Liz Weston

Your 401(k) just got more valuable

If your tax refund this year was disappointing, you may be able to do something about it: Contribute more to a retirement fund. Tax-deductible contributions to 401(k)s, IRAs and other retirement accounts are among the few remaining ways to reduce taxable income if you don’t itemize deductions. And few of us do these days: Only about 1 in 10 taxpayers is expected to itemize now that Congress has nearly doubled the standard deduction, tax experts say. That’s down from about 1 in 3 before the law changed. Fewer ways to trim tax bills As a result, many of the traditional tips and tricks for reducing tax bills either no longer work or are of limited help. Deductions for mortgage interest, charitable contributions and medical expenses, for example, can be taken only if you itemize. In addition to increasing standard deductions, the tax law enacted in December 2017 also did away with personal exemptions and curbed or eliminated many other common deductions: • Unreimbursed work expenses, tax prep fees and job search costs are no longer deductible. • Moving expenses aren’t deductible unless you’re active-duty military. • Casualty and theft losses are deductible only in a federally declared disaster area. • State and local tax deductions are capped at $10,000. • Home equity loan interest is deductible only if the money was used to substantially improve your home. Student loan interest is still deductible if you don’t itemize, as are certain self-employment expenses. You can reduce taxable income by contributing to workplace flexible spending accounts and the health savings accounts that are paired with high-deductible health insurance plans. Retirement plan contributions offer multiple benefits Not everyone can take advantage of those deductions, but the vast majority of working people can contribute to retirement plans, says Michael Eisenberg, a CPA personal finance specialist with the AICPA’s National CPA Financial Literacy Commission. If you don’t have a workplace plan such as a 401(k), you can make tax-deductible contributions to an IRA as long as you’re under 70½ and have earned income, typically from salary, wages or self-employment income, that’s at least equal to your contribution. People can put up to $6,000 into an IRA in 2019, or $7,000 if they’re 50 or older. (If you or your spouse has a workplace plan, you can still contribute to an IRA, but how much you can deduct depends on your income. Check the IRS site for details.) Contribution limits are higher for workplace plans such as 401(k)s: $19,000 for 2019, or $25,000 if you’re 50 or older. If you have a workplace plan, your company also likely offers matching funds, says Jarod Taylor, a financial counselor in Westerville, Ohio. “Let’s say you put in 4 percent (of your pay), and your employer matches that up to 4 percent,” Taylor says. “You just gave yourself a 4 percent bonus.” Lower-income taxpayers may receive an additional benefit: a tax credit of up to $2,000 for single people or $4,000 for married couples filing jointly that can further reduce the cost of contributions. Tax credits are even more valuable than deductions, and it’s rare to get both at the same time. Credits of 50 percent, 20 percent or 10 percent of retirement contributions are available for singles with adjusted gross income up to $32,000 or $64,000 f or a married couple filing jointly. How to find the money For many people, tax refunds aren’t “extra” money. Every dollar may be needed to catch up on overdue bills or pay for health care. If that’s not the case, though, you could put a chunk of this year’s refund into a retirement account. You can do that directly, by opening or contributing to an IRA. Or you can boost your 401(k) contribution and use the refund to help replace money deducted from your paycheck. If you don’t mind a smaller refund and just want to pay less taxes, another possibility is reducing your withholding and channeling the additional money into your retirement fund, Taylor says. Taylor also advises clients to look for small expenses to trim, such as negotiating a cheaper cable package and avoiding bank fees. “You’ve already been living without that money, so just funnel that off to saving for retirement,” Taylor says. Even small amounts can add up. As traditional pensions become rarer, it’s important for most people to save if they want a comfortable retirement. “You don’t want to work for many, many years and wind up, if you can help it, living on Social Security alone,” Eisenberg says. This column was provided to The Associated Press by the personal finance website NerdWallet.

