Baby boomers, Americans born between the years 1946 and 1964, are reaching age 50 at a rate of more than 12,000 a day. That’s one person turning 50 every 8 seconds! Yet, reports show that 70 percent of all adults are living paycheck-to-paycheck. In fact, out of 100 people age 65, 97 of them can’t write a check for more than $600 and only three percent are financially secure. That’s incredible for a country that boasts it’s the wealthiest nation on earth!
It’s time to join the Three-Percent Club, i.e., those who are financially secure. Here’s four suggestions to help you become part of the Three-Percent Club who can retire comfortably and live financially secure.
Maximize your savings by contributing to both your IRA and 401(k)
Many people don’t realize that they can contribute to both an Individual Retirement Account (IRA), known by the Internal Revenue Service (IRS) as an Individual Retirement Arrangement, and a 401(k), a tax-qualified, defined-contribution pension account.
If you have a 401(k) account, you can contribute up to $18,000 for 2016 if you’re under age 50 and up to $24,000 if you’re 50 or older. You should contribute the maximum you are allowed regardless of your age. If you’re age 30, you can amass over $1.2 million in principal plus a lot more in tax-deferred or tax-free interest depending on whether your account is a Traditional (tax-deferred) account or a Roth (tax-free) account. You have until December 31, 2016 to make your contribution.
If you have an IRA account, you can contribute $5,500 to your IRA if you’re under 50 years old or $6,500 if you’re 50 or older. Depending on your earned income, you can contribute to both a Traditional or Roth IRA in addition to contributing to your 401(k) or other defined-contribution pension account. If you started making contributions at age 30, you would have over $200,000 in the bank by the time you’re ready to retire. That doesn’t include any earnings on the money. You have until April 15, 2017 to make your 2016 contribution.
If you don’t have a 401(k), now is the time to set one up
If you’re not an employee of a company with a 401(k) or other defined-contribution plan, it’s likely that you can set up your own 401(k) account as a self-directed One-Participant 401(k). There are several self-directed custodians and third party administrators (TPA) who can assist you with setting up an Individual or Solo 401(k).
If you have no full-time employees and are a sole practitioner, self-employed consultant, real estate professional, sales person, private contractor, or one of a myriad of “1099” independent contractors, you are the perfect candidate for a self-directed individual 401(k) plan. Here are the steps:
1) Set up a limited liability company with the state;
2) Get an Employer Identification Number (EIN) from the IRS;
3) Find a good self-directed third party administrator;
4) Fill out the required paperwork;
5) Make your contribution.
Most of this process can be done online and it doesn’t take big bucks. You can usually set up an LLC with your state for $70. The EIN from the IRS is free once you have an LLC. The TPA will charge some fees, but they are minimal.
There are huge advantages to having a self-directed 401(k) over an IRA
The biggest advantage is that you can contribute so much more money to a 401(k) than to an IRA. If you contributed the maximum amount to your IRA, over 35 years, you would have about $200,000. If you contributed the maximum amount to your 401(k) over 35 years, you would have over $1,200,000. That’s a huge difference!
Another advantage to having a self-directed retirement account versus a non-self-directed retirement account is that you control the investments that you make. All retirement accounts are self-directed but some financial planning and securities firms limit you to the types of investments you can make. Most stock brokerage companies limit you to publicly-traded stock and bond investments which has proven problematic for many investors and retirees due to the volatility in the stock market.
Another advantage with a self-directed 401(k) account is that you can invest in leveraged income-producing real estate investments and have no immediate tax consequences. Leverage meaning, having some debt on an investment property, enables you to get a higher return on the capital invested. That’s called positive leverage. If you invest with an IRA, the IRS wants to tax the portion of the income attributable to the debt financing. That’s called Unrelated Debt Financed Income (UDFI) tax. 401(k) accounts are exempt from UDFI tax.
Finally, with both an IRA and a 401(k) account, you can designate your contributions to be Roth (after tax) rather than Traditional (pre-tax). Making Roth contributions instead of Traditional contributions allows your money to grow tax-free rather than tax-deferred. Tax-free means you pay no tax on the principal or the interest earned. Period. Tax-deferred means you pay tax on both the principal and the interest earned at ordinary income tax rates when you pull the money out. Another benefit to a Roth IRA is that there are no Required Minimum Distributions (RMDs) at age 70 ½.
Use your 401(k) to invest in income-producing real estate
With a self-directed 401(k), you can invest in income-producing real estate which will help you generate the income you need for retirement nearly three times faster than investing in stocks and bonds. When you invest in stocks, you pay one dollar for a dollar’s worth of stock. There is no leverage. When you invest in income-producing real estate, you pay one dollar and can purchase four dollars’ worth of real estate because you can leverage real estate.
For example, if you invested $100,000 in stocks and they averaged a six-percent return over ten years, the value of your stock would appreciate to about $180,000. If you invested the same $100,000 in income-producing real estate and borrowed $300,000 for a total investment of $400,000, the value of the real estate would appreciate to over $716,000. After 10 years, the debt would be paid down to $244,000, leaving you with equity of $472,000. That’s nearly three times more income at the end of ten years with the same dollars invested!
It also means that, at retirement, you don’t have to liquidate your investment to provide for your retirement. With an investment in stocks you have to liquidate your investment. With an investment in income-producing real estate, you live off the income generated from the investment and continue to own the appreciating asset.
Now is the Time to Put the Power of Your 401(k) to Work for You!
Now is the time to put the power of your 401(k) and your IRA to work for you. Don’t wait another minute to get your accounts set up and start contributing. Years ago you could work 20 or 30 years for a company and retire with a nice pension for the rest of your life. Today, that isn’t the case. The burden for providing for your retirement years is squarely on your shoulders. If you don’t provide for your retirement, no one else will.
When social security began, there were 155 workers contributing to the system for every retiree that was drawing from it. Today, there are 3 workers contributing to the system for every retiree drawing social security. Social security accounts for less than forty percent of your retirement income. Who knows how much will be available when you retire? When workers started contributing to the social security fund, they assumed the government wasn’t going to touch their money and it could continue to grow. Unfortunately, the government took it all and spent it and now requires that you pay taxes on the money you receive.
There is no shoebox in Baltimore with your name on it and your money inside. It’s up to you to prepare for your retirement. You need to decide now to become a member of the Three-Percent Club rather than the other ninety seven percent who are broke! Contact me if you need help setting up your retirement accounts. My email address is firstname.lastname@example.org.