How to Save $1 Million in Your IRA Accounts
With retirement now on the horizon, it’s time to double down your retirement savings. You’re feeling the pinch – you can actually now see the point at which you’ll be retiring. As a Gen Xer, it’s only a couple of decades off. That’s not a lot of time to save.
According to a report released by the Government Accountability Office (GOA) in 2014 (originally released in 2011), more than 314 Americans held IRAs with more than $25 million in them. That’s a significant amount of money.
Even more startling was the fact that more than 630,000 Americans have IRAs that hold more than $1 million.
Is there a way that you can achieve the same thing?Actually, there is.
Choosing between IRA Accounts
Before we go too much further into the discussion, we need to talk a bit about the types of IRA accounts out there. You’ll find both traditional IRAs, as well as Roth IRAs. While they sound similar, they’re very different.
In a nutshell, a traditional IRA allows you to put money away for retirement before paying taxes. You’ll be taxed on the income later, when you withdraw your money. You’re betting that those withdrawals will be made after you retire, and have dropped a tax bracket, but that doesn’t always happen.
In fact, more and more retirees are finding that they either remain in the same tax bracket, and are liable for the entire tax bill they would have paid originally, or they’re in an even higher tax bracket due to their investing activities.
A Roth IRA is a little different. It allows you to save, but it requires that you put money in after Uncle Sam has taken his share of the pie. Why invest with after-tax dollars, though? What makes these IRA accounts better options than traditional IRAs?
Simply put, there’s no tax paid on your withdrawals when you retire because you’ve already paid it. That means no matter what your tax bracket might be during your golden years, you don’t need to worry about tax liability on your withdrawals.
Other Reasons Roth IRA Accounts Trump Traditional Options
The fact that you’re not taxed on withdrawals is just one of the perks you’ll discover when using a Roth IRA, rather than a conventional individual retirement account.
For instance, maximum contributions within a Roth IRA always go farther than with a traditional IRA if you’re not investing your tax savings with a conventional account.
Simply put, if you’re dead set that you want to stick with a traditional IRA and still plan to build a $1 million nest egg, you’re going to need to take the taxes that you saved and invest them somewhere else.
Investing those tax savings (and taking them off the table for immediate spending) is the only way that a traditional IRA stacks up to a Roth IRA.
Think about it this way. With traditional IRA accounts, if you were to withdraw $30,000, you’d then need to pay tax on it after the withdrawal.
Depending on your tax rate, this could be a significant chunk of change. With a Roth IRA, you get the full $30,000 value, because the taxes have already been paid.
Another way that Roth IRAs trump other IRA accounts is that if you are likely to be in a higher tax bracket, you win more with a Roth account.
In fact, a recent study found that you stand to earn an additional $185,000 or so over 30 years with a Roth as compared to a traditional IRA if you’re facing the highest effective income tax rate at the time of your retirement. And, if you’ve been doing your legwork, you should definitely be in that tax bracket.
Of course, there’s the fact that funds within a Roth IRA can be removed at any time (but not earnings). This is in direct contrast to conventional IRA accounts, where withdrawing funds before the age of 59.5 can hit you with both a tax bill and a 10% penalty.
What If You Don’t Know Your Expected Tax Rate at Retirement?
Roth IRAs don’t offer you money for nothing. You still have to pay taxes upfront. That may or may not be a tenable position for you.
In fact, the immediate tax savings are the primary reason most Americans still use traditional IRA accounts, rather than a Roth account.
It’s difficult to figure out what your tax liabilitywill be at retirement, particularly if it’s still a couple of decades off. Things can change quickly, and it’s very possible that you won’t be liable for the highest income tax rate at that point.
In this scenario, a traditional IRA might be better.
The Solid Path Forward with IRA Accounts
Really, both traditional and Roth IRAs offer benefits, and it’s impossible to predict the future with 100% accuracy. This means that perhaps the best solution is to use both types of IRA accounts – a traditional account and a Roth IRA.
Savings can always be converted from a traditional IRA into a Roth IRA, as well. You can also convert a 401(k) to an IRA account.
Reaching $1 Million
The best way to reach $1 million in retirement savingsis to take advantage of your maximum contribution amounts – $5,500 per year for both regular IRAs and Roth IRA accounts.
Know your time horizon – how long do you have for retirement? If you’re contributing the maximum every year, it would take roughly 36 years to reach $1 million.
Is that doable for you? If not, consider combining different accounts. Use a 401(k), a conventional IRA and a Roth IRA.
Make sure you’re also using high-quality individual bonds, rather than bond funds to ensure a predictable return on your investment, and the ability to create a bond ladder that reaches years into the future.