What do you drive?

I wish I could answer this question by saying I have that beautiful 67’ Shelby GT500 Mustang in my garage. Unfortunately, that isn’t the case, but hopefully one day maybe?

The vehicle in your garage may get you from point A to point B, but the investment vehicle you drive into retirement can make that phase of your journey much smoother and less stressful. In today’s post, I’ll share three common investment accounts most of us utilize to get to retirement. Going in the right direction is only part of the equation, but what car I take down this road may determine if I get to my destination (freedom in retirement) or if my ‘Uncle’ Sam is waiting for me when I get there.

Let’s take a further look at the three most used vehicles that get us to retirement: the Toyota Rav 4 Prime Hybrid (Traditional 401(k)), Tesla Model S (Roth IRA), and the 67’ Shelby GT500 (Brokerage account).

**Retirement planning can get complicated, so I always recommend working with a financial advisor to reach your destination.

Toyota Rav 4 Prime Hybrid: your traditional 401(k)

A hybrid? Summit must be losing his mind. My 401(k) is nothing like a hybrid. Well, actually, it is! Your 401(k) is the most common strategy most investors use and has dual benefits.

Just like a hybrid using gas and electricity to improve your mileage and range, traditional 401(k) accounts allow your investments to grow rapidly and decrease your current MAGI (modified adjusted gross income), so you pay fewer taxes now. Traditional 401(k) contributions grow as a tax-deferred account. This means that when you take your money out in retirement, you are required to pay taxes based on your taxable income at that time. If you plan to have a lower income in the future, consider using this ‘hybrid’ strategy to support your retirement. Some 401(k) plans also can contribute to a Roth account (post-tax contributions), which we’ll discuss in more detail next.

The annual contribution limit is $23,000, with an additional catch-up option for those aged 50 or older of $7,500 (as of 2024).

Traditional 401(k) Pros:

·        Less taxes today, contributions reduce MAGI

·        Larger $ contribution to retirement may lead to better returns

·        If your taxable income is much less during retirement, it could yield great tax savings (depending on future tax rates)

·        Contributions can be automatically deducted from your paycheck

·        Employers can ‘match’ contributions (% dependent on your contributions and company), thus providing access to ‘free’ money

Traditional 401(k) Cons:

·        Contributions are capped per year

·        Unknown what taxes may be in the future; withdrawals are taxed at ordinary income tax rates

·        Required Minimum Distributions

·        Inherited 401(k) (non-spouse) required full funds withdrawal within ten years, and taxes paid based on current income bracket

·        May have limited investment selections based on employer plan

 Tesla Model S, your Roth IRA

The Tesla Model S is electric, self-driving, minimalistic, and can do 0-60 in less than 3 seconds, so how is this similar to a Roth IRA? Think of it this way. When you buy a Tesla, you have an initial purchase price and fees. Once you’ve paid the upfront costs, the long-term benefits of owning an electric vehicle come into play. Very low maintenance fees, cost of ownership, low cost to charge, environmentally friendly, and technologically advanced are only a few of the many benefits. Similarly, after you pay your Roth IRA taxes, the contributions can grow with compounding interest, have zero tax liabilities in retirement withdrawals (growth and contributions, as long as the account has been open for five years), and can be inherited with no tax liabilities (as long as the account has been open for five years).

Some employers may offer this option in the company’s retirement plan, in which you have a contribution limit of $23,000 plus an additional $7,500 if you are over the age of 50 (as of 2024). However, if your company does not offer a Roth option in their retirement solution, you can still contribute to a Roth account for a maximum of $7,000, or if you are older than 50, then the maximum contribution is $8,000 (as of 2024). There are contribution limits based on your income, but don’t be discouraged. Consult your financial advisor if a backdoor Roth is a good option for you.

Roth IRA and 401(k) Pros:

·        Taxes paid, growth, and contributions grow tax-free!

·        No tax liability for inheritance beneficiaries

·        Contributions can be automatically deducted from your paycheck

·        Employers can ‘match’ contributions (% dependent on your contributions and company), thus providing access to ‘free’ money – made available in the SECURE 2.0 Act, but dependent on availability within your employer’s plan.