Investment fees could leave you old and broke

You want to save as much as possible for retirement. The financial services industry wants to make as much money off you as it can. That thorny conflict is at the heart of the battle over what is known as the “fiduciary rule.” If implemented, it would require financial advisers to put clients’ best interests first when counseling them about retirement savings. In practice, it typically would prevent financial pros from steering you into a high-cost investment if similar low-cost choices are available. The differences in fees — often fractions of a percent — may sound minuscule. Over time, though, higher fees can dramatically reduce the amount of money that investors accumulate for retirement, according to the Securities and Exchange Commission and other investor watchdogs, and significantly increase the chances that savers will run out of money late in life. Here’s an example from the Big Picture app, which helps financial advisers test investment strategies for retirement plans with historical market-performance data and inflation rates. Assume you have a portfolio that’s divided equally between stocks and bonds, with the goal to sustain a 30-year retirement. You plan to withdraw 4 percent the first year and increase that withdrawal by the inflation rate each following year. (This “4 percent rule” is widely used in financial planning to minimize the chances that savers will run out of money in retirement.) You’ll pay fees at every step. Mutual funds charge fees. Brokers who buy stocks and bonds on your behalf charge fees. Financial advisers charge fees. Those costs can dramatically affect your odds of success. Based on Big Picture’s data, the chances you’ll run out of money in retirement are: • 9 percent if the annual cost of your investments is 0.5 percent • 17 percent if your cost is 1 percent • 29 percent if your cost is 2 percent • 50 percent if your cost is 2.5 percent “High fees can cut safe spending in retirement by hundreds of dollars a month for the average retiree, take years off a portfolio’s life or leave retirees with much less in legacy capital,” said Ryan McLean , founder of Los Altos, California-based Investments Illustrated, which created the Big Picture app. “I don’t think investors have been adequately informed on these effects.” Financial advisers understand the risks of high fees — or they should. But it may not be in their best interests to educate clients if advisers make more money pushing high-cost investments. 3 reminders as you invest The fiduciary rule was supposed to change all that starting April 10, but the Labor Department has delayed its implementation 60 days at the Trump administration’s request. The rule may be further delayed or modified, or it may not be enforced if it goes into effect. So retirement investors should consider themselves on their own when it comes to protecting their nest eggs. Here’s what to keep in mind: • There’s no such thing as a “no-cost” investment. Investors always pay something, either as a direct cost such as an annual expense ratio or an indirect cost such as a reduced return. Fixed and indexed annuities, for example, are often pitched as no-cost investments, but the insurer typically pays the investor less than what the account earns. • Lower-cost investments tend to outperform higher-cost ones. Decades of research have shown that lower-cost mutual funds offer above-average returns, while higher-cost ones tend to trail market averages. When it comes to costs, what’s considered “low” or “high” varies by the investment. For example, mutual funds cost an average of 0.61 percent, according to Morningstar. Variable annuities, which are insurance contracts with investments similar to those in mutual funds, cost an average of 2.24 percent. • Investment management doesn’t have to cost a lot. Digital investment companies, or robo-advisers , offer computerized investment management for an all-in cost of about 0.5 percent of your portfolio. That includes an investment management fee plus the cost of the underlying exchange-traded funds. Some robo-advisers, including Betterment and Vanguard Personal Advisor Services, offer access to financial advisers for a slightly higher fee. By contrast, human advisers charge an average of 1 percent for the first $1 million they manage, on top of any underlying investment costs. A 1 percent fee may be justified if the financial adviser offers other services, such as comprehensive financial planning, or keeps an investor from fleeing the market in a panic. But it’s a pretty high toll if all the client gets is investment management. Ultimately, you’re the one who has to live on what’s left after all the fees are paid. That’s a good incentive for keeping a lid on them. ^ This column was provided to The Associated Press by the personal finance website NerdWallet. Liz Weston is a certified financial planner and columnist at NerdWallet. Email: lwestonnerdwallet.com. Twitter: lizweston.
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