On a football field, the area inside the 20-yard line is referred to as the “red zone” because it’s where teams are most likely to score a touchdown. Similarly, when it comes to retirement planning, the ten years before and the five years after retiring are considered the “retirement red zone” because it’s when you need to be most vigilant. Below are some ideas for boosting savings and implementing a tax diversification strategy to help ensure you reach your retirement goals as you approach the retirement red zone.
Tips For Boosting Savings When Approaching The Retirement Red Zone
Maximize Retirement Plan Contributions
Currently, the maximum contribution to a PRAP plan is $19,500; However, if you will be 50 or older by the end of the calendar year, you can contribute an additional $6,500. After you max out contributions to your PRAP, subsequent contributions will “spill over” or be contributed to your United Health Reimbursement Account (HRA). You should max out these before-tax savings and take full advantage of after‐tax contributions as well. Please see below for greater detail about after-tax contributions and rollovers.
Eliminate Consumer Debt
Pay off or pay down any credit card or car loan debt as quickly as possible and adjust your monthly expenses to avoid taking on additional debt. Then you can put the money you had used for monthly payments toward retirement.
Evaluate Insurance Policies
You might not need the same level of insurance in retirement as you needed earlier in your life and career. If you reduce your coverage, the premium savings can then go toward your nest egg.
Many people plan to move to a smaller home upon retiring. But if downsizing earlier is possible, you may be able to reduce your mortgage payments, property taxes, insurance and other large monthly expenses.
Consider Taxable Accounts
Once you have maxed out contributions to your tax‐advantaged accounts, put any additional savings in after-tax accounts for even more retirement income later.
Spend Less And Save More
Take a hard look at your spending. The small everyday indulgences as well as big‐ticket splurges can really add up. By the same token, cutting back a little here and there can mean more to put toward retirement.
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If you have sufficient income from other sources, you can increase your eventual Social Security monthly income significantly by deferring the benefit. According to socialsecurity.gov, if your full retirement age is 66 and your monthly benefit at that age is $1,000, delaying to the maximum of age 70 increases your monthly benefit to $1,320—a 32% increase. In contrast, if you take Social Security early, at age 62, your monthly benefit is reduced to $750.
Tax Diversification in the Retirement Red Zone
Anyone 10 to 15 years away from retirement should consider implementing a tax-diversification strategy for savings.
Some employer-sponsored retirement plans, including pilot 401(k) plans like PRAP, allow you to contribute after‐tax money. While not widely used or known, these after‐tax contributions may be made in excess of current deferral limits up to the annual combined defined contribution plan limit (currently $58,000, or $64,500 with catch-up contributions). These contributions then grow tax-free, like in a Roth account.
It’s important to note that IRS Notice 2014‐54 makes it easier to roll after‐tax money out of a 401(k) —allowing you to maximize the value of your plan. If you have invested after‐tax money in your 401(k) plan, the rule allows:
- After‐tax money to roll into a Roth IRA;
- Money to grow tax‐free; and
- Pre‐tax money to roll tax‐free into a regular IRA simultaneously.
The example in the IRS Notice cites a 401(k) account with a $250,000 balance—$200,000 in pre‐tax savings and $50,000 in after‐tax savings. The employee separates from service and requests a distribution of $100,000. The distribution is split proportionally. The pre‐tax amount is $80,000 and the after‐tax amount is $20,000. The result under the rollover rules: “The employee is permitted to allocate the $80,000 that consists entirely of pre‐tax amounts to the traditional IRA so that the $20,000 rolled over to the Roth IRA consists entirely of after‐tax amounts.” In other words, you can direct pre‐tax dollars to one place and after‐tax dollars to another and it will still be treated as a single distribution.
This allows higher-income individuals, like pilots, who can make contributions in excess of the pre‐tax annual limit ($19,500, or $26,000 with catch‐up contributions) to save even more. Pilots can make after‐tax contributions knowing that their savings can be rolled directly into a Roth IRA when they leave their 401(k) plan, without tax consequences and complexities.
Please read more about the advantages of a tax diversification strategy for retirement savings in the article The Art of Retirement Income: Making the Most of Your Savings.
Article By Robert Warner, Executive Vice President ChFC®, AEP®, CLU® | Johnson Financial Group
About the Author
Robert Warner, Executive Vice President, specializes in helping clients achieve their financial, retirement and estate planning goals with emphasis on retirement income, estate conservation, and family wealth transfer planning.