Advertiser Disclosure

Life Events, News, Retirement

Why Sabbaticals Could Be the New Pre-Retirement

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Brad N. Shaw, a Dallas, Texas-based serial entrepreneur, took a two-year sabbatical from 2011-2013 to spend more time with his family. He’s pictured here with his family in Vail, Colorado. (Photo courtesy of Brad M. Shaw)

Serial entrepreneur Brad M. Shaw made a bold decision several years ago to take two years off from work and move his family to Vail, Colo.

Taking a two-year sabbatical had its challenges, the major one being uprooting his family in pursuit of more work-life balance and a change of scenery. But overall, he says taking time off was more than worth it — both for his family and his business.

“My daughter was growing up so fast,” says Shaw, who is CEO of a web design firm in Dallas. “As a serial entrepreneur, I was always away traveling or at the office. I wanted to be a present father and play a role in her upbringing. I also wanted to show her a life outside of the Dallas suburbia bubble.”

‘No reason to wait’

The concept of taking a sabbatical is not new. People have been taking them for decades. They’re typically thought of happening in academia, in which professors are paid to take time off for research. But sabbaticals have transcended academia and have spread into the general workforce in recent decades.

Thanks to a new wave of workers who value purpose over stability, the upswing of the gig economy, and companies that offer unlimited vacation time or paid sabbaticals, taking an extended break is becoming more of a reality for many. Many major companies in the United States offer unlimited vacation time or paid sabbaticals, such as Groupon, General Electric, and Adobe.

There’s also the reality that today’s American workers are not able to retire as early as previous generations — and they’re living longer, healthier lives. So a sabbatical can serve as a mini retirement, or a chance to take a break from the grind of 9-to-5 life.

Ric Edelman, the founder and executive chairman of Edelman Financial Services, explores this topic in his new book, “The Truth About Your Future: The Money Guide You Need Now, Later, and Much Later.” He says the combination of people living longer and being healthier in old age means the notion of retiring at 65 will be gone in the near future, both because it won’t be affordable and people will get restless.

“You’ll be healthy enough to work, you’re going to want to work, and economically, you’re going to need to work,” he says. “For all those reasons, you’ll continue working. And so that notion that you’ll wait until you’re 60 to take that around-the-world cruise really won’t exist. There won’t be a particular reason to wait.”

Edelman says that instead of the traditional life path (go to school, get a job, retire, die), we’ll have a cyclical one in which people go to school, get a job, take a sabbatical, go back to school, take a different job, etc. Instead of having one big chunk of a 30-year retirement, people will take two years here, three years there, six months here, and they’ll enjoy time off throughout their life at various intervals.

Research has also proven that companies and the economy benefit when employees take sabbaticals. According to a report by Project: Time Off, an offshoot of the U.S. Travel Association, there has been a jump in employees taking time off in the last year. Unused vacation days cost the economy $236 billion in 2016 — an amount that could have supported 1.8 million jobs. In essence, employees not cashing in on their paid time off hurts the economy because employees are forfeiting money that could instead have been used to create new jobs.

Dan Clements, author of “Escape 101: The Four Secrets to Taking a Career Break Without Losing Your Money or Your Mind,” says the biggest benefit of taking a sabbatical is the perspective change it offers.

“People come back from sabbaticals with a completely different vision for how they want to live their life,” Clements tells MagnifyMoney. “They come back and they change jobs or they transform themselves in the company they’re in or they change their business.”

Upon returning to Dallas, Shaw says he made the decision to forgo scaling up his business in favor of running it on a smaller scale so he could be less stressed.

“The time away allowed me to reset my business ideas,” he says.

Clements thinks many companies have begun to offer unlimited vacation days or paid sabbaticals to keep up with the new generation entering the workforce, because by and large, millennials value purpose over stability. Companies want to keep employees happy by offering them the opportunity to find purpose in a way their 9-to-5 job might not be able to.

“You have a different generation of people entering the workforce for whom work means something different,” Clements says. “What they expect from work is not necessarily security and a paycheck, but what they expect is meaning from work more than previous generations have. Part of the way companies can supply that is to give people the time and flexibility to find it.”

