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October 14, 2013 at 08:30 PM
One of the unfortunate casualties of the recent economic downturn is distrust in the stock market and investments tied to it. That includes IRAs, Roth IRAs and 401(k) plans.
But market-related investments are intended for the long term, of course, and consumers need to stay the course when it comes to retirement investing. That is among the best advice you can give clients this year. Especially since the market has largely corrected itself and most stocks have recovered their lost value.
“It has certainly been hard for people to watch their balances go down, although the last year-and-a-half the market has been stronger, so they’ve seen a lot of recovery too,” said Lea Ann Knight, a certified financial planner at Garrison Knight in Bedford, Mass. “I think it was human nature that many people stopped contributing, which was really a mistake. Psychologically, they would be contributing, and watching it go down; contributing, and watching it go down. So they were like; ‘Why am I throwing good money after bad?’” she said.
“Obviously with my clients I tried to discourage that. So those people who continued the regular contributions have a lot more money than those who didn’t during the last four years,” Knight said, adding that they also have a better nest egg for retirement, since many people are now playing catch-up.
Whether your clients are playing catch-up, continuing an in-place retirement strategy, or starting the process anew, this is a good time for them to invest. And it makes your role as retirement planner all the more important. Investment choices can get complex, and they have different payout formulas, tax rates and withdrawal penalties.
Roth IRAs and 401(k) plans continue to be among the most popular investment options, so you should start there, according to experts. Explain how a Roth IRA works as a tax-deferred account that is available to them up to certain income levels. If your client is under 50 they can put in up to $5,500 per year into a Roth IRA. If they are over age 50 they can take advantage of a catch-up provision that allows for up to $6,500 per year, Knight said.
Your client should understand the difference between a Roth IRA, which is essentially growing tax-free, and a traditional IRA, which enables them to take a deduction for putting money into the account, but they pay taxes on the account when they take the money out in retirement, according to Knight. Your client should also understand that employer-sponsored 401(k) contributions are treated much like a traditional IRA. An individual can contribute money and take a tax deduction in the year they contribute, and the account grows tax-deferred like an IRA. But again, they will pay taxes on the account in retirement.
Penalties Recent times have certainly been tough on many individuals and couples. Your clients may be tempted to want to cash a Roth IRA in early. Your best advice here is on the key age factor of 59 ½, the point at which your client can draw on a Roth IRA without penalty.
“The nice thing about a Roth: not only does it grow tax free, but unlike the traditional IRA or the 401(k) – where you have to start making the minimum distributions at 70 ½ — the Roth does not have that requirement. You could really leave that money there throughout your lifetime if you didn’t need it. It would continue to grow,” Knight said.
Clients may also be tempted to cash out a 401(k) plan in tight times. But again, tell them to wait until 59½, according to Ray Mignone, a certified financial planner and CEO of Ray Mignone Associates in Little Neck, NY. At that point your client can withdraw without penalty, other than the tax they pay. Some employers will also allow individuals to borrow against a 401(k) account.
“As a financial planner I don’t recommend that because you’re borrowing against your own retirement, and most people haven’t saved enough for retirement to begin with,” Knight explains.
