Blog for Professors and TIAA Participants

The Bedrock Principles of Retirement and Estate Planning

Introduction

For the first two first posts, we will preview the most fundamental principles of retirement and estate planning.

The Bedrock Principles

Concerted saving for retirement is essential. How to best go about that can be structured on some fundamental principles, the simplest but also the most nuanced is:

Pay Taxes Later, Except for Roth Accounts, Roth IRAs and Roth Conversions

We will delve into the intricacies of the Roth world in later blogs. Or you can immediately read more in our book, Retire Secure for Professors and TIAA Participants.

Plan for Retirement Before You Retire

Advance planning for retirement and for your estate is always a good idea. But first, you must make sure you have sufficient resources to afford the life you want to live after you retire. It is extremely profitable to do appropriate planning while you are still working. And please consult someone you trust who can provide good advice before you announce your retirement or sign any retirement papers.

The Accumulation Years

Here are our broad recommendations on the hierarchy of contributing to accounts when you are working (subject to availability and personal circumstances).

1. Take advantage of any employer match.
2. Take advantage of a Health Savings Account (HSAs), if available to you.
3. Contribute to Roth IRAs and back-door Roth IRAs.
4. Contribute to Traditional retirement plans or IRAs.
5. Contribute to nondeductible IRAs or nondeductible contributions to a retirement plan.
6. Save money in a plain old after-tax brokerage account.

Make no bones about it, the cardinal rule of saving for retirement is taking advantage of employer matching contributions. Most universities and many hospitals, non-profits, governments and museums offer matching contributions, but some offer a percentage of your salary regardless of whether you contribute to the plan. So, if your employer has a retirement plan and an employer match is available to you, make sure you are (1) participating in that plan and (2) contributing at least enough to take full advantage of the match. It’s like free money! And recent legislation allows employer matching contributions to go into a Roth or a Traditional account if the plan permits.

In the following figure, two professors with the same tax rates, investments, etc. invest in their retirement differently. The professor represented in the solid black line took advantage of his employer’s retirement plan, even disregarding the match. The professor represented in the dashed line did not take advantage of his employer’s retirement plan.

Detailed assumptions can be found by clicking here.

The professor who used his employer’s plan had $1,118,724 more at age 80 than the person who did not invest in his employer’s plan, even though the amount of money he saved on a tax-adjusted basis was the same and there was no employer match. This figure reflects our basic premise that paying taxes later while you are in the accumulation stage means you can retire richer instead of “broker.”

A Note on Health Savings Accounts

Health Savings Accounts are only available to those who choose a high deductible health insurance plan. But with an HAS you get a tax deduction, the money grows tax free, and withdrawals are tax free if used for qualifying medical expenses. They are even more advantageous than Roths!

The Distribution Years

Subject to exception, we recommend you spend money in the following order:

1. Spend your income first.
2. Spend your after-tax dollars that don’t have any or much appreciation.
3. Spend your highly appreciated after-tax dollars.
4. Spend your traditional retirement assets like IRAs and 403(b)s.
5. Spend your Roth dollars last.

The following figure supports the premise that, subject to exception, you should spend your after-tax dollars before your retirement plan, IRA or Roth dollars.

Please look at the figure that follows. Both retirees start with the same amount of money in a regular brokerage account—which I refer to as after-tax dollars—and in their traditional retirement plans which could be IRAs or 401(k)s. The figure below indicates, subject to exceptions, that most readers should spend their after-tax dollars first and then IRA and retirement plan dollars. The solid line shows what happens to the first retiree who spends after-tax dollars first and withdraws only the minimum from the IRA when required to (more on RMDs in the next section). He paid taxes later. The dashed line shows what happens to the second retiree who spends his IRA before his after-tax dollars. He paid taxes now.

Detailed assumptions can be found by clicking here.

The only difference between the dashed line and the solid line in this figure is that the first retiree retained more money in the tax-deferred IRA for a longer period. Even starting at age 65, the decision to defer income taxes for as long as possible gives the first retiree an extra $340,199 if he or his spouse lives to age 89. If one of them lives longer, paying taxes later will be even more valuable to them.

As a rule of thumb, deferring income taxes due on your retirement plans for as long as possible and generally holding off on spending your Roth dollars will benefit you and your family.

Conclusion

Even for a first installment, this is a lot of information to digest. But building a strong financial foundation is critical for the whole family, and first steps will set the journey in motion. The next installment in this blog will introduce some of the positive and negative impacts of the SECURE Act on retirement savings legacy planning, explain the basics of required minimum distributions (RMD), and the delve into some of the reasons to plan now to take advantage of relatively low tax rates. If any particular topic catches your attention, remember a full discussion is always available in our book Retire Secure for Professors and TIAA Participants which is available for purchase on Amazon. Click here to get your copy today!