By Eric Reich
I’m a big believer in saving money. That’s a shocker, I know. So I am always looking for ways to save not only more but smarter.
One of the first questions I like to ask new clients is, what are you saving for? Many of us save for the sake of saving, not necessarily for a specific goal. Are you saving for retirement? College? A vacation house? Knowing what you’re saving for makes it easier to focus on the right savings rate, portfolio allocation, and even tax management and estate implications. It is difficult for an advisor to answer the common question, “how much should I be saving?” when we don’t know the what, when, or the how behind it.
Let’s look at some of the things we save money for and how we might want to go about it.
- Saving for retirement
The amount you should save depends on a lot of different variables. Sure, I would like to see a 20-something saving 10% of their income for retirement, but I still need to know what the goal is. Do you want $250K in retirement from your investments or $25K? The amount you need to save depends heavily on the end goal.
How should you save for retirement? The answer may lie in your current tax situation. If you are just starting out, maybe look to a Roth 401(k) or Roth IRA instead of traditional versions. Yes, by investing in the Roth option, you forgo the current tax deduction, but does it really matter that much? Most young people starting out are not in a high tax bracket anyway, so what is the real value of the tax deduction you are giving up? You might be in a much higher tax bracket in retirement than you are today. Side note: Don’t automatically assume you will be in a lower tax bracket in retirement. For many retirees, that old way of thinking simply isn’t true. I would much rather have a large pool of retirement assets in the future that are tax-free than get a comparatively small tax deduction today. Look at it from a farming perspective. Would you rather pay tax on the seeds or the crop? Another great feature of a Roth is that if you don’t use all of the money, it is also income tax-free to your heirs!
- Saving for college
I often get questions about which is the best way to save for college. First, we need to understand if you are going to be eligible for financial aid. As a guideline, you can use each college’s net price calculator or the Federal Student Aid Estimator at studentaid.gov.
Also, it’s important to understand that different savings vehicles count differently for aid purposes. A 529 owned by the parents counts as a parent’s assets, which is assessed against you much lower (5.64%) than a custodial account (UTMA/UGMA), which counts as the child’s assets (20%).
I personally never use UGMA/UTMA accounts for a whole host of reasons, including tax, estate, financial aid, control, etc. My go-to savings vehicle for college is the 529 plan. Funds in a 529 grow tax-deferred. If used for qualifying higher education expenses or private grade/high school, then all of the growth can be tax-free.
The next question I get is, “but what about the penalty if I don’t use it for those reasons?” Yes, if you don’t use it for a qualifying expense, then the earnings only are subject to tax (which they would have been in a regular investment account all along anyway) and a 10% penalty on the earnings only. Being able to defer taxes for decades and earning interest on the money I would have paid in taxes all along in exchange for a small penalty is well worth it to me.
Lastly, yes, using an insurance policy is an option as well. However, I like that more for helping to qualify for aid than I do as a general savings vehicle.
- Saving for a vacation home or a general goal
Unfortunately, there are more limited ways to save for these goals that are tax-free and completely accessible at any time. For these goals, a time horizon is key. When do you need the money? That will dictate the investments that should go into the accounts. It helps to determine the tax efficiency of the investments needed too. It might determine the ownership structure of the account as well.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures.
Eric is President and founder of Reich Asset Management, LLC. He relies on his 25 years of experience to help clients have an enjoyable retirement. He is a
Certified Financial Planner™ and Certified Investment Management AnalystSM (CIMA®) and has earned his Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) designations.
