Contributing to an Account Outside of Work

Financial Planning

As we navigate through the twists and turns of life, it's essential to plan for the future, especially when it comes to retirement. While employer-sponsored retirement accounts and Social Security play crucial roles, relying solely on them may not be enough to ensure a financially comfortable retirement. Together, let’s explore the reasons why contributing to a retirement account outside of work is a smart move, considering the limitations of employer plans and the potential shortcomings of Social Security. With the help of our example friend Mary, we’ll use some real numbers.

  1. Beyond the Workplace: While employer-sponsored retirement accounts, such as 401(k)s, 403(b)s, and 457s are valuable benefits, they come with certain limitations. Contribution limits imposed by these plans might restrict the amount you can save. By contributing to a retirement account outside of work, such as an individual retirement account (IRA) or a self-employed retirement account (SEP IRA or Solo 401(k)), you have the opportunity to supplement your savings beyond these limits, providing a solid financial foundation for retirement.

Example: Mary, who diligently contributed $400 per month, which amounts to $4,800 per year to her 401(k) over her 35-year career. Assuming an annual return of 6%, her 401(k) grew to approximately $525,000 by the time she retired.

In addition to her 401(k) savings, Mary received Social Security benefits. Let's assume her estimated Social Security benefit is $1,800 per month or $21,600 per year.

  1. Bridging the Gap: Social Security has been an essential safety net for retirees, but it was never designed to be the sole source of income during retirement. As life expectancy increases and the future of Social Security remains uncertain, it becomes crucial to take control of your retirement savings. Contributing to a retirement account outside of work allows you to bridge the potential income gap and ensure a more comfortable lifestyle in retirement. By proactively saving for your future, you're empowering yourself to maintain financial independence and enjoy the retirement you envision.

Example: With her 401(k) and Social Security combined, Mary had an annual retirement income of $21,600 from Social Security and would need to rely on withdrawals from her 401(k) to cover the remaining expenses. However, upon evaluating her retirement needs and considering factors such as inflation, healthcare costs, and desired lifestyle, Mary realized that her retirement expenses amounted to $50,000 per year.

Considering her estimated Social Security benefit of $21,600, there is a shortfall of $28,400 per year that Mary needs to cover. Over a 25-year retirement period, this shortfall accumulates to a staggering $710,000.

Despite Mary's diligent contributions to her 401(k) and her reliance on Social Security, the combination of these income sources falls short of meeting her retirement needs. This highlights the importance of considering additional retirement savings strategies beyond employer-sponsored plans and Social Security.

  1. Flexibility and Control: An advantage of contributing to a retirement account outside of work is the flexibility and control it offers. Unlike employer-sponsored plans, which often limit investment options, an IRA or self-employed retirement account provides a broader range of choices. You can tailor your investment strategy to align with your risk tolerance and goals. This flexibility allows you to diversify your portfolio and potentially maximize returns, creating a more robust retirement fund.

To address the shortfall, Mary decides to explore alternative retirement savings options. She opens a Roth Individual Retirement Account (IRA) and contributes an additional $200 per month, equivalent to $2,400 per year. Assuming the same average annual return of 6% on her Roth IRA investments, over the course of her retirement, Mary accumulates an additional $240,000 in her Roth IRA.

By incorporating the additional savings from her Roth IRA, Mary's retirement funds increase to $765,000. This extra savings cushion helps bridge the gap and provides Mary with a more comfortable retirement, enabling her to cover her expenses and enjoy her desired lifestyle without financial stress.

  1. Weathering Employment Changes: The modern workforce is characterized by frequent job changes and periods of self-employment. If you find yourself in such situations, contributing to a retirement account outside of work ensures that you can maintain consistent savings for retirement. Regardless of your employment status, these accounts provide a stable and independent avenue to build your retirement nest egg. By taking charge of your financial future, you're safeguarding yourself against potential disruptions and ensuring a smoother transition into retirement.
  2. Tax Advantages: Retirement accounts, such as traditional IRAs or 401(k)s, offer tax advantages that can further bolster your retirement savings. Contributions to these accounts are often tax-deductible, reducing your taxable income in the year of contribution. The potential for tax-deferred growth means your investments can compound over time, generating significant returns. Alternatively, Roth IRAs and Roth 401(k)s allow for tax-free withdrawals in retirement, as contributions are made with after-tax dollars. By capitalizing on these tax benefits, you can optimize your savings and potentially minimize your tax liability in retirement.

Contributing to a retirement account outside of work is a proactive step towards securing a financially stable future, Mary was well short before she started saving in an account outside of the IRA. While employer-sponsored retirement plans and Social Security are important components of retirement planning, they may not provide the full financial support needed. By leveraging the advantages of contributing to a retirement account outside of work, such as increased savings potential, flexibility, and tax advantages, you're taking control of your retirement destiny. By making thoughtful choices today, you can ensure a more comfortable and fulfilling retirement tomorrow. Start planning for your future today and let your retirement dreams become a reality. If you don’t know how much you need to save or have trouble choosing the right account. Reach out to a professional who can help.

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