Retirement Planning Guide: 7 Steps + Tips for 2023

by | Jun 2, 2023 | News

The right time to start saving for retirement is said to be yesterday – and we could not agree more. But what does saving for retirement mean?

For some, it means:

  • maxing out a 401(k) or 403(b)
  • maxing out an IRA, whether it’s traditional, Roth, or SEP
  • maxing out an HSA to cover future medical expenses, including nursing care
  • choosing a hybrid retirement vehicle, such as a so-called Mega Backdoor Roth
  • contributing to a Cash Balance Plan or Profit Sharing Plan
  • investing in an annuity
  • investing in a Private Deferred Compensation Plan
  • investing in real estate or various stocks and bonds
  • investing in precious metals such as gold
  • investing in purchases that lead to passive income, such as partnerships or green energy projects
  • investing in your small business with the intent to sell upon retirement
  • investing in other types of businesses

The options – both traditional and creative – are endless. Your retirement portfolio is, of course, dictated by your income and the choices available to you, but also by your risk tolerance or views on taxes (more on that below).

So how do you choose a retirement plan (or plans)? In this retirement planning guide, we outline seven steps you can take now to prepare for retirement.

1. Decide if you want a tax break now or tax-free income upon retirement.

Whether you take a tax break now or skip taxes upon retirement, you’ll have to pay them. Let’s explore the two options at your disposal.

Tax Break Now: Tax-Deferred Retirement Accounts

Most people assume their income taxes will be lower when they retire, as they will be earning less and qualify for a lower tax bracket than the one they are in today. This is why they choose tax-deferred retirement plans such as a 401(k), 403(b), or a traditional / SEP IRA.

Tax-deferred means you are not paying taxes now, and contributions to a retirement account are tax-free for you today – but you will pay income taxes when you retire and start taking distributions.

We are not escaping income taxes, merely delaying them.

The problem with these types of tax-deferred accounts is that we assume tax brackets will remain the same, and income taxes will not go up. While this is certainly possible, who knows what the tax situation will be in 10, 20 or 30+ years?

There is simply no way of knowing whether your 401(k) is actually decreasing your overall tax liability.

However, there are other considerations than just taxes, such as employer match and diversification of retirement vehicles.

TIP: Taxes might increase by the time you retire. Those contributing to a tax-deferred retirement account, taking up to a 37% federal deduction, might find themselves in a 50% tax bracket (or higher) upon retirement, and end up paying MORE in taxes upon distribution. This is why it might make sense to supplement your tax-deferred account with a post-tax retirement account, if possible. 

Tax Free Later: Post-Tax Retirement Accounts

As an alternative to tax-deferred retirement accounts, we have those in which you make post-tax contributions (using your net income, which is income that has already been subject to taxes). These include Roth IRAs and annuities, as well as Private Deferred Compensation Plans.

With this retirement planning, you are betting that your taxes upon retirement will be higher than your taxes today, and you want a tax-free source of money in the future. These accounts can also be used simply to supplement your tax-deferred retirement vehicles.

Roth IRAs are the most common among these types of accounts, but they have their downsides, including an incredibly low annual contribution limit ($6,500 for those under 50 as of 2023). A Roth IRA will also have an income limitation; once you pass a certain income threshold, you cannot contribute to a Roth IRA directly.

Private Deferred Compensation Plans, as well as annuities, also are not for everyone. They may not be the best choice if you are uncertain whether you can pay your premiums for the required duration, which may be a period of over ten years.

A Private Deferred Compensation Plan is medically underwritten, and your premiums depend on your health and habits. These solutions may also not be advisable if you are unable to max out your available retirement vehicles, such as a matched 401(k) and a Roth IRA.

TIP: Some people say they would rather default on a mortgage rather than their policy premiums – but we would not recommend an annuity or Private Deferred Compensation Plan to someone who cannot easily afford both.

2.  Decide how much you can contribute.

It’s important to specify an annual or monthly amount you would like to set aside for your retirement plan and to calculate whether this amount will allow you to retire comfortably and maintain your lifestyle. 

Some retirement accounts have annual contribution limits, such as:

  • Roth IRA has a $6,500 annual contribution limit as of 2023 for those under the age of 50
  • a 401(k) will have a $22,500 contribution limit for employees under 50
  • total 401(k) plan contributions by an employee and an employer cannot exceed $66,000 in 2023

A Cash Balance Plan, however, has a maximum annual contribution of up to $398,000!

If you’re looking for even higher contribution limits, or retirement solutions without contribution limits, you may need to settle for unconventional retirement planning strategies, such as a Private Deferred Compensation Plan, or other out of the box retirement strategies.

TIP: Most experts recommend setting aside at least 10%-15% of your pre-tax income for retirement.

3. Ask yourself: what is your risk tolerance?

The various types of retirement plans listed above each come with their own risks.

Some common retirement plan risk factors include the following:

  • Taxes may go up in the future, and your tax-deferred 401(k) or traditional IRA may end up costing you more than you anticipated.
  • Taxes may stay low or go down and your Roth IRA or Private Deferred Compensation Plan and annuity contributions may end up being more expensive than tax-deferred vehicles, especially those with an employer match.
  • You may be unable to continue making payments on a Private Deferred Compensation Plan due to health or employment problems, and it will lapse.
  • Any investments you made for retirement may go down in value due to various economic or political factors, such as  real estate prices dropping due to a recession or depression.
  • If your plan for retirement is selling your small business, there is always the risk of a lower than anticipated valuation, or the business losing relevance and ceasing to be profitable in the future.
  • Tax laws may change, and long-term capital gains tax may increase, leading to unexpected costs on some investments.

