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GRAND RAPIDS, Mich. — Stocks, IRAs, 401(k)s — if the mention of investing for retirement overwhelms you, you’re not alone. Which investment should you choose? How much should you contribute? These are common questions as many work to get more financially fit this new year.
I spoke with David Sponhauer at Mattson Financial to break down the basics of retirement investing and help make sense of your options.
The three-bucket approach
Financial advisors often recommend thinking about retirement investing in three different categories: pre-tax, after-tax, and what’s called the “non-qualified” bucket.
“I like to look at it as three different buckets. We got pre-tax, we got after-tax, and we got the, I guess tax being now bucket or the non-qualified bucket,” David Sponhauer, a Mattson Financial advisor, explained.
Roth IRA: Pay taxes now, grow tax-free
With a Roth IRA, the money you invest is taxed upfront, but then grows tax-free over time.
“So when I pull that out, when I get to retirement, it’s tax-free to me,” Sponhauer said.
This option works well for people who expect to be in a higher tax bracket during retirement or believe tax rates will increase in the future.
Traditional IRA: Tax break now, pay later
A traditional IRA offers a different approach. Contributions may be tax-deductible now, but you’ll pay taxes on both your contributions and growth when you withdraw the money in retirement.
“So I pay taxes on the growth when I take that out, when I get to retirement,” Sponhauer noted.
This strategy can benefit high earners who want to reduce their current taxable income, especially business owners looking to lower their tax burden.
Non-qualified investments: Flexibility with annual taxes
The third option involves investing in stocks, bonds, exchange-traded funds (ETFs), and other securities outside of retirement accounts. While these investments are taxed annually like normal income, they offer more flexibility since there’s no penalty for withdrawing money before retirement age.
“A lot of times folks say, hey, tax is probably going up in the future. So that’s where leaning on the Roth makes a lot of sense. There’s also a lot of business owners out there that are paying a lot in taxes they want to reduce their taxable income. And so that’s where the pre-tax comes in to reduce that taxable income down,” Sponhauer explained.
Planning for retirement income
Once you have your retirement investments in order, it’s important to create an income plan for when you retire. This helps ensure you won’t be surprised by costly life events without money to pay your bills.
“What if I have a long-term care event at age 75? What if my spouse has a long-term care event at age 75? Planning for it,” Sponhauer said, emphasizing the importance of preparation.
“Making sure that we’re diversified — we have a diversified portfolio. So, when it comes to income planning, do we have an income plan in place? Do we have some safer assets with some protection if we have some volatile markets?” Sponhauer added.
The magic number: 10-15%
After setting up your emergency savings, financial experts recommend putting 10% to 15% of your take-home income into retirement investments. This percentage can be adjusted as needed for larger purchases, such as paying for your child’s college education or a wedding.
The key is to start early and stay consistent with your contributions, regardless of the investment strategy you choose.
Diversity in investment is also key, according to Sponhauer.
“As we get older, obviously, we want to include some more fixed income or some bonds into there. That’s going to help reduce the risk for us.”
Sponhauer notes that the earlier you start investing in retirement, the more aggressive you can be in your investment portfolio compared to later in life, when you don’t want as much volatility or risk in your investments.