Taking the plunge

Tori Tait, the director of content and community for The Grommet, an e-commerce website that helps new products launch, took a 30-day sabbatical in August. Her company offers paid sabbaticals at employees’ five-year mark. Tait, who lives in Murrieta, Calif., spent time relaxing in Huntington Beach, Calif., boating on the Colorado River, and living on a houseboat in Lake Mead, Ariz. Like Shaw, she says the biggest benefits for her were time off with family and a fresh perspective once she returned to work.

“I’m a working mom, so summers are often filled with me in the office, and [my kids] wishing we were at the beach,” she says. Tait says she enjoyed how during her month off, she didn’t have work in the back of her mind the way people often do when on a five- or six-day vacation.

Tori Tait, pictured with her daughters London, 10, and Taylor, 16, took a company-sponsored, 30-day sabbatical in August 2017. (Photo courtesy of Tori Tait)

Her biggest piece of advice for those planning a sabbatical is to not dwell on the planning aspect of it. “I grappled with trying to plan how I would spend my time,” she says. “Would I travel abroad? Volunteer? Finally do that side project I’ve been thinking about? In the end, I just thought, What is it that I always wish I had more time to do? The answer for me was: spend quality time with my family. So that’s what I did.”

Daniel Howard, the director at Search Office Space, a website that helps businesses all over the world find office space, took a sabbatical after the financial crisis in 2008. He says he took 12 months off to recharge in hopes of returning to work with more optimism and drive. His employers didn’t pay him for the time off, but promised him his job would be there upon his return.

He traveled with his then-girlfriend (now his wife) to Southeast Asia, Australia, New Zealand, Fiji and Central America. They left their phones at home and relied on physical maps to get around. Aside from the occasional email to family to check in, they were completely disconnected. The biggest benefit for him? “The ability to completely disconnect from my working life and the opportunity to become a more well-rounded person by immersing myself in different cultures and experiences,” Howard says.

Although many people take their sabbaticals overseas, one doesn’t need to travel around the world to reap the benefits. Extended time away from work and technology is beneficial no matter where you are.

“I think for a lot of people, a sabbatical is the first real vacation they’ve ever taken,” Clements says. “I tell people that taking a one-week vacation is sort of like trying to swim in a puddle. You wade in a little bit, and you’re barely wet, and then you have to go inside. When you actually get away from your life for two or three times longer than you’ve ever taken a break from work, you get this sense of perspective that I think most people don’t normally get a chance to experience.”

The 4 stages of preparing for a sabbatical

If you don’t work for a company that offers unlimited vacation days or paid sabbaticals, that doesn’t mean you can’t take one. Clements shares his steps for saving up for a sabbatical:

  1. Boost your earnings. Try to figure out if there’s a way you can earn more before taking your sabbatical. Can you finally ask for the raise you’ve been wanting? Can you do freelance work on the side? Can you rent out part of your home on Airbnb, or drive for Uber? Consider all of your options.
  2. Make it automatic. Have money automatically withdrawn from your bank account the same way you would for retirement, a mortgage or automatic bill payments.
  3. Put it out of reach. Once you set aside money in a separate account, make sure it’s out of reach. Put it in a savings account that isn’t accessible online or via the ATM. If you have to physically go to the bank to withdraw cash, you’ll be less tempted to do so.
  4. Stretch yourself. Don’t be afraid to make your automatic savings plan more aggressive than you think you can handle. Challenge yourself to save more than you think you need, because you can always change the amount if you have to.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Jamie Friedlander
Jamie Friedlander |

Jamie Friedlander is a writer at MagnifyMoney. You can email Jamie here

Advertiser Disclosure

Retirement

I Am a Foreign National — What Should I Do With My 401(k)?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Thanasis Konstantinidis didn’t know what a 401(k) was when he got his first job in the United States almost four years ago. He just thought the term sounded a bit strange.

