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The Four Steps to Retirement Saving

April 30, 2015 at 12:00 PM

Saving for retirement is a no-brainer. But knowing the smartest ways to do that saving is anything but easy to figure out, given all the choices. Don’t worry, I’ve got you covered. Here’s exactly what you should do, in the order I list:

1. If you get a matching contribution from your employer, save in your workplace 401(k) or 403(b). Contribute only enough to qualify for the maximum matching contribution.

No workplace match, or no workplace retirement plan? On to step 2:

2. Save in a Roth IRA. The prospect of having tax-free income in retirement makes a Roth IRA a great deal. There is no upfront tax break that you can sometimes claim if you save in a Traditional IRA, but that’s okay. I want you to focus on the end goal: no tax on withdrawals with the Roth vs. having to pay income tax on every penny that comes out of a Traditional IRA.

2A. For High Income Earners: Consider a Back Door Roth IRA. Above certain income thresholds you are technically not allowed to contribute to a Roth IRA. But there is a totally legal and smart way to save via a Roth IRA. First make a contribution to a Traditional IRA. Then within a few days convert the Traditional IRA to a Roth IRA. As I said, this is completely legal. If you do not have any existing Traditional IRAs this is a smart move; you will likely owe no income tax on the conversion, and once your money is in the Roth IRA you will not face any tax on withdrawals made in retirement.

If you do have existing Traditional IRA accounts (including Traditional rollover IRAs) there will be a tax bill due in the year you convert. Consulting with a tax pro is advised.

3. Save (More) in your 401(k). Able to save even more? Okay, use your company plan if you have one. Boost your contribution rate so instead of just saving enough to qualify for the match, you instead are saving even more.

4. Save in a Regular Taxable Account. As long as you hold an investment for at least one year, any investment profit you have when you sell will be taxed as a long-term capital gain, not income. And the good news is that long-term capital gains rates remain very low-typically 15% for most investors−so the tax bit isn’t going to be too bad. Invest in low cost index mutual funds and exchange traded funds and you can minimize any tax bill while you own the shares, as well.

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