Money Mondays: 3 Types of Accounts You Should Open Now to Save for Retirement

Happy Monday, Friends!

Today, I’d like to talk about retirement.  Every time I think about having this conversation with my clients, I think about this one young man I spoke with not too long ago.  We were talking about managing his debt, and he said, “When the bills come in the mail, I swerve them.”

“Swerve them?” I asked, clearly feeling older and older by the second since I wasn’t up to date on the lingo.  “Yeah, I swerve them.  You know, I don’t open them and just put them in the trash.”  We laughed and laughed and laughed.  (And then of course we talked about how avoiding you debt doesn’t make it go away – it actually makes worse, and then we came up with a plan.  But I digress.)

The reason I think about this young man and this conversation in particular is that a lot of people I meet also avoid thinking about/saving for retirement.  It could be for a myriad of reasons – lack of understanding or fear being two main ones.  (Example: “I don’t have time to figure this out so I’ve just been avoiding it!”)  But the point, my friends, is that “swerving” your retirement, by not saving enough & in the right way, is just as damaging in the long-term as avoiding your bills.

I’m sure you’ve all seen/heard these commercials from big banks where they tell you that people who start to save really early magically have millions in their retirement accounts. Well, it’s not that easy, but those ads did get something very important right:  The earlier you start, even with small amounts of money, the quicker it builds and the easier it is to get to your retirement goal.  It’s a little more complicated than that, though.  Because it’s not just about timing of the saving or how much you save – it’s about HOW you save it.

In that spirit, today we are going to address the 3 Accounts You Should Open and Contribute To NOW to Be Retirement-Ready Later.

achievement-bar-business-chart-40140.jpeg

1. Pre-tax Retirement Account:  This is a 401k or 403b (Depending on the type of company you work for).  If you don’t work for a company that offers a retirement account, you should open an IRA.  Contributions to any of these three accounts are with your income BEFORE it is taxed.  This means, you get paid, you (automatically) put money in this account and you don’t get taxed on it this calendar year.  When do you get taxed?  Later when you take it out.  You should put in at least the amount that is matched by your employer if you have an employer that offers a match.  Your employer’s match is a contribution they make to YOUR retirement account that’s free money to you that you otherwise wouldn’t get.

Here’s when people make a big mistake – Some people don’t contribute enough to get the full match.  Here’s when some people make another big mistake – they ONLY contribute to this type of account and think it’s enough for retirement.  However, that’s not ideal.  Why?  Remember when I said that it’s pre-tax money, so when you take it out you get taxed?  This is important.  In retirement, if all you have is a pre-tax retirement savings account, every time you use that money, you pay income taxes on it.  That’s why you also want to have the next two kinds of accounts.

2. Post-tax Retirement Account:  This is called a Roth account.  It comes in many forms – Roth 401k, Roth 403b, Roth IRA. The important thing to know about this account that it is a retirement savings account that grows tax-free, but you are taxed before you put the money in.  So, if you are in a high tax-bracket, it’s not an ideal time to make a contribution to a Roth account.  However, if you are in a moderate to low tax-bracket, you should be contributing to this account.  When you take the money out once you are in retirement, you are able to remove it tax-free.  (This is because you already paid taxes on it when you made your contribution!)  You did hear that right  – You pay taxes on it, put it in the retirement account, it grows tax free, and then you take it out tax free.  So, when you are in retirement and you need to access cash, you can access this cash without paying taxes on it.  This is one way to help mitigate taxes in retirement.  If you can, try to put a chunk of money into your Roth automatically every month just like you do for your Pre-tax Retirement Account.

3. Taxable Account:  This is a regular non-retirement savings account, but unlike your savings account at your bank, this is a brokerage account that allows you to invest the money you deposit.  You can usually set this up at your bank or at another place like Charles Schwab, TD Ameritrade, or Fidelity.  Every month, you should be saving what you can into this account, and depending on your age and timeframe for need of the money, investing it appropriately.  There are lots of professionals out there that can help you with this at a very affordable rate.  Similar to the Roth, you can access this money in retirement without paying income taxes on it.  The only drawback to this account?  It is subject to capital gains taxes every year based on trading in the account.  So, if you sell a bunch of highly appreciated stock in the account one year and realize that gain, you’ll need to pay taxes on it that year.