The 34-year-old software engineer from Greece eventually learned the basics of the classic American retirement investment account. But it didn’t exactly seem like the wisest move. He was granted a temporary work visa for three years. If at the end of three years he wasn’t granted permanent residency in his host country, there was a chance he would have to leave the country all together.

“My future was very uncertain at the time, and I wasn’t sure if I’d stay in the U.S.,” Konstantinidis told MagnifyMoney.

In 2016, there were 27 million foreign-born workers in the U.S., according to the Bureau of Labor Statistics. These workers made up nearly 17 percent of the American labor force that year, up from 13.3 percent in 2000.

Many non-native workers in the U.S. are young professionals hired by firms seeking workers with highly valued skills. In 2016, more than 870,000 foreign nationals were granted the most common temporary work visas. The U.S. has also seen a dramatic increase in the number of international students at colleges and universities in the past decade. After graduation, these students are often eligible for visas that allow them to pursue jobs in the U.S.

It is tricky enough for the average millennial to think about the future. The temporary immigration status of foreign nationals and the fact they may travel between countries in the future add additional layers of complication when it comes to retirement planning. How can they make long-term financial plans when they aren’t sure if they’ll be able to continue working in the U.S.?

In this article, we answered typical questions foreign nationals may have about 401(k)s as they pursue careers in the U.S.

Should foreign nationals contribute to a 401(k)?

The answer here may seem intuitive to those who, like Konstantinidis, think they will only stay in the U.S. for a few years. Tying up their funds in a 401(k) in a country they may be leaving soon might seem unwise. And by choosing not to participate in a 401(k) plan, they may have more cash available for their immediate needs.

In truth, there are pros and cons depending on a few factors, so you have to ask yourself a few questions first:

Do you view this 401(k) as part of a long-term investment plan or only as a short-term savings account?

When you are young and start saving early, you have a huge advantage on your side — time.

“Most of those folks who are here on a temporary visa tend to be young,” said Chris Chen, a Waltham, Mass.-based wealth strategist at Insight Financial Strategists. “They happen to be able to take the advantage of the power of compounding. That is truly a gift that you can’t get when you are older.”

It’s also an opportunity to invest in the U.S. market, which is among the strongest economies in the world and has a relatively mature and stable market with lower fund fees than many other countries.

Are you a high earner, which would increase the tax benefit of opening a 401(k)?

Another immediate and major benefit that you would lose is the tax advantage. Especially for those high-income earners, you are saving money by not paying taxes now, and when you withdraw the money at retirement, you will pay fewer taxes because ideally, you will be in a lower income bracket.

Is there an incentive to contribute to your 401(k), like a company match?

If your employer offers a match, you would be walking away from additional income if you fail to contribute. Many U.S. employers offer to match up to a certain percentage of employee 401(k) contributions.

For example, an employer may offer to match up to 3 percent of the employee’s contribution.

Let’s say you make $60,000 a year and contribute 6 percent (or $3,600) into a 401(k) for the year. Your company would match up to three percent (or $1,800) of that contribution. This means you would only contribute $3,600 to your 401(k) but end up with $5,400 thanks to the match.

“They would be leaving money on the table by giving up on the match,” said Chris Chen.

How certain are you about returning to your home country in the near future?

It may not feel like your odds of needing a U.S.-based retirement fund are certain, especially if your circumstances are anything like those of Konstantinidis.

However, Chris Chen argues that an international worker’s future isn’t all that uncertain. In fact, if anything is certain at all, it’s the fact that they will likely retire at some point.

“Whether it is India or China or Europe, when you go back to your country, you are going to have to use the tools available there for retirement,” he said. “And in the meantime, you will still have an extra little [retirement fund] out there in the U.S.”

If you were to leave the U.S., you have several options on managing your U.S.-based savings, some of which will require some administrative hassle. We’ll cover these options later.

Furthermore, your plans may change. You might have planned to stay in the U.S. for just two years, but you may end up staying longer. In that case, it could be wise to start saving for retirement early.

Can your 401(k) help with non-retirement goals?

