Does Your Savings Strategy Provide Enough Flexibility for Your Life?
There is no doubt that saving for retirement is a vital piece of a financial plan when you are in the wealth and growth accumulation phases of life. Perhaps you have a company 401k that you are maxing out or maybe a SEP IRA if you are self-employed that you are contributing to. At this stage of the game, there’s really no debate that taking advantage of retirement accounts like these is important, but what if you are putting too much in your retirement accounts? Here are some ways that you can accumulate wealth without feeling “Brokerage Account Poor”.
Retirement Account Rich, Brokerage Account Poor
Perhaps you have heard of the expression “house rich and cash poor” for folks who have the majority of their wealth tied up in their home. The same can be said for your retirement accounts. As a financial planner, I have seen this scenario play out more often than you would think. Here is an example:
- Carrie and Matt are married and make great money together. Carrie and Matt are both 38. They have a 2-year-old, a couple of Great Danes, and own their home.
- They both max out their company 401ks, which is $22,500 in 2023.
- They both do backdoor Roth conversions of $6,000 per year.
- They are now at $57,000 in total retirement savings, and that’s not including their employer matches on their 401k retirement accounts.
Now, you are probably reading this and thinking this seems like a really fantastic savings plan. What is the problem? The issue is that, after their retirement savings, paying the mortgage, paying the bills, taking care of their child’s needs, and all that dog food for the Great Danes, Carrie and Matt do not really have much left over. Their liquid balance sheet, not including debt looks something like this:
- Matt’s 401k – $165,000
- Carrie’s 401k – $275,000
- Matt’s Roth – $65,000
- Carrie’s Roth – $50,000
- Joint Checking Account – $2,000
- Joint Brokerage Account – $10,000
- Total Liquid Assets: $567,000
$567,000 in liquid assets (not including their home or mortgage) is a pretty darn good place to be, right?
Notice that I have italicized their taxable, after-tax joint brokerage account. There is just enough in this account to cover several months of emergencies if needed. What you are seeing here is extremely common. A balance sheet like this can create issues with providing the requisite flexibility, not only later in retirement but leading up to it, as well.
Living off your retirement savings whether you are nearing retirement or still years away from it is an issue that you want to plan for. You could very well be actively contributing to some sort of retirement account in order to address this.
Why This Sort of Retirement Account Scenario Can Create Issues
Let’s start by addressing retirement itself. Let’s assume both spouses in the above example continue on this savings path and retire at age 62. If they want to delay taking Social Security, they will need to supplement from their savings. It would be unwise for them to dip into their Roth exclusively, as it is ideally best to allow that retirement account to grow as much as possible and tap into it later on in retirement.
Matt and Carrie don’t have much in their brokerage account, which leaves them with their 401ks. By dipping into these accounts, they pay ordinary income tax. They continue to do this throughout retirement, even after drawing their Social Security benefits. The excess taxable income they have coming in increases their Medicare premiums and the marginal tax brackets they are in. If they want to gift to their future grandkids or make a one-off large purchase/expense, there is not much wiggle room without depleting their Roth retirement accounts or incurring more taxable income.
Let’s also address the road leading up to retirement. Carrie had always dreamed of starting her own business, but her business idea required her to have at least 40k to get it off the ground and she would have no income coming in. With little flexibility to dip into their brokerage account, they would be forced to dip into their 401k retirement accounts early, incurring taxes and penalties, or tap their Roths. Carrie, being debt averse, may simply decide to give up her dream and not pursue this venture.
Matt and Carrie also thought about buying a rental property. However, with the 20 percent down payment requirements, they decided to forgo this as well since they didn’t have a lot in their brokerage account.
By now, you are probably beginning to see the picture more clearly. Although Matt and Carrie are doing a fantastic job saving for retirement and could get away with continuing down this path, this savings strategy provides them little flexibility in terms of pursuing ventures outside the confines of retirement. What’s more, it limits them from a tax standpoint once they are in retirement.
A Solution
If your savings plan or balance sheet looks similar to my example of Matt and Carrie’s, you could benefit from diversifying your savings strategy. Part of what I do for a living is to create comprehensive financial plans that cover what your future liquid balance sheet looks like, based on a particular savings plan. It is entirely within the realm of possibility that Matt and Carrie could put more money into their brokerage account, create an investing strategy for that particular account so it aligns with their objectives, and still save a significant amount in retirement account assets.
Imagine if you and your family had more in a taxable brokerage account. Would you pursue that business venture you always dreamed of? Would you buy another home? Would you pay for private school for your children? Would you buy the best treats money could buy for those Great Danes?
A major reason why many people are so aggressive about savings, specifically in retirement accounts, is that they simply do not know how much they will need at retirement. However, this often means they neglect adding to their brokerage accounts. They neglect other aspects of their lives because they would rather be safe than sorry. This is precisely why a comprehensive financial plan is so critical. An in-depth financial plan will give you the data needed to know how much you need to save in your retirement accounts and how to go about it.
If you are not working with a financial planner or have never had a truly comprehensive financial plan done before, please feel free to throw some time on our calendar.
