Qualified and Tax-Advantaged Retirement Savings Plans are the most effective tools employed in saving for retirement and reducing taxes. Examples of employee-sponsored qualified retirement plans include 401(k)s, profit sharing plans, defined benefit plans, SEP IRAs (Simplified Employee Pension Plan) offered by small business owners, and 403(b) or 457(b) government employee plans, among others. You may also have a tax-advantaged retirement savings plan such as a traditional or Roth IRA. All these plans are structured to offer tax benefits during and after retirement. In this blog, we will discuss how to leverage tax advantages through these types of plans, which we will just refer to as, “retirement plans”.

Different Types of Retirement Plans and Benefits – 401(k), IRA, Roth IRA

Retirement plans not only provide a platform for money-saving but also offer multiple tax advantages. The advantages may seem minor at first, but over an extended period, the accrued benefits can amount to significant savings.

An employer-sponsored qualified retirement plan (QRP) such as a 401(k), 403(b), SEP IRA, or 457(b) meets certain IRS Code requirements and allows employees to contribute pre-tax dollars towards their retirement savings.  One of the biggest benefits of a QRP is the ability to contribute pre-tax dollars. This means that any money contributed to the Plan is taken out of your paycheck before taxes are applied, which can significantly reduce your taxable income for the year. Over time, this can add up to significant tax savings and help you maximize your retirement savings. Another advantage of a QRP is the potential for employer matching contributions. Many employers will match a certain percentage of their employees’ contributions to the plan, up to a certain limit. Additionally, QRPs typically offer a wide range of investment options to choose from, which can help you build a diversified investment portfolio. This can help minimize risk and maximize potential returns over time. It’s important to note that there are some limitations to 401(k) plans, such as contribution limits and age restrictions on withdrawals.

IRAs, or individual retirement accounts, are another popular type of retirement plan. Unlike a QRP, which is sponsored by your employer, an IRA is a personal retirement savings account that can be opened by anyone. There are two main types of IRA: traditional and Roth.

A traditional IRA allows you to make tax-deductible contributions up to a certain amount each year. This means that any money you contribute to the account can be deducted from your taxable income, which can result in significant tax savings. In addition, traditional IRAs also offer tax-deferred growth, which means that any earnings or gains on your investments are not taxed until you begin making withdrawals at retirement age. However, it’s important to note that when you do start taking withdrawals, they will be taxed as ordinary income.

A Roth IRA, on the other hand, does not offer immediate tax benefits on contributions. Instead, you contribute after-tax dollars, which means that you’ve already paid taxes on the money you’re investing. However, the big advantage of a Roth IRA is that once the money is in the account, it grows tax-free. When you make qualified withdrawals at retirement age, you won’t have to pay any taxes on the earnings or gains. This can be a huge advantage, especially if you expect to be in a higher tax bracket when you retire.

In the past several years, many employers have added a Roth contribution feature to their QRPs.  This is a great option if you have many years before retirement and are in a lower tax bracket.  Although your Roth 401(k) contribution will be made to your account post-tax, your contributions will grow tax-free and upon retirement, your withdrawals will also be tax-free.

One key benefit of both traditional and Roth IRAs is that they offer a high degree of flexibility when it comes to investment options. Unlike a QRP, where your investment options are typically limited to a handful of choices selected by your employer, with an IRA you have a much wider range of options to choose from. This can be especially valuable if you’re looking to diversify your investment portfolio, or if you have a particular investment strategy in mind.

Another advantage of IRAs is that they can be used to complement other retirement savings plans. For example, if you’re already contributing to a QRP at work, you can still open an IRA and continue to contribute to both if you meet certain income limitations. This can help you maximize your retirement savings and take advantage of the tax benefits of both plans.

Here is a quick review of why most of us choose to invest in a tax-favored retirement plan vehicle, versus in a non-tax qualified account.  In the illustration below, we see the growth of $10,000 invested annually over the period of 30 years.  If we don’t take advantage of investing in a tax-advantaged retirement plan our investment grows at a much slower pace because we must pay taxes on the interest and realized gains.  However, in a retirement account such as a traditional IRA or QRP, we don’t pay any tax on the initial contributions, and the assets grow tax-free until we take them out.

In this scenario, while investing the same amount over a 30-year period, our tax-deferred account earns about $145,000 more.  And, even better if you are investing in a tax-free Roth IRA or 401(k)!  You will pay income tax on the original contribution, and you can access those funds tax-free after certain conditions are met.  In this scenario, investing the same amount in a tax-free account earns over $300,000 more than a taxable account over the same period of time, and over $160,000 more than a tax deferred account.