Hui-chin Chen, a financial planner with Arlington, Va.-based Pavlov Financial Planning, who works with foreign nationals in their 20s to 40s, told MagnifyMoney some have other plans for their 401(k) than just retirement.

Many of her clients stayed in the U.S. for jobs after completing their college or graduate studies here. Although some eventually left the country, they still wanted their children to have the same study abroad experience. So they considered their 401(k) an education fund.

“They think, ‘Okay, I can leave some money in the U.S. I don’t care about taking it with me,” Chen explained. “‘And if I leave the money in the U.S., I might as well get some tax benefits. I can wait until I am older and I can take that money out to pay for their college.’”

Just keep in mind that if you try to tap your 401(k) for funds before you turn 59 1/2, you will likely face early withdrawal penalties and could be hit with income taxes.

The disadvantages of contributing to a 401(k)

While financial planners encourage foreign nationals to invest in their 401(k) in general, they would advise against the idea in some cases.

For those who are certain that they are just staying in the U.S. for a very short time, are in a relatively low tax bracket, and don’t see 401(k) as a long-term savings plan, experts suggest they open a taxable account — like a brokerage or savings account — or send money back home if they have better investment choices over there.

But do take note that you are a considered a U.S. resident from the tax perspective as long as you live in this country. This means if you invest outside the U.S., your income from those investments are still subject to U.S. taxes.

The tax benefits could justify the administrative hassle for those who have worked in the U.S. for a long time and have a big 401(k) balance. That’s because they are able to save a potentially significant sum of money without paying taxes upfront. And when they withdraw those funds later, they will likely be at a lower tax bracket and, hence, enjoy big tax savings.

For international workers whose stay in the U.S. is shorter, however, that tax benefit doesn’t necessarily pack the same punch, especially if their account has a smaller balance.

“It’s OK if [your 401(k) is worth] $200,000. If it’s $18,000, the benefit is offset,” said Andrew Fisher, president of Worldview Wealth Advisors, a financial advisory firm that specializes in working with cross-border individuals with U.S. connections.

How much should I invest and where do I invest?

If you’ve decided to open a 401(k) with a U.S. company, the next challenge is figuring out how much to save and where to save it.

The answer to the first question — how much to save — is simple if your company offers a match.

Sirui Hua, 26, a producer with a New York-based digital media company, told MagnifyMoney that he saves 4 percent of his income in his 401(k). His employer offered to match up to 4 percent of his income and he didn’t want to give that up.

“If I don’t save the money now, I’d have nothing when I go back,” Hua said. “At least I would have a little something one day I go home.”

Hua, originally from China, was recently approved for his work visa by his employer, which allows him to continue working in the U.S. for up to six years. Knowing that he has a full six years of stable work ahead of him, he is planning to increase his 401(k) contribution. He’s still not sure if he’ll use it as a retirement account if he returns home to China, but he would rather take the opportunity while he has it.

At least contribute enough to capture the full match. From there, consider increasing your contribution based on your other financial goals.

Depending on your personal goals and future plans, contribute more if you are able to. Just remember the legal contribution limit for 401(k)s is $19,500 in 2020.

It may also make sense to save cash in a standard savings account so that you can access money in an emergency. Remember, early 401(k) withdrawals come with potential tax penalties.

What do I do with my 401(k) if I leave the country?

This is the question that has deterred many foreign workers from investing in their 401(k) accounts.

There are basically two solutions: You can either leave it in the U.S. or take the money out and deal with the tax and early withdrawal penalties — and the potential hassle of getting a U.S.-based bank to transfer funds to an international account.

Leaving your 401(k) in the U.S.

You can leave your 401(k) with your employer’s plan administrator or you can roll it over into an IRA.

In general, pros recommend that you do not cash out your 401(k) before age 59 1/2 (to avoid penalty) if you don’t have to. Keeping your 401(k) is the easiest solution.

“It’s less likely that [the plan providers] will say, ‘We have to close your account,’” Hui-chin Chen said. ”Because as long as you are still a plan participant, they cannot kick you out unless there is plan provision specifying it.”

