Staying Ahead Of Inflation

The first step toward reaching your retirement savings goal is to be certain you're setting aside enough in tax-advantaged retirement accounts. Then you'll need to ensure your investments are properly diversified and that you have a consistent savings and spending plan in place. Where should you put your retirement savings? "With the multiple options available, this question can be difficult for some investors to answer," says Stuart Ritter, CFP®, a senior financial planner with T. Rowe Price. "The first step for investors is to make sure they're taking full advantage of employer matching contributions to a workplace retirement plan. And often, Roth IRAs and Roth contributions within a 401(k) may make the most sense for many individuals." Determining how much to contribute to each type of accountand in what orderwill maximize the benefits available to you.

At the core of a strong retirement plan is a spending and saving strategy that will help you live within your means today and, at the same time, prepare you for retirement. "Think of your strategy as a map," Ritter says. "Knowing where you are now and where you want to go will help you understand your future income needs and how to get there."

Project your expenses.
As retirement draws closer, begin by documenting an inventory of current expenses. Then add a "projected" column to get a sense for what you may spend in retirement. Consider changes in your spending patterns that may occur. For example, you won't be commuting to work each day, and you may have paid off your mortgage. Ask yourself if you plan to stay in your current home and how you plan to spend your time. "Dream about the life you want to lead," Ritter says. "It will help you see the steps you need to take now to move toward your goals."

How to Decide Your Retirement Account Contribution Order

The order in which you make contributions to retirement accountsincluding 401(k)s, Traditional IRAs, and Roth IRAsand ordinary taxable accounts can lead to more financial flexibility in retirement. As you decide how to distribute your contributions, ask yourself the following questions:
Click Below
Question 1.

Do Roth contributions make sense
for my situation?1

Click Below
Question 2.

Does my employer offer a Roth contribution option within my 401(k)?

Click Below
Question 3.

Am I eligible to contribute to
a Roth IRA?2


Contribute the maximum to your Roth account within your 401(k).3 Then contribute the maximum you are eligible to contribute to a Roth IRA.

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Contribute the maximum to your Roth account within your 401(k).3 Then contribute the maximum to a Traditional IRA.4, 5

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Contribute enough to your pretax account within your 401(k) to earn your company match. Then contribute the maximum amount eligible to contribute to a Roth IRA. If you still have money left to invest, contribute it to your pretax account within your 401(k).

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Contribute the maximum to your pretax account within your 401(k). Then contribute the maximum to a Traditional IRA.4, 5

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1 Roth options may make sense if you are age 50 or younger or you are over age 50 and don't expect your tax bracket to decrease significantly in retirement. 2 To make the full Roth IRA contribution for the 2013 tax year, you must have a modified adjusted gross income (MAGI) below $112,000 as a single taxpayer or below $178,000 as a married taxpayer filing jointly. Partial contributions for 2013 to a Roth IRA are permitted for single taxpayers with MAGI below $127,000 and MAGI below $188,000 for married taxpayers filing jointly. 3 All individuals are eligible to make designated Roth contributions within a 401(k) if offered by their employers—there are no income limitations. 4 To make nondeductible contributions to a Traditional IRA, there are no income limits. However, if you and/or your spouse participate in an employer-sponsored retirement plan, the amount of the deductible contributions will depend on your MAGI. 5 If your contributions to a Traditional IRA are nondeductible, you may want to consider a nonretirement account instead. Meet with a financial advisor for additional guidance.

Save for the income you'll need.
"Our research shows that you can build a sound retirement income plan if you follow some standard guidelines," Ritter says. The rule of thumb is to plan on replacing 75% of your preretirement income. As much as 50% of that income may come from investments, 20% from Social Security benefits, and the rest from other sources such as a pension or part-time work. Most people need to save 15% of their annual income, including any employer contributions, to achieve those percentages. On the other hand, your savings percentage may need to be higher if you're getting a late start or if you stop saving for a significant period of time, a situation discussed at length in "Catching Up on Your Savings."

Once you have determined how much to set aside in annual retirement savings, map out a strategy for your contribution sequence. See the "How to Decide Your Retirement Account Contribution Order" above.

Do Roth contributions make sense for you?
Roth contributions may provide the most flexibility for you—and they may be your best option—in retirement. Withdrawal of any earnings from a Roth IRA made after you reach age 59½ are not subject to federal income tax if your account has been open for five years or more, and contributions can be withdrawn at any time penalty- or tax-free. Additionally, there are no required minimum distributions (RMDs) from a Roth IRA for the account owner, which gives you the flexibility to determine when to take distributions—and, in fact, whether you want to take them at all. You must, however, take RMDs from a Roth account within your employer-sponsored retirement plan.

