Jan 24, 2020 3 min read

Today, people are more responsible for their retirement than ever before. Unless you work for a government entity or large corporation, they probably will not receive a pension. This means to have income during retirement to supplement your Social Security, you must save money.

The first mistake many people make is they do not save enough. There have been studies saying the average 401(k) balance is only $83,000. Using the 4% rule, that would provide a 65-year-old retiree with about $275 per month. This is not going to provide the money necessary to help supplement the retirement of your dreams.

There are three types of money in the eyes of the Internal Revenue Service. The first is non-qualified, or post tax account. This might be money left over after you pay bills from your paycheck. You might receive this type of money as a gift or by being the beneficiary of a life insurance policy. You owe taxes only on any earnings from this money.

The second type is a Roth. You can contribute earned income to a Roth each year. For 2020, the amount is $6,000. If you are over 50, you can put in an extra $1,000. You do not get a tax deduction for this contribution. It grows tax-free if you follow two basic rules to take out the earnings: You must be at least 59½ and you must have had a Roth for at least five years. You can always pull out your contributions penalty-free because you have already paid tax on this money.

It is important to remember you must have earned income at least equal to your contribution. Earned income is basically income you are paying SS taxes on, not from gifts or other investments. There are no required minimum distributions during your or your spouse’s lifetime. They must follow the new 10-year rule when left to any other beneficiary.

Qualified or pre-tax money is the third type. These are accounts such as 401(k), IRAs or 403(b)s. When you contribute to these accounts, you get to reduce your current income tax. The funds get to grow tax-deferred until you pull the money out. The income contributed must be earned income. You pay ordinary income taxes on this money when you receive it and required minimum distributions start at age 72.

This type of account can be very important. The problem is many people end up with almost all of their savings in this type of account. This can create a tax time bomb during retirement. If Secure Act changes these plans to opt-out instead of opt-in, this will make more people participate, which will help their family’s retirement future.

What you do not want to do is have large balance in only qualified accounts and very little in the other two types. This will give you better options to manage future tax obligations.

Saving more is necessary. Just do it in the best ways possible.

Gary Boatman is a Monessen-based certified financial planner and the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.