That being said, you will want to check in every now and then to be sure your investments are properly allocated based on your needs. Hui-chin Chen notes that companies may offer good low-cost index funds with balanced asset allocations for employees. However, it’s important to be sure your investments are well-balanced and you’re not taking on more risk than is suitable for your age and goals.

You can keep your 401(k) with most plan providers even after you leave the company, she added. However, there are exceptions. Check with your HR department and read the details in your plan documents to find out specific plan rules.

Rolling it over into a traditional IRA

Another option for workers who leave the country is to roll the funds into a traditional IRA (Individual Retirement Account) that you can control yourself. Just like a 401(k), you may be able to defer paying taxes on money contributed to an IRA.

A major difference between an IRA and a 401(k) is that you are limited to a total annual contribution of $6,000 ($7,000 for those over age 50) with the IRA. But an IRA may potentially offer a wider variety of investment choices than a typical employer-sponsored 401(k).

The challenge with opening an IRA for foreign nationals is that not many plan providers work with people with foreign mailing addresses because they are seen as a potential risk, experts said. You should check with brokerage firms to see whether they will hold accounts for people with international addresses.

The advantages of keeping your 401(k) in the U.S.

Potential tax benefits

When you withdraw your 401(k) funds from a U.S.-based account, it’s likely that your home country will not treat it as taxable income.

Tax laws in different countries vary. There is a grey area whether other countries respect the tax benefits of the U.S.-based 401(k) or IRA.

Fisher of Worldview Wealth Advisors explains that in his experience, most countries have not expressly accepted or denied the tax-deferred status of funds held in a 401(k) or IRA, but most foreign tax preparers are treating it as such. In other words, you may continue to enjoy a tax-free growth investment vehicle even if you move overseas. But you want to check your country’s tax laws to make sure this is the case.

The magic of compounding

Before you take this road, remember you could face a 10% early withdrawal penalty plus a hefty income tax bill.

If you’re a younger worker, you’re also missing out on potentially decades’ worth of growth that you might enjoy if you leave your funds where they are.

Let’s say you save $18,000 in a 401(k) over your time working in the U.S. It might seem like peanuts to you. But consider this: If you never contribute another penny to the account, you could grow that savings to over $317,000 over the next 40 years (assuming an average annual return of 7.2%).

“It’s no longer peanuts,” said Chris Chen. “When you take [the money] out, think of that $18,000, what are you going to do with it? People often do that without much savings, so they will end up spending it.”

Cashing out your 401(k)

If you don’t want to leave the money in the U.S. to invest for the long run, there are more tax complications and administrative hassle to contend with.

You’re allowed to withdraw the money from your 401(k) when you leave the country, experts say. The amount you withdraw will count as taxable income unless you’re 59 1/2 or older. You’ll also face a 10 percent penalty.

You have to notify your plan provider when you leave that you are no longer a U.S. tax resident. The provider most likely will withhold taxes on the money withdrawn, and you will have to file a U.S. tax return for that income the following year, Hui-chin Chen said.

If you want to save money on taxes, Hui-chin Chen suggests you wait until the year after you leave or even later to take the funds out. When your U.S. income becomes just the amount of money you withdraw from your 401(k), you may be put in a lower tax rate than when you had full employment income in the U.S., Hui-chin Chen said.

But note that you need a bank account to receive the distribution, and not every provider may be willing to mail a check to an overseas address. It is likely that you probably have to keep a checking account open in the U.S., which is also easier said than done — banks don’t like clients with foreign addresses, either, Hui-chin Chen said.

“In the grand scheme of things, [for] most people, if they don’t stay in the U.S. for the long term, taking the money with them is probably not that difficult the year they leave or the year after they leave when they still have some leverage with the bank,” she said.

If you have a sizeable 401(k), taking a small distribution each year to pay zero-to-minimum amount of taxes is doable, experts say. But then you are facing far more complicated ongoing maintenance, which includes filing taxes every year, and keeping a U.S. bank account and address live. You may also be subject to some state taxes depending on your resident country, Fisher said.

