You can get ready for retirement by putting your savings into three different buckets.
Fifty may be the new 40, but the numbers don’t lie when it comes to retirement savings.
Retirement income used to be based on the big three: Social Security income, savings, and a pension. But many companies have put the brakes on pensions and these days it’s a given that Social Security doesn’t cover nearly enough of individual retirement needs. But by better balancing your retirement savings during your 50s, when most savers experience their peak savings ability, you can bolster your savings potential by contributing to three “buckets”: IRA (pre-tax), Roth (post-tax), and taxable.
IRA (Pre-Tax Bucket)
Money placed in an Individual Retirement Account (IRA) can be from a traditional IRA or from funds transferred from other retirement accounts such as a 401(k) from a previous employer. Typically, money in this bucket is contributed on a pre-tax basis: You earned the money and invested it before taxes were taken out. But as with many things, time changes everything: Limitations on adding money to this bucket change annually. It’s important to remember that you’ll have to pay taxes on IRA monies when taking any distributions. Come retirement, funds you take out of this bucket are fully taxable at ordinary income rates.
The Roth IRA Bucket
The most complex of the three buckets, a Roth IRA bucket is a special retirement account funded with any earned income you have remaining post-tax. Unlike traditional IRAs, any withdrawals from this bucket during retirement — including investment
gains — will be tax free if you follow IRS rules. Be sure to file away this important fact: Contributions to this account can’t be deducted on your income taxes.
CDs. Stocks. Mutual funds. Savings accounts. All of these are considered examples of investments in your taxable bucket. Money in this bucket reaches your account after the IRS has taken its share. Think of this cash as money that you’d see in your paycheck after tax deductions or that is direct deposited into your checking account on paydays.
Which bucket is best for you? It all depends on your specific finances, your tax bracket before and during retirement, and tax rates, to name just a few of the financial considerations that may impact your choice. One thing is certain: Retirement will eventually come and your best bet is to be prepared by choosing the right bucket rather than trying to duck it.