Financial planning can become overwhelming when you’re aiming to maximize your retirement savings while juggling various accounts and tax implications. One of our clients found herself in just such a situation.
She wanted to maximize her 401(k) contributions and contribute to a Traditional IRA. However, her 401(k) coverage meant she would receive no tax deduction for her IRA contributions. Additionally, her primary goal was to purchase an investment property and given her age, that means if she did an IRA, she would be locking up money that could be used in the near term for a down payment.
Understanding the Tax Issue
Our client’s initial goal was to contribute to her 401(k) and Traditional IRA accounts. We understand that many people have this goal, but we almost never recommend it.
When you’re covered by a 401(k) plan at work, your ability to deduct Traditional IRA contributions may be limited, especially if your income exceeds certain thresholds. In such cases, you might not benefit from the tax deduction, making the Traditional IRA less appealing. Our client’s financial situation made her ineligible for the deduction.
Understanding Client Priorities
With the client’s primary goal being to purchase an investment property and maximize her retirement savings, we had to challenge her initial strategy. In her case, contributing to the Traditional IRA without the tax deduction wasn’t the most efficient use of her resources. To help her make an informed decision, we discussed alternative options.
Maximizing 401(k) Contributions: We emphasized the importance of maxing out her 401(k) contributions. 401(k) plans often come with employer matching, essentially free money. Even without the tax deduction, her 401(k) contributions would continue to grow tax-deferred until retirement.
Exploring the Roth IRA Option: If our client wanted to invest in an IRA, we advised considering a Roth IRA. Contributions to a Roth IRA are not tax-deductible, but withdrawals in retirement are tax-free. This can be a valuable tax advantage, especially if she expects to be in a higher tax bracket during retirement. However in her case, her income made this potential investment avenue not an option (which admittedly is a nice problem to have).
Employer ESPP (Employee Stock Purchase Plan): We suggested she maximize her participation in the Employee Stock Purchase Plan (ESPP). ESPPs allow employees to purchase company stock at a discount, which can be a valuable investment opportunity.
ESPP, in this case, was particularly attractive since it provided a discount on stock and didn’t overlap with her retirement savings strategy like the Traditional IRA did.
Combining Strategies
Ultimately, the client prioritized her 401(k) and ESPP contributions. This strategy made sense for her, allowing her to take full advantage of the company’s benefits while building her retirement nest egg. While she was initially concerned about missing out on the Traditional IRA deduction, the long-term tax advantages of the 401(k) and her future investment property remained essential goals.
No One Perfect Fit
The key takeaway here is that financial planning is more than one-size-fits-all. Working with a financial advisor who can help you tailor your strategy to your unique goals and circumstances is essential. Ultimately, the peace of mind that comes with a well-thought-out financial plan is well worth the effort.
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