Next Tuesday is the deadline for making IRA contributions for 2016. Last year’s Accountable Update on the same subject, Allergies and April 18, explored the “cost” of skipping a contribution. That message is still timely if you have the means to make a contribution beforehand.
The fact is, however, that "nearly half of families have no retirement account savings at all," the Economic Policy Institute (EPI) reported last year. EPI went on to show that the median retirement savings for all families in the US is less than the maximum IRA contribution for 2016 ($5,500).
While it is a sad reality that some folks just have too much month leftover after the money runs out to put something away, for many it is more about the choices we make. So, this year, let’s look at how making different choices can quickly get you on the right track.
Give A Hand Up
This first tip is for parents and grandparents that have the means to make a gift to your kids and grandkids. While the tax laws require earned income to qualify for making an IRA contribution, there is no restriction on where the funding for the IRA comes from.
For example, my 17-year-old had a summer job last year that earned him about $1,200. For 2016, the rules regarding funding an IRA limit contributions to $5,500 or your taxable compensation for the year, if your compensation was less than $5,500. Thus, my son can contribute up to $1,200 to an IRA for last year.
The problem? He has already spent about half of what he earned. But, I’m willing to match him dollar for dollar if he’ll invest it in a Roth IRA. I have taken time to explain to him the value of investing at such a young age. Showing him a compound interest calculator, like the one on the SEC’s website, allowed him to easily see the benefits of regular savings over time.
We've also discussed that he can expect similar matching "gifts" going forward. I hope this results in an early appreciation for the value of saving and investing by improving his understanding that the real payoff is down the road.
While annual gifting does have limitations ($14,000 per donee in 2016-17), it can also provide a very efficient way to transfer wealth, especially if you anticipate your estate will be above the estate tax thresholds.
Spend What’s Left
Have you ever noticed that no matter how much money you make, it never seems to be enough? Perhaps you are seeing the effects of the psychological phenomenon known as “present bias”. This predisposition to opt for the immediate gratification of making a purchase today ultimately comes at the expense of saving for tomorrow. But knowing that we may have that tendency can allow us to effectively plan to overcome it.
Take for example, tax refunds. In 2015, about 70% of tax returns resulted in a tax refund that averaged nearly $3,000. That would fund over half of an IRA contribution for those taxpayers! Some may suggest paying off debt with your refund, but since retirement contributions are "use or lose" opportunities, I favor paying yourself first while you still can.
In households with < $61,500 Adjusted Gross Income, there is also a tax credit available for up to $1,000 if an IRA or other retirement account contribution is made. The credit is referred to as the Retirement Savings Contributions Credit, and while it may only apply to those with relatively modest incomes, it is a pretty sweet incentive for those that qualify.
I’ve also previously discussed cash back credit cards and “snowballing” debt payments by paying off your highest interest debt first and then applying those payments to the next highest until the debt is paid off. Taking cash back rewards or extinguished debt payments and putting those into your retirement account can really help in making the shift to saving first and spending what is left.
Small Changes Add Up
While having Mom & Dad helping foot the bill or getting some cash back from Uncle Sam are great, for most of us the reality is that we have to make occasional hard choices when it comes to saving or spending. Before getting into how a few small changes might add up to significant retirement savings, let’s be honest. Budgets, like diets, get blown by rationalizing. Telling yourself that this “one cookie” won’t hurt anything is probably true, until your “one” turns into several. Suddenly those hundred or so calories are now 400-500 and you're left staring at the scale wondering why those pounds won't come off.
The same thing happens when we grab a bottled water, coffee shop latté, or take-out meal. Not only may some of those add inches to our waist, they all take bites out of our wallets. If we just partake in these indulgences on rare occasion, it’s no big deal. But if we aren’t honest with ourselves and allow them to become habit, they can quickly eat up our potential to save more.
Some ideas of places to look for some savings include:
- Limiting withdrawals at your bank’s ATM to once per month instead of hitting any ATM (especially out of network) every time you need $20.
- Cook your own dinner or bring lunch instead of eating out.
- Drinking tap water.
- Making your own coffee.
- Dropping that premium cable subscription, or cable altogether.
- Stop paying for gym memberships you aren’t using.
- Keep that old phone a while longer and drop the replacement insurance plan.
- Arrange a work carpool.
As you can see below, these can really add up.
Everyone’s personal situation will vary, but by employing one or more of the ideas we’ve touched on today, you’ll be well on your way to being one of the good statistics. Get in touch if you have any questions.
[v] Based on average commute distance of 12.6 miles each way and IRS mileage rate of $.535 per mile