·        Mega-backdoor Roth strategy (we’ll explore in detail in a future post)

·        Contributions can be withdrawn at any time with no penalties, but earnings cannot be withdrawn until 59 ½, and the account has been open for 5 years.

·        Indirect benefit - Backdoor Roth strategy, if your MAGI exceeds contribution limits

Roth IRA and 401(k) Cons:

·        Contributions are capped per year

·        No tax deduction or impact on current taxes

·        No RMD, but inherited Roth Accounts require complete withdrawal within ten years of inheritance. This is only for non-spouse beneficiaries; additional rules are based on whether a minor or chronically ill/disabled person is the beneficiary.  

·        Depending on your tax bracket, you may end up paying more taxes now

·        Contributions based on income are capped

·        Roth IRA contributions limits are much less than 401(k) contributions

·        May have limited investment selections based on employer plan

67’ Shelby GT500, your Brokerage account

Finally, we come to the beautiful 67’ Shelby GT500. Since this is an article with no video features, I’ll ask you to imagine Nicholas Cage’s reaction to meeting ‘Elanore’ in Gone in 60 Seconds. If you recall, he was initially timid, frightened even. This beautiful vehicle had him nervous. There is no reason to fear Elanore; we just need to learn to embrace the power of this vehicle. Similar to the power and strength of Elanore, we cannot overlook the power of a Brokerage account. The flexibility, options, and potential are vast.

Credit – www.Musclecarzone.com

Let’s review some of the pros and cons of having a brokerage account:

 Brokerage account Pros:

·        The principal (amount you contributed) is not taxed, and as long as the money is invested in the appropriate funds, the gains are not taxed until you sell. This is a complex topic, so be sure to discuss it with your Financial Advisor.

·        Unlimited deposits

·        Appreciation is taxed at the capital gains rates instead of ordinary income rates for long-term gains (+1 year)

·        Investors can buy and sell anything available in the market, access to all – maximum flexibility for diversification

·        Can be used for retirement or other goals – college tuition, down payment, etc.

·        Money can be withdrawn at anytime

·        Beneficiaries get a step-up in basis when they inherit the funds

·        Very easy to open and maintain

·        No RMDs

Brokerage account Cons:

·        Dividends and interest are taxed at ordinary income rates

o   1099 Composite is issued to pay taxes on interest and dividends from the year

·        No current-year tax deductions for contributions

·        May have minimum deposit and balance requirements. However, at Whitaker-Myers, we do not maintain this requirement

·        Due to the liquid nature of the funds, investments can be sold at any time. This can greatly impact the long-term growth of the portfolio

·        Incorrect fund selection can lead to unexpected capital gains

What do you want to drive?

As with all investing, it’s never one size fits all. I’ve previously mentioned that we should never focus on one metric to drive our decision when analyzing investments. Similarly, we should never only look at one vehicle’s pros and cons list to determine what is best for our future. Honestly, there is sometimes a need or desire to have all 3 vehicles. This is because, with all three types, you have the maximum flexibility and options as you approach and are in retirement. To clearly understand the holistic picture, speak to your financial advisor.  

Simply stating that one vehicle is better than the other is not the right approach toward retirement. Questions such as: How much fixed income will you have in the future? What are your projected expenses? How much do you anticipate living off of each year? Are your expenses going down as you get to retirement? These are just a few questions your financial advisor will ask to determine if one, two, or all three strategies align with your goals. Diversified investing is excellent not only within your portfolio based on the key four categories that the Ramsey team talks about (Growth, Growth and Income, Aggressive growth, and International) but also the vehicles you take to get there. Are you driving a Toyota Rav 4 Prime Hybrid (traditional 401(k)), Tesla Model S (Roth IRA), or a 67’ Shelby GT 500 (Brokerage account)? Whichever one or more you choose, our team of Financial Advisors at Whitaker-Myers Wealth Managers will sit in your passenger seat with the windows open and cruise with you to your favorite tunes (figuratively, of course!).