Does your employer offer a Roth contribution option within your 401(k)?
If so, it may be in your best interest to contribute the full 15% to your plan. There are no income limitations for Roth contributions to your account in 401(k) plans. If your employer doesn't offer the option of contributing to a Roth account, contribute enough to your 401(k) plan on a pretax basis to earn the full company match, if available. Then consider whether you're eligible to contribute to a Roth IRA. Please note that if your plan allows for Roth contributions within your 401(k), your employer may offer only a match based on your non-Roth, pretax contributions. In this case, contribute enough in pretax contributions to receive the match, then contribute what remains of the 15% goal to the Roth portion of your 401(k).

Are you eligible to contribute to a Roth IRA?
For tax year 2013, you can fully fund a Roth IRA if your modified adjusted gross income (MAGI) is under $112,000 as a single taxpayer or $178,000 if you are married and file a joint return ($110,000 and $173,000, respectively, for 2012). You may want to contribute the maximum annual contribution to a Roth IRA and then contribute additional pretax savings to your traditional workplace plan, if your employer plan doesn't offer a match or a Roth 401(k) contribution option.

When should you consider a Traditional IRA?
A Traditional IRA may be an appropriate option if you are both over age 50 and expect your marginal tax bracket to decline significantly in retirement, you have contributed the maximum to your 401(k) and still want to contribute more to retirement (and you are ineligible to contribute to a Roth IRA), or you don't have a 401(k) to contribute to and Roth contributions don't make sense for your personal situation. Also, if your contributions to a Traditional IRA are nondeductible, you may want to investigate the advantages of a taxable account instead. Consult with a financial advisor to discuss your personal circumstances.

The precise mix of stocks and bonds in your portfolio will depend on how close you are to retirement and your personal circumstances. Investors more than 15 years away from retirement should consider a portfolio with more than 80% allocated to stocks, since they provide the long-term growth potential you will need. As investors get older, they should gradually shift their allocation toward a more balanced mix of stocks, bonds, and short-term investments to dampen volatility. Be mindful of the continual shifts in your investments. When specific areas of the financial markets post gains or losses, that performance is reflected in your portfolio. If you do not monitor your allocations, the financial markets can cause the balance to shift—sometimes significantly. Says Ritter, "You need to pay attention to changes in your portfolio—and take care not to let it get too far from your target allocation."


If you decide the tax advantages are right for your situation, you can take steps to maximize the benefits and minimize the costs of a Roth conversion.

Converting to a Roth IRA triggers one immediate cost: The amount of the conversion that is composed of earnings and pretax contributions is included in your income that year for tax purposes. For that reason, a Roth conversion could produce a significant tax bill, especially if the additional income pushes you into a higher income tax bracket. The taxable amount is due for the year the conversion takes place. Consider the following:

Rather than converting your entire IRA balance at once, you might decide to conduct multiple partial conversions over a number of years so the tax impact is not too big in a given year.

It's generally best to pay the taxes on a conversion using assets from a taxable account. However, you may choose to pay the taxes by withdrawing principal from the Roth IRA you just created if you don't have a taxable account. If you are under age 59½ at the time of the withdrawal, you will have to pay a 10% early withdrawal penalty but no additional taxes.

Once the conversion is complete, you'll no longer have to comply with any minimum distribution requirements in retirement. As a result, you can potentially pass on a greater amount to your heirs than you would by holding a Traditional IRA.

The tax-advantaged benefits of employer-sponsored retirement plans and IRAs can provide you with a significant opportunity to maximize the amount you save for your later years. Consider which accounts work best for your situation and keep your overall financial strategy firmly in view by saving enough consistently and reviewing your portfolio at least annually, actions discussed at length throughout this "How To" retirement issue.

Converting to a Roth IRA
photograph from getty images
1 Unforeseen expenses can be mitigated by establishing an emergency fund.
2 Judith Ward, CFP®, a senior financial planner with T. Rowe Price, explains how you can guide children toward financial responsibility.
3Jerome Clark, portfolio manager of the
T. Rowe Price Retirement Funds.
4Strong research is the foundation for these municipal bond investments.
5To attain financial security in retirement, you have to make sure you save enough.
6 A lapse in contributions doesn't need to translate into lost income in retirement.
6 What do the changes in tax rates mean for investors?
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9 "Social insurance" originally was proposed when more people started to live beyond their ability to work effectively.
11Growing Opportunities in Developed and Emerging Markets.
12History provides a powerful reason for you to establish and maintain an allocation to stocks and bonds that is appropriate for your financial goals.
12Reviewing your estate plan routinely can help ensure that assets pass to your heirs according to your wishes.