Updated: Mar 3
So this week we're reading the question of the week:
My wife Jen is getting forced out of her job with a major US insurance company. She doesn’t want to work for them with their current practices but we are trying to build our retirement being that we are within 10 years of retirement. Would it be practical for her to work at a job without a retirement contribution while we max out mine? Could she open a Roth IRA and create her own per se?
Thank you Tom for the question.
First off. We are sorry to hear that your wife will have to part ways with her employer.
We certainly understand when a situation arises where things do not work out for both parties and it can be a stressful situation to leave a job and then take the time to find a new one.
So let’s address the first question . . . is it okay if she takes a new job that doesn’t have a retirement contribution plan and at the same time Tom will maximize his full 401(k) plan.
There is no problem with taking this path. Right off the bat if your wife invests with her after-tax money then the good thing is that she will not be subject to future tax on her contributions except for the gains on the investments.
She can also take her investment gains tax-free providing that she is over 59½ years of age and she has to hold that money for five years. So with 10 years left in retirement she is in the clear.
So the first thing is that she needs to qualify for a Roth. If she files as a single person, her Modified Adjusted Gross Income (MAGI) must be under $139,000 for the tax year 2020 and under $140,000 for the tax year 2021.
MAGI can be defined as your household’s adjusted gross income with any tax-exempt interest income and certain deductions added back.
Now if Tom and his wife file jointly the MAGI has to be under $206,000 for the tax year 2020 and 208,000 for the 2021 tax year.
So let’s say that they qualify for the Roth so this means Tom’s wife can invest:
$6,000 if she’s under 50.
$7,000 if she’s age 50 or older.
The Downside of not Having an Employer-based Retirement Plan
By not having a plan as an option this means she misses out on the opportunity to have the potential employer match. For example, with a $3,000 match over 10 years that equates to $30,000 in contributions and taking our typical 7% gain over that time, the compound interest comes to a total investment of $44,350. So in this example, this $14,350 that could have been realized.
Putting a New Financial Plan
We are assuming that Tom and Jennifer are over 50 years of age and with that being said, Tom can contribute $19,500 to his 401(k) plan and this means that his catch up contributions can also be applied at $6,500 that would give him the maximum investment of $26,000 and his wife can contribute $7,000 to her Roth IRA.
If the scenario is that Tom is only reaching the $19,500 level they can opt to take her contribution away and give that money to Tom’s 401(k) and that would increase the tax-deferred deduction meaning they’d owe less tax to the IRS at the end of the year.
So let’s assume the best case scenario and that is the maximum 401(k) contribution and the Roth IRA and/or brokerage account investment and this equates to them accumulating $33,000 into their retirement accounts over the next 10 years.
Hence, taking our 7% number they would have $487,858 dollars as they get ready for retirement. Very nice!
To go one step further if Jennifer took a job with an employer match using our hypothetical $3,000 employer match, they’d have $532,209.
Altering Investing Decisions
As Tom and his wife have 10 years left until they don’t have to answer to a boss or the “man” anymore, they need to decide how they want to budget their money.
As we always point out, it is always up to the individual to make decisions with his or her money. Typically as people reach five years or less before retiring people begin to become more conservative with the investment choices. The whole point in doing this is to err on the side of caution to maintain capital preservation.
This is why many people choose conservative investments such as target-date based funds as they capture all of the investments in stocks, bonds and other securities on one fund. For example, Tom is planning on retiring in 2031 and the year is 2020, then he may choose a 2030 or 2035 fund, and the fund manager will be allocating the portfolio with that conservative investment mindset.
You can catch the full details on mutual funds in this Podcast #46 - 401(k) Asset Allocation with Mutual Funds in the Stock Market & Valentine's Day Break Up Therapy
Keep in mind that Social Security’s goal is to provide 40% replacement income and the individual’s goal should be to have 80% replacement income meaning people need to come up with the other 40%. For example, if someone lives off $100,000 a year, he/she will need to target $80,000 in replacement income.
The reason the percentage is 80, is that the goal at this point is not have debt with credit cards, car/automobile payments, student loans, a mortgage and the children have had their weddings meaning the nuclear family is now an empty nest situation.
Building Up Cash Liquidity
One more piece to this equation is that if Tom and his wife begin to build money in a Roth IRA, a traditional IRA or a brokerage account, they’re creating options meaning the beauty is that they can have cash and money to access when they retire without having to take from their IRAs or 401(k) accounts for a period of time, or until age 72, where it is taxed on distribution.
And to go one step further, depending on what Tom and Jennifer have saved, Tom could continue to contribute the max to his 401(k) contribution then also contribute the max to a Roth IRA, because in this case for Tom, contributing to both a Roth IRA and an employer-sponsored retirement plan can make it possible to save as much in tax-advantaged retirement accounts as the law allows. In effect, this would help supplement what isn’t going into Jen’s 401(k).
We feel this is the best type of investment savings for the long haul; and we might assume they may have regular investment accounts and personal savings as well, which would effectively be the first money they would touch in retirement.
When doing this, it will also pad that after-tax contribution to investment savings. Remember tax deferred contributions into IRAs or pre tax 401(k) contributions get taxed only when a distribution is made.
Roth IRA contributions are tax advantaged because they grow tax-free and get withdrawn tax-free after meeting the Roth qualifications. Regular investment accounts are those that are invested with after taxed money, but then get taxed for dividend and interest income, as well as capital gains on investment growth.
If you use that money first, you’re not taxed for distributions from those types of accounts, but you may pay capital gains tax if you sell investments to cover retirement income. So these are all just options depending on their situation.
Let’s Do the Recap
Tom’s wife is losing her job and the question is . . . should she get a new job with an employer that has a retirement plan and if not can she take the Roth route while Tom maxes out his 401(k).
#2 There is no right or wrong answer here. If a new job is taken and it doesn’t offer a retirement plan, then Tom’s wife may be missing out on a potential 401(k) employer match, as well as the max contribution of either $19,500 or $26,000 for tax advantaged savings.
If the choice is to work without a retirement plan then Tom’s wife can invest via a Roth IRA, a traditional IRA or a brokerage account. In addition, Tom can also open one of these accounts to help supplement what Jennifer may have utilized.
#4 The advantage to investing in the Roth IRA, is that the money has been invested with after-tax money and she can take her contributions out any time tax-free once she meets the qualifications and then all of her money can be withdrawn without penalty and tax-free in retirement.
The bottom line for Tom and his lovely wife Jennifer is to find a situation that works for both of them. What we like here is that they’re asking questions and they’re working on a plan that works for both of them.
They’re looking at the budget, their current investment time horizon and have a goal to retire in the next 10 years. If they manage their money correctly, we hope they have no debt and have their rainy day fund and emergency funds in place.
Because they are doing their homework, we have a feeling that they will succeed with their budgeting and retirement plan.