The Importance of Monitoring Your Plan

As a responsible saver or investor, monitoring your financial plan is critical for staying on track and achieving your long-term goals. Keeping track of your contributions and withdrawals ensures that you are not overspending or under saving, and helps you make informed decisions about where to allocate your funds. Consistent tracking also allows you to adjust your financial plan if your circumstances change, which is especially important when planning for retirement or other major life events. By staying vigilant about your plan and regularly checking in on your progress, you can ensure that you are well-positioned for a secure financial future.

Managing Your Retirement Plan

As you approach retirement age, it’s essential to review your investment portfolio and make necessary adjustments to align with your goals and risk tolerance. Choosing the right mix of stocks, bonds, and other assets can make a significant impact on your portfolio’s performance over time. Additionally, diversification across asset classes can help reduce your portfolio’s risk.

Many employer plans offer services to retirement plan participants such as professional asset management or financial planning tools.  Sometimes these services can cost extra, but if you are not well-versed in the ins and outs of investment management (or simply don’t have the time or inclination), it can be financially rewarding to take advantage of these services.

Similarly, the brokerage firm holding your IRA account has tools, services, and experienced wealth advisors available to assist you in minimizing portfolio risk, maximizing return on your investments, and helping you to strategically plan for the savings and distribution of your wealth both before and after your retirement begins.

Retirement planning is essential to build a secure financial future. By understanding the details of your retirement plan and the various types, benefits, and tax advantages offered, you can make a more informed decision about how to save for retirement. With careful planning, saving for retirement does not have to be difficult, and it can help you on a path toward financial stability and peace of mind. Members Trust Company is committed to helping our clients make informed decisions for their future.

Discover More Flexibility with the FlexIRA

Members Trust Company’s FlexIRA product provides additional benefits for IRA account owners seeking to optimize their estate planning options. The flexibility of the product is indicated in its name, as it offers three different support levels to allow account owners to choose the best option that fits their individual needs. With the FlexIRA, beneficiaries gain access to innovative payout options that enable them to use retirement savings in different ways.

The first key benefit of the FlexIRA is its ability to extend payouts beyond the 10-year limit, which was established by the SECURE Act in 2019. This is an important feature for those who want to provide additional support to their beneficiaries, such as children or grandchildren, over an extended period of time.

In addition, the FlexIRA product allows IRA account holders to support beneficiaries with special needs without risking access to government benefits, which is a critical consideration for many families. This feature is attractive for IRA account owners who have dependents with disabilities, as it can provide financial security beyond the account owner’s lifetime.

Another benefit of the FlexIRA product is its ability to adapt as your circumstances change. If you change your mind about the level of support you want to provide to your beneficiaries, you can easily upgrade your plan from one option to another, at no additional cost. This level of flexibility is crucial, particularly given that estate planning often requires regular reviews and updates.

The FlexIRA also offers the ability to grow assets tax-free for charities while providing a steady income stream for the charities chosen by the account owner. The option to support charities in this manner not only benefits the organization but also provides an opportunity for individuals to give back in a way that has been traditionally reserved for larger corporations. With the FlexIRA, the account owner has the power to choose how his or her retirement savings can contribute to the greater good. In conclusion, the FlexIRA offers greater flexibility and distribution options for account holders as they provide for their beneficiaries, protect their assets, and support charitable organizations. To learn more about the FlexIRA, give us a call today at (888) 727-9191.

Non-deposit investment products available through Members Trust Company are not deposits of or guaranteed by the trust company, a credit union or credit union affiliate, are not insured or guaranteed by the NCUA, FDIC or any other governmental agency and are subject to investment risks including possible loss of the principal amount invested. Members Trust Company, owned and managed by America’s credit unions, is a special purpose federal thrift regulated by the Office of the Comptroller of the Currency. Past performance is not indicative of future results. This is for informational purposes only and is not intended to provide legal or tax advice regarding your situation. For legal or tax advice, please consult your attorney and/or accountant. Any opinions expressed are those of the presenter and do not necessarily reflect the position of Members Trust Company. The information above is obtained or compiled from sources we believe to be reliable. We Do Not Guarantee that such information, will be free from errors, omissions, whether human or mechanical, nor do we guarantee their timeliness, accuracy, or completeness.