People automatically think about retirement plans when they try to figure out how to retire . That’s because when it comes to having enough money to retire, the tax deductibility of qualified plans provides a significant boost to investment returns.
But some of your best retirement assets may be investments that aren’t tax deferred in a formal retirement plan. And there can be advantages to building those assets as well, even if we don’t call them “retirement assets”.
Any asset can be a “retirement asset”
The truth about retirement planning is that any investment asset you have can be a retirement asset. An investment doesn’t have to be in a qualified plan to provide for you in retirement.
Retirement plans, such as 401k’s, IRAs, SEPs and 403b’s have been set up to encourage savings and investment specifically for retirement purposes. They have tax deferral status, which provides an incentive to save money today, and penalties for early withdrawal to discourage us from tapping those savings before retirement age.
But when you retire you’ll be relying on any and all assets you own, whether they include the word “retirement” or not. And that opens possibilities, especially if you don’t qualify for participation in the most popular qualified retirement plans.
The tax advantages of non-retirement assets
We tend to put great emphasis on the tax advantages that tax-sheltered retirement plans provide. But it’s important to realize that these plans are tax deferred, not tax exempt. Taxes will have to be paid on tax deferred plans on withdrawal but the plans are in no way tax exempt.
The tax “advantage” of non-sheltered investments is that they’re accumulated post-tax, which is to say that there will be no tax (or penalties) when you withdraw the money. The tax will already have been paid on the money you put into the investments, and on any income the investments have produced since.
This offers important tax diversification in retirement—you’ll have retirement plans to draw income from, sure—but any money taken out of your other investments won’t be taxable. This will be especially important in your retirement years when your income requirements are unusually high. If you have to withdraw larger than normal amounts from your retirement accounts your income tax will be higher. This happens often because of the Required Minimum Distribution rules. But if you can instead withdraw money from non-sheltered investments you’re tax liability will be unaffected.
Another BIG advantage of non-retirement savings
All qualified retirement plans have limits on them. Some allow you to make contributions only if you aren’t covered by an employer pension plan. Others allow you to make contributions even if you are covered by an employer plan, as long as you earn under a certain income limit. And if your employer doesn’t offer a self-directed plan, you’re mostly out of luck.
In additions, one of the problems with employer pensions today is that many people aren’t with an employer long enough to ever collect the pension benefit. In the meantime, you may be prohibited or limited from making contributions to a self-directed plan because of the pension.
Let’s say that your pension plan and income limit you to nothing more than a $5,000 annual IRA contribution; will that be enough to fund a comfortable retirement? Probably not, especially if you don’t get the pension. But you don’t have to limit your retirement provisions to your IRA. You’re always free to invest in any non-sheltered investment you choose.
And here’s another benefit: there are no income or contribution limits on non-retirement savings. $5,000 each year contributed to an IRA plus $10,000 added to a non-qualified plan may get you to where you want to be in retirement.
What kind of investments can you make that can be for your retirement but not included in a tax-sheltered retirement plan? Just about any investment you can think of.
Non-retirement investment accounts
These can be any type of investment accounts—stocks, bonds, mutual funds, commodities, certificates of deposit, treasury securities—that aren’t sitting in tax sheltered retirement accounts.
The disadvantage is that you can’t fund regular investment accounts with tax deferred money, nor can you defer the tax on the earnings they generate. But as discussed earlier, these accounts will provide you with a source of cash that won’t be taxable on the back end when it’s withdrawn.
Invest as much as you can in tax deferred retirement accounts, but don’t overlook building up those non-retirement accounts either. And if you can’t put much (or any) into retirement plans, this is your next best option for insuring yourself a comfortable retirement.
Real estate doesn’t fit neatly into retirement plans, but that doesn’t disqualify it as a retirement asset. If fact, it’s an excellent retirement asset.
Because it’s a long-term investment it’s a perfect component to a larger retirement strategy. Your primary residence is your first, best real estate investment, but you can also buy investment property. In either case, if you do nothing more than pay off the mortgage on the property you will have a) created a potential cash windfall by selling the property, or b) created a cash flow from the rent income on an investment property.
Both are nice options to have, but one of the biggest advantages of real estate is that it’s a large asset, which is to say that it can be sold for a large amount of money. Would that help your retirement plans? Sure.
The idea isn’t to abandon tax sheltered retirement plans in favor of non-sheltered ones, but to maximize your savings by using both. Consider all of your investment options and you may find your retirement will be a lot more golden then you expected.
Are you planning on using assets in and outside your qualified retirement plans to fund your retirement?