Before making a decision regarding any retirement plan, make sure to evaluate all the pros and cons, including risk factors.

TIP: It is important to think about your family’s risk tolerance before deciding to invest. If a lower but guaranteed rate of return will allow you to sleep better at night, then that might be your best option. If you want to be as aggressive as possible, your CPA or financial adviser will certainly have options for you with a larger ROI but no guarantees.

4. Gauge how much you want to think outside the box.

We all know about 401(k)s or Roth IRAs, but what about investing in a rental property, and then selling it upon retirement? What about investing in gold or a different precious metal? What about investing in a partnership or other business? Or a commercial solar energy project purchase that generates passive income? There’s constantly new trends when it comes to saving for retirement, and it can be difficult to gauge whether these trends are worth your time and investment.

For example, real estate investments or accounts tied to the value of precious metals are certainly not for everyone (see risk tolerance above) but may be an option for high-income, out-of-the-box thinkers, who are already contributing to traditional retirement plans, or who, for various reasons, do not want to tie their money up in such retirement vehicles.

Your CPA might be a good source of information when it comes to out of the box, tax-advantaged saving or passive income strategies. These do not have to be strategies normally associated with retirement, such as certain commercial solar project purchases that can give taxpayers access to tax credits, depreciation deductions, and passive income for 30 years or more.

A CPA can also let you know more about the tax implications of selling an investment or rental property, such as capital gains taxes.

5.  Diversify, if you can.

We love to see our clients have several types of retirement accounts or vehicles, like a tax deferred account (such as a 401(k)), a post-tax account (like a Private Deferred Compensation Plan), interest in a business (such as investing in an LLC), or other investments (like stocks, bonds, REITs, mutual funds, and options) and multiple rental/residential properties. This way you are covered for all scenarios.

That being said, not everyone is able to diversify – either due to lack of funds, regulatory limitations, or lack of a professional adviser that could explain a range of suitable options.

If you’re unable to diversify for now, plan to revisit potential diversification of your retirement plans in the future. Consider consulting with a CPA for their advice.

TIP: As we cannot know what the future will bring, we like clients to put their money into a healthy mix of tax-deferred, pre-tax, high risk, low risk, and out of the box vehicles, if possible.

6. Decide if it makes sense to work with a professional.

One of the decisions that you will have to make is whether to use the services of a financial adviser or someone specializing in financial or tax planning, such as a Certified Public Accountant (CPA) or Certified Financial Planner (CFP). These professionals may charge an upfront fee and/or take a commission to manage your retirement portfolio.

You may also choose to invest in a self-directed retirement vehicle with you calling the shots and saving on fees, but potentially missing out on the expertise and experience of those who manage or advise on these types of accounts for a living.

If you do go the DIY route, please know that the internet contains a lot of misinformation. It’s best to check regulations at the source by visiting rather than reading a plethora of financial or retirement blogs with contradicting advice.

TIP: Not everyone needs to work with a retirement adviser, but you should consider it if your retirement accounts have significant funds, you are setting up a retirement plan for your business, you need to roll over several accounts, or you would like to set up a higher risk account.

7. Don’t touch the money until you reach retirement age!

Finally, it may be tempting to use your retirement savings before you actually retire (or before you reach retirement age). This may be for a downpayment on a home, a medical emergency, or a child’s college tuition.

It’s important to know that an early withdrawal of retirement funds can trigger a taxable event and/or penalties, which can really add up.

As an example, if you take out funds from your 401(k) too early (as of 2023, this means before reaching the age of 59 and a half), you will pay a 10% penalty. Additionally, because the contributions to the 401(k) were tax-deferred, you will be subject to federal and state income taxes on the amount you took out, which will be treated as income.

Even if your retirement plan does not have a penalty for early withdrawals, you are still missing out on any interest or investment income you could have accumulated over the years.

It’s important to read your retirement plan’s policy and IRS regulations very carefully to see when you can start taking distributions, what the penalties are for early distributions, and if there are any exceptions.

For example, a Simple IRA allows for a penalty-free distribution for qualified education expenses or on up to $10,000 for qualified first-time homebuyers. Many plans, including a 401(k), allow penalty-free early distributions in case of total and permanent disability of the participant.

TIP: You may be thinking about using your retirement funds for a downpayment on a home, an opportunity to invest, starting or maintaining a business, or paying off debt. It is generally unwise to do so and will often lead to penalties and/or additional taxes and loss of compound interest. 

Get Started Now for Successful Retirement Planning

Choosing a retirement plan or a retirement strategy is not easy, especially if you are a high-income earner and have the funds to contribute to multiple retirement and investment vehicles.

Quick Summary: Retirement Planning in 2023

It is important to carefully consider the tax implications of your choices, as well as the risks involved. Additionally, do your best to diversify and work with a good tax or financial professional. Finally, don’t withdraw your money too early in order to avoid possible penalties or taxes.

Connect with a Qualified Tax Professional Today

At Ratio CPA, we have over two decades of experience with tax planning, accounting, wealth management, and other consulting services for both individuals and small- to medium-sized businesses. Contact our team today to get started planning with confidence for retirement.