As a financial planner, I know exactly what is on everyone’s mind as we move through the holidays and into 2019: Retirement plans. More importantly, which one should I contribute to? Below are some thoughts on retirement plans specifically targeted at people who are either “millennials” or those that share common characteristics.
Assuming everything on the internet is true, then millennials are quite the interesting species. Especially in the workplace. We want to have our cake and eat it too. We’re lazy. We job hop. We want more flexible work, and less of it, but we want to be paid more. Sometimes, we don’t want to work at all. We want to take a year off and travel to Thailand to try our hand as an Instagram influencer. We want to start companies. We want to take two years off for grad school. We want to retire early.
If there was an investment account created for someone in the group of people described above, it would look a little something like this:
Get a tax benefit when contributing
Have it grow tax-free
Pay zero taxes on withdrawal (i.e. never pay taxes)
Have access to the funds whenever we want, free of penalty.
Of course, this exact type of account doesn’t exist. But for “millennials” it’s possible to get most of the way there.
As an aside, most professionals push roth accounts pretty hard, especially for younger people. This isn’t a bad thing at all. After all, it’s an amazing type of retirement fund. It’s the gold standard. For me, it’s more about the journey, not the destination. It may be more important as to how you got your funds into the roth.
For example, if someone contributed to traditional 401ks, or made deductible traditional IRA contributions, they can achieve #1 and #2 above. Tax benefit on contribution. And tax-free growth.
This is where the stereotypical “millennial” comes into play. When you quit your job to launch your startup, driving your salary from “good” to zero, you may also be driving your tax bracket from high to zero. This is the scenario where you would consult your financial planner and tax advisor to determine if it makes sense to convert some Traditional money into Roth money.
This is called a roth conversion. This is you telling the IRS “I would like to move this amount into my Roth and pay taxes on it now versus when I’m 70.” The catch is, you may be in a very low tax bracket. And depending on your specific situation the tax you pay on the conversion could be zero, or quite low.
Once this step is completed, you are now on path to check box #3 above. When you withdrawal it during retirement there will be no taxes to pay..
You can also achieve step #4 but there is a small catch. With direct contributions (not via a roth conversion) into a roth account you are able to pull out your contributions (not the growth) at any time, tax-free. However with roth conversions you have to wait 5 years, which could be a lot quicker than waiting until age 59.5 for Traditional accounts.
If you’ve made it this far, here is the real kicker. If someone believed that at some point in their career that they would move from a high tax bracket to a very low one (time off, startup, grad school) but it did not happen, what is the drawback? In a sense, it’s a win-win scenario. If you ended up being in a high tax bracket from age 22 to 70, and never got the opportunity to perform a roth conversion, then you are likely in great financial shape. The drawback of not experiencing any low-income years is you had 48 high income years!
Disclaimer: None of the above is meant to be considered tax or financial advice. If you are interested in any off the above, please consult with your financial planner or tax advisor.