Although Konstantinidis didn’t contribute to his previous 401(k) plan, his employer invested 3 percent of his income in a 401(k) for him for free. Konstantinidis, who lived through nearly a decade of financial crisis in Greece, is ultimately skeptical about the stock market.

Now, the self-acclaimed “paranoid” computer scientist is considering contributing 3 percent of his income to the 401(k) with his current employer as he awaits his green card — he is settling down.

“I’ve actually seen my 401(k) go up,” he said. “That’s really impressive. Now I am convinced.”

401(k) Frequently Asked Questions

401(k) is the name of an account U.S. workers can use to save for retirement through their employer. The name 401(k) comes from the section of the U.S. tax code that it was derived from in the 1980s.

The traditional 401(k) allows workers to set aside part of their pre-tax income to save for retirement. It’s up to the individual to decide how much to save. Even if you are not an American citizen, you are eligible to participate in a 401(k) plan, experts say.

There is also a Roth 401(k) option, which is becoming increasingly common. With a Roth 401(k) you would contribute funds and pay taxes on them right away, with the ability to withdraw funds in retirement tax-free.

When an employee signs up for a 401(k) plan, they’re typically given a choice of different investments, such as mutual funds, stocks, or bonds. The benefit of a 401(k) is that you not only avoid paying income taxes on your savings now but you’ll have a source of additional income later when you are ready to retire.

The legal maximum amount you can save in your 401(k) is $19,500 in 2020.

Employers may offer to match employees’ contributions up to a certain percentage.

For example, an employer may offer to match up to 3 percent of the employee’s contribution. Say you make $60,000 a year and contribute six percent (or $3,600) into a 401(k) for the year.Your company would match up to three percent (or $1,800) of that contribution. This means you would only contribute $3,600 to your 401(k) but end up with $5,400 thanks to the match.

Some employers may vest your match immediately. That means as soon as they contribute to your 401(k) the funds belong to you. However, others may have a vesting schedule, which is a set timeline that dictates how long it takes for you to own the money your employer contributes.

Generally speaking, you can start taking money out of your 401(k) account when you reach age 59 1/2. There are ways to tap into your 401(k) sooner, but you’ll face an additional 10 percent early withdrawal penalty and you could owe income taxes on the amount withdrawn.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Shen Lu
Shen Lu |

Shen Lu is a writer at MagnifyMoney. You can email Shen Lu at [email protected]

Advertiser Disclosure

Retirement

Maximize Your Retirement Savings with IRAs

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Americans don’t like to think about retirement. According to a recent report by the Federal Reserve, 6 in 10 respondents who aren’t retired yet and have a self-directed retirement plan, such as an individual retirement account (IRA) or a 401(k), don’t feel comfortable making investing decisions.

This discomfort with key retirement decisions can be blamed in part on the fact that many Americans don’t have the right savings strategy for retirement. Let’s take a look at some scenarios of hypothetical savers that could provide you with novel IRA saving strategies.

Picking the right IRA for your retirement savings

401(k) accounts provide millions of Americans with a retirement savings account. Still, not everybody has a 401(k) — and even those who do have one should complement it with an individual retirement account (IRA).

Given you have a limited amount of income at your disposal to sock away for retirement, what kind of IRA would work best for you depends on your individual situation. Here’s a few scenarios for different kinds of savers, providing a combination of accounts that play to the strengths of their financial situations.

IRA retirement saving strategy: Entry-level office worker

What you need to do: You may have to endure endless status meetings and office birthday parties for coworkers you barely know, but at least you have a 401(k) with an employer match. You should set your contribution to maximize your employer’s 401(k) match and open a Roth IRA in order to take advantage of your biggest asset: your potential future earnings. Check out our review of the best Roth IRA providers on the market to help you find the right broker for your retirement savings.

Why you need to do it: Employers who match your contributions to your 401(k) are essentially giving you free money. Even if you’re working for a modern day Mr. Scrooge who doesn’t give you a match, a regular 401(k) account still allows you to make contributions directly from your paycheck before any tax is applied, and those contributions will remain safe from the IRS until you begin taking your withdrawals decades later.