However, that’s great news, because it means you made cash!!

bald-eagle-portrait-white-tailed-eagle-adler-38998.jpeg

Do you see a theme here?  You WILL pay taxes – Uncle Sam will get his chunk of flesh from you whether it’s now or later.  For the post-tax retirement account and taxable account, you are paying taxes now but not later.  For the pre-tax retirement account you are paying taxes later but not now.  So, it’s a game of tax brackets and hedging your bets. You want to have access to various types of accounts in retirement so you can minimize the amount of taxes you will need to pay in retirement and keep yourself in the lowest tax bracket possible in retirement.

I know what you are thinking: “But, Margo, I live paycheck to paycheck.  I can’t save for retirement!” Let’s unpack that a bit together.

Everyone can look at their spending habits and identify the difference between things that are “need-to-have,” “want-to-have,” and “nice-to-have.”  Need-to-haves are things you can’t live without.  Want-to-have’s are things that you want but aren’t too extravagant – like a cup of expensive coffee every now and then.  Nice-to-have’s are like motorcycles and $500 purses.  You should not be spending money on Nice-to-have’s until you already are saving a chunk every month into the three accounts I mention herein.  You shouldn’t deprive yourself of the Want-to-have’s, within reason, but I can guarantee you can look through your spending habits and eliminate a few small things and use that money, no matter how much it is, to save for retirement.  Whatever you can put in each account is great – AND don’t forget, I want you to be putting in at least the match of your employer, if they offer one, if you have a 401k or 403b.

When I am at cocktail parties, I am often asked, “So, Margo, how much does the average person need to save to be ready for retirement?”  I always say the same thing: It’s impossible for me to tell you how much you need to save for retirement because I have no idea what it costs to be you.   The point of retiring is to have a chance to enjoy your life.  So how can I tell you how much you need in order to enjoy your life if I don’t know what a month in your life looks like and/or what it costs?  There is no “average person” when it comes to spending.  Do you spend the same way as your next door neighbor?  Do you have a boat?  Do you want to travel?  Do you have an expensive hobby?  Do you want to sell everything and move to an island?  Would I want my financial advisor to assume I am the same as the “average person” in my geographic area/age group and then base my savings off of those assumptions?  The answer to that is NO.

pexels-photo-104750.jpeg

So, go see a financial advisor to figure out how much you need to save.  If you can’t make that happen, in the very least, save based on the capability of your budget until you can see a financial advisor.

Follow us and Tune in next Monday for the follow up to this discussion: How are financial advisors paid?  And how do you find one you can trust within your budget?

me and kidsMargo is a married mom of 2 and financial adviser in the Annapolis area.

Momday Hacks: Repairing Your Credit Score

We are in a judgement free zone here.  Everyone, and I mean everyone, makes bad financial decisions as a teenager and young adult.  I walked onto my college campus at University of Miami, and on the first day got offered a credit card through Capital One.  You’d be wrong if you didn’t think that I used that card like it was free money for the first month and then was horrified when I realized I needed to pay it back with 24% interest!  (Yikes!!)  Then, as an adult?  Life happens.  Jobs come and go, (and sometimes marriages come and go) but life expenses don’t.  Sometimes this can cause our credit scores to tank.

Image result for gifs for mistakes

Why do we care about our credit score?  First of all, if you have a bad credit score, it means you will pay more to borrow money than someone with a good credit score.  If you walk into a used car lot with a bad credit score and finance the purchase of a $10,000 car, you will end up paying more for that car than if someone with a good credit score walked in the same day to buy the same car for the same amount of money.  Why?  You’ll be offered a higher interest rate for that financing and ultimately make higher payments over a period of time.  Also, nowadays, when you are interviewing for jobs, most potential employers run your credit score before deciding to hire you.  Seem unfair?  Perhaps, but it’s a common practice because they want to know if you are reliable.  Finally, if you are looking to rent a home, they’ll run your credit score too.  These are just a few examples.  Your credit score follows you everywhere, and, like an annoying little sister, it doesn’t care whether you want it there or not!

