make Your Money Last

David Arky

Take advantage of Uncle Sam's help to make your money last longer in retirement.

You can take it with you

If and when you change jobs, your plan travels with you. Your key objective is to preserve the tax umbrella over it. There are five ways to accomplish this.

1. If your new employer also offers a 401(k), you can transfer your money tax-free into the new employer's plan. This option has the advantage of consolidating your retirement savings in a single account.

2. You can usually keep the old 401(k) if you like, as long as the balance is at least $5,000. The pros: You're in a familiar investment; the fees may be lower than elsewhere; and you can usually make withdrawals without penalty if you're between 55 and 591/2. The cons: There may be limits on how and when you can withdraw the money; the fees may be higher than at a no-load (no sales charge) mutual fund; you could lose track of the old 401(k); and an heir could miss out on tax advantages that might otherwise be available.

3. Most commonly, people transfer the money from the old plan, tax free, into a "rollover IRA." There's no limit on the amount you can roll. You can choose the IRA offered by your plan's current administrator — an attractive option if it's managed by a no-load mutual fund group such as Vanguard, Fidelity or T. Rowe Price; a discount broker such as Charles Schwab or TD Ameritrade; or a low-cost firm that specializes in retirement plans. Or you can roll your old plan into an IRA administered by a different firm, preferably one of those just mentioned. Definitely switch if your current 401(k) is invested with a firm whose advisers charge sales commissions, even if you don't use those advisers. The IRAs of such firms often contain high-cost mutual funds. Also switch if you're in a 403(b) or 457 plan whose only investment option is a fixed or variable annuity. And run away — fast — from the friendly "advisers" who call, email, mail and even visit your office with recommendations for your rollover account.

4. If you have multiple retirement plans, roll them together into a single IRA. Separately, they're a pain to keep track of and likely add to your costs.

5. If you want to buy individual stocks (an imprudent move), roll your retirement plan into a self-directed IRA with a discount or full-service brokerage firm or financial adviser.

Note: The money you move should go directly from your old plan to your new one without passing through your hands. (Your new plan's trustee will explain.) If the check goes to you, it's counted as a taxable withdrawal unless you deposit it into your personal bank account, write a new check, and send it to the new plan within 60 days. Too much can go wrong, so don't do it.

Should you convert to a Roth IRA? You can roll any amount of money from a traditional IRA, 401(k) or similar plan into a tax-free Roth IRA regardless of how much income you earn. There's a cost to this transfer, however — perhaps a big one. You pay current income taxes on the money you move even though you don't withdraw any of the cash.

You might want to switch to a Roth if: 1) You won't need the money until your later age, if ever. 2) You plan to leave all or most of your Roth to your heirs and want them to receive it tax free. 3) You expect to be in the same, or higher, tax bracket when you retire, although you can't know for sure. 4) You're young enough that future growth in your investments could more than offset the cost of paying current income tax. 5) You can pay the taxes due from outside funds without having to tap your tax-sheltered retirement account.

For the average person, however, the size of the current tax from a Roth conversion might overwhelm any likely benefit he or she would get from future tax-free growth.

When there's no more paycheck

So you're officially retired? Congratulations — we think. Your income now will derive from many possible sources, including Social Security, pensions, and taxable savings and investment accounts, as well as the tax-favored plans discussed here. It can be hard to know which funds to tap when. Your goal is to make your collective nest egg last as long as possible. The key? Use it tax-efficiently.

The general rule is to spend taxable savings (money held in regular investments) before dipping into an IRA (our term here for your tax-deferred savings, since you've likely consolidated them in a rollover IRA). You should also tap your savings — taxable first, then tax-deferred — if doing so enables you to put off collecting Social Security until age 70, the point at which you will get the highest possible monthly benefit for life.

That said, there are times when you should tap your IRA first:

  • When you're in a low tax bracket and your heirs are in a high one. The IRA money is worth more if you take it now.
  • When you want to shrink your IRA so that, upon reaching 70 1/2, your required withdrawals need not be large. This strategy could save you from paying higher income taxes on your Social Security benefits when IRA withdrawals start.
  • If you're in the 15 percent tax bracket. You might want to withdraw money from the stock funds in your IRA, even if you don't need the cash, and pay income taxes on it now. Then you can reinvest the money in stock funds in your taxable account. That way any further increase in their value will be taxed at the low capital gains rate.
  • If you have both taxable and tax-deferred accounts for long-term investments. Keep stocks in the taxable account. That way, any profits will be subject to the low capital gains rate. Taxable bonds, such as Treasury funds, belong in the tax-deferred account. Interest income is always taxed as ordinary income.
  • If you have both a Roth and a tax-deferred IRA. Normally, spend the latter first. The longer the Roth can grow tax-free, the better. But tap the Roth first if you're in a high tax bracket and expect it to drop in the future.

Excerpted from How to Make Your Money Last: The Indispensable Retirement Guide by Jane Bryant Quinn. Copyright © 2016 Jane Bryant Quinn. Reprinted with permission of Simon & Schuster Inc.

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