As an entry-level office worker, you’re probably not making a lot of money, and that likely puts you in a lower tax bracket. By the time you’re ready to take your withdrawals, you may discover the money you saved by avoiding taxes isn’t worth the bigger bite Uncle Sam takes now that you’re a member of the country club crowd.

To see this in action, take a look at the income tax brackets for tax year 2020. Even if we make a generous assumption regarding your salary as an entry level office worker and say you earn more than $40,125 (but less than $85,525) a year, you still would only be taxed 22% on this income. That means the money you contributed to your 401(k) was sheltered from this 22% tax, and you face tax payments when you withdraw it in retirement, decades later. If you were a retiree taking withdrawals this year and making, for example, more than $163,300 (but less than $207,450) you could be paying up to 32% on money you withdraw from a 401(k).

Contributions to a Roth IRA are not sheltered from taxes, meaning you pay taxes on all your income and then make your Roth contribution, while the interest earned in the Roth is tax-free. Because you’ve already paid income tax on Roth IRA contributions, you aren’t taxed again when you take your withdrawals from the account. Anyone who expects to find themselves in a higher tax bracket when they’re ready to retire should open a Roth IRA now, as you can reap extra tax benefits from your current status as a lowly office drone.

IRA retirement saving strategy: Self-employed freelance worker


What you need to do: Whether you’re making enough money from your Etsy shop to avoid the 9-to-5 office grind or you hop between projects as a freelancer, the freedom of self-employment comes with non-trivial costs. But you don’t have to sacrifice your retirement savings just because you don’t have a 401(k). On the contrary, you need to look into opening a Simplified Employee Pension (SEP) IRA and a Roth IRA. We’ve taken a close look at the best IRA providers on the market to help you choose the right provider, so go check out our round-up.

Why you need to do it: A SEP IRA is a retirement account that’s easy to set up and has low, or often zero administrative fees, which are big advantages for the busy freelancer. It also allows you to contribute up to 25% of the gross annual salary you make from the business (which as a self-employed freelancer usually works out to about 20% of your adjusted net income), up to a limit of $57,000 in 2020. That far outstrips the $6,000 contribution limit on traditional and Roth IRAs for those under 50 years of age, making it a powerful saving tool for your retirement.

However there’s no Roth version of a SEP IRA, meaning all of the contributions you make to it will be taxed when you start making your withdrawals — at whatever tax bracket you happen to find yourself in. That’s why you may also want to open a Roth IRA so you have a source of money you can withdraw tax-free.

IRA retirement saving strategy: Bold market expert with money to burn


What you need to do: When it comes to saving for your retirement, we generally advocate for a slow and steady approach. However, if you don’t have confidence in traditional investment assets such as stocks and bonds but are brimming with self-assurance about your ability to judge non-traditional investments such as real estate, you can open a self-directed IRA.

Why you need to do it: Because you’re convinced you need more flexibility in your investments than a gold medal gymnast, you want a tax-advantaged account for your holdings in peacock farms, marshmallow factories, and yacht fleets. In short, you want to make sure you’ve diversified your investments to such a degree that even if the unthinkable happens and the market permanently implodes you’ll have a safe haven of funds.

If you go down this route, pay attention to the additional pitfalls that come with a self-directed IRA, such as the fact that you won’t have a team of financial experts vetting the quality of your investments and that you can inadvertently disqualify your IRA of its tax advantages if you gain a direct financial benefit from one of the IRAs investments (beyond the money it earns for your IRA).

The bottom line on IRAs

None of the three scenarios outlined above will likely fit your unique financial situation to a T, but it should prove a good starting point for you to think about how an IRA can work into your overall retirement savings strategy. Putting away any money at all is better than nothing, but when it comes to the savings that will fund your golden years, “better than nothing” may not be good enough. Make sure you’re doing everything you can to make sure your IRA is A-OK.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

James Ellis
James Ellis |

James Ellis is a writer at MagnifyMoney. You can email James here