Image result for gifs for fixing

For most people, there will be times when their credit score is less than stellar.  However – Don’t despair!  The great news about your credit score is that you can ALWAYS take steps to repair it.

What are those steps?

  1. Online Auto-Bill Pay: This is the most important one.  Set this up immediately!  Remember, online bill pay is different than automatic-debit.  Automatic debit is when you allow a creditor (like your cable company or electric company) to TAKE money from your account on a monthly basis.  (I don’t want you to do automatic debit, and I will explain why.)  Online bill pay is when you schedule to SEND money every month to a creditor from your bank account.  So, why is online bill pay better for your credit than automatic debit?  The credit bureaus are computers, and they track your reliability as a credit-worthy consumer based on the regularity with which you make payments on the exact same day every month.  When you allow automatic debits from your account, the cable company likely takes your monthly payment on different days every month based on its business schedule.  Sometimes it’s the 1st, sometimes the 2nd or sometimes the 3rd depending on the month.  The credit bureau doesn’t deem you as reliable when your payments are taken this way.  When you set up online bill pay to send your payment every month on the 1st of the month, the credit bureaus will deem you more reliable more quickly, and your credit score will improve much faster.  Bottom line: Cancel ALL of your automatic debits and instead set up online bill pay through your bank for at least the minimum payment every month on the exact same day.  Then, once a month go in and adjust the amount you will pay depending on the fluctuations of what you owe (like for your electric company).  Watch your credit score improve in the months to follow!
  2. Pay your credit cards down to less than 50% of the total limit. Here is another important one.  Credit bureaus deem you worthy of an improved score when you have all of your credit card balances down to less than 50% of the total limit.  This is indeed the magic calculation.  Of course, it’s always preferable to keep your credit card balances down to zero because they are high-interest rate debt vehicles, but realizing that’s not always possible, try to focus on keeping them down to 49% of limit or lower.  For example, if you have a credit card with a limit of $5,000, be sure to keep your balance at $2,499 or less.Image result for gifs for credit cards
  3. Pay at least the minimum you owe on all of your bills every month.  This seems like a simple one, but some people don’t realize how important it is.  Don’t avoid your bills – they won’t go away.  They’ll only get worse!  If you can’t afford the minimum payments, call the creditor and ask them for options.  Proactively addressing these issues is always seen in a more positive light, and the creditor is less likely to send you to collections when you do this (which will cause a decline in your credit score.)
  4. Monitor your credit score, pull your report once a year and dispute any fraudulent (or wrong) charges. Image result for gifs for stolen identityThere are truly free companies that allow you to do this, and you should.  I know someone who looked at their score to find that someone across the country had used their information to get a knee replacement, and never paid for the surgery.  This is a huge pain in the butt to comb through the report and make disputes, but this is an absolute necessary exercise to ensure you aren’t being punished for fraudulent activities, or in some cases, mistakes of companies who report to the bureaus.  Keep in mind, if a company who claims to provides “free” reports asks you for your credit card information to sign up, they will at some point start charging you for the service.  And, it’s very hard to cancel.  So, don’t do that.  There are also businesses that you can pay to dispute charges – but why pay someone else to do it when you can easily do it yourself?  All it takes is some time and a little bit of patience.  An example of a company to check out for this service once a year is: freecreditreport.com.
  5. Stay away from bankruptcy: Yes, sometimes it is necessary to consider this, but it should ALWAYS be a LAST RESORT.  Bankruptcy is very, very hard to recover from.  You should always consult a financial advisor and an attorney if you are considering going this route, however, remember that there are a bunch of steps you can take to climb out of a bad financial situation that don’t include bankruptcy.  It takes between 7-14 years for your credit score to bounce back from bankruptcy.  Don’t make this decision lightly.

The bottom line is that ignoring your credit score is like ignoring poor heart health.  Just because you ignore it, doesn’t mean it will go away, and ultimately it will harm you significantly if you don’t address it proactively!  It’s not as hard as you think, I promise!

Image result for gifs for money

Your friend,

Margo