Rethinking Retirement Savings: Diversify Your Investment Strategy for a Better Future

Rethinking Retirement Savings: Diversify Your Investment Strategy for a Better Future

May 20, 2024

Introduction 

I have a lot of discussions with clients about retirement, especially regarding how much and where one should be saving. Today, I want to encourage a slightly different approach to retirement savings than what you might have heard in the past. Don’t worry—I’m not here to discredit the importance of 401Ks or IRAs. Instead, I'm suggesting that perhaps we've been putting too much emphasis on these traditional retirement accounts. Let's explore some alternative methods to ensure a well-rounded financial future.

 

Three Buckets of Investment: Tax Now, Tax Later, Tax Never

In the realm of saving and investing, we can divide our strategies into three buckets based on how they are taxed: the 'tax now' bucket, the 'tax later' bucket, and the 'tax never' bucket. Traditionally, most people have focused heavily on the 'tax later' bucket.



Importance of Emergency Savings

First and foremost, ensure you have three to six months' worth of living expenses in an emergency savings account. This is the foundational step before any other investments.

 

Maximize Employer Matches 

The next rule is to max out the match on your 401K or Simple IRA if your employer offers one. This is free money that you don’t want to miss out on. Whether it’s putting in 3% to get 3% or 6% to get 3% or another matching schedule, always ensure you’re maximizing this benefit.

 

The Tax Later Bucket

The 'tax later' bucket includes familiar vehicles like 401Ks, IRAs, SEPs, and pensions. When you contribute to these accounts, you get a tax deduction, and the money grows tax-deferred. However, it's 100% taxable when you withdraw it at retirement. While this has been a popular saving strategy, it comes with limitations, particularly around accessing funds before retirement.

 

The Tax Never Bucket

Recently, there's been a growing focus on the 'tax never' bucket, which is a bit of a misnomer. Essentially, this involves paying taxes on your contributions upfront, as with Roth IRAs or Roth 401Ks. Though the money grows tax-deferred and withdrawals are tax-free, you do pay taxes on the money before it goes in. These accounts are effective, especially if you anticipate being in a higher tax bracket in retirement.

 

The Often Overlooked: Tax Now Bucket 

However, what if you need access to funds before reaching retirement age? This brings us to the 'tax now' bucket. Investing in a tax now strategy, also known as non-qualified investments, requires you to pay taxes on any gains or dividends as they are realized. Though you miss out on some tax deferral benefits, you gain the flexibility to access your money without the heavy penalties associated with early withdrawals from retirement accounts.

In addition, these accounts can be an effective place to hold some of your emergency savings, especially if you don’t like the idea of six months’ worth of expenses collecting dust in a traditional savings account.

 

Planning for the Unanticipated: The Role of Non-Qualified Investments

Lately, I've had many discussions around the need to save for goals that fall outside the traditional retirement framework. These include early retirement, children's educational expenses that don’t fall neatly into a 529 plan, or simply major life projects. In these scenarios, non-qualified investments can be invaluable.

 

Test Driving Retirement: Mini Retirements

One intriguing idea is the concept of ‘mini-retirements.’ If you’ve done an effective job of saving by your 50s, why not take some prolonged time off before hitting traditional retirement age? This helps you test the waters of retirement living, whether it's spending seasons in another state or trying out a lifestyle you think you might enjoy permanently. However, without accessible funds, this becomes harder to accomplish. Non-qualified investments can provide the liquidity needed for such explorations.

Conclusion

In summary, while it's crucial to continue benefiting from tax-advantaged retirement accounts, also consider diversifying into non-qualified investments. This ensures you have accessible funds for various life events, providing more financial flexibility and confidence. So, as you continue to save for retirement, think about spreading your investments across all three buckets—tax now, tax later, and tax never—to create a more robust, adaptable financial plan.

*Commonwealth Financial Network® and R2 Financial Strategies do not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation. Diversification does not assure a profit or protect against loss and cannot guarantee that any objective or goal will be achieved.

To learn more, check out the video below.