Question: I am prevented from contributing to my company’s 401(k) because I am a HCE and the average contribution rate is less than 3%. I make just over the Roth contribution limit so I can’t contribute to a Roth either. What am I supposed to do to save for retirement? Andrew, Wheaton, MD
Answer: Our retirement pension system is byzantine and bizarre in many ways, with twists and turns that often defeats or disappoints savers. You’re caught in that maze.
It drives me crazy that the folks in Congress are always making speeches that Americans need to save more for their retirement and then they pass laws that make it hard to do, with different rules and regulations, diverse income phase-ins and phase-outs, and other distinctions. For instance, an employee 49 years old and under at a company with a 401(k) can set aside a maximum of $16,500 this year. Her peer person at a company with a SIMPLE retirement plan can only salt away a maximum of $11,500. And the spouse taking care of the kids at home can save up to $5,000. It makes no sense.
Okay, now on to what you can do. (I wouldn’t wait on Washington.) First, on the corporate level, I hope you and other highly compensated employees are lobbying senior management to do a better job of boosting the participation rate and retirement savings of low-income employees. That’s one way to increase how much you can set aside a year.
On the personal level, the key is to keep saving, including in taxable accounts. Indeed, if you are a disciplined saver you’ll do well over time with taxable accounts. You’ll also enjoy greater flexibility with those savings. For instance, if you pull money out of a 401(k) you’ll pay a 10% penalty plus your ordinary income tax rate on the withdrawal. But with a taxable account you can tap the money at any time without penalty. You’ll also pay Uncle Sam a low long-term capital gains tax rate (assuming you’ve owned the investments for more than a year).
The trick is to make the savings automatic. The money should come out of your checking account into your investment portfolio. You also want to minimize your annual tax bill. There are a number of other portfolio options available to you. For instance, you don’t pay state and local taxes on U.S. Treasuries–just the federal tab. Another possibility is to buy up to $10,000 a year in I-bonds, the inflation protected savings bond. ($10,000 a year is the legal maximum.) Your money is protected from inflation and it compounds tax deferred until you cash it in.
If you like equities, you could also consider investing in a broad based equity index fund. The tax bill isn’t large since index funds require minimal trading. You could investigate tax-advantaged mutual funds, too. These are mutual funds run with an eye toward keeping the tax burden low. The drawback to these funds is that the entrance fee is typically high, usually around $10,000.
As you can see there are many options available to you. No matter what investments you choose, the important mantra is save more and save automatically.