A retirement gap analysis shows if you are on track to having enough to retire on your terms. It does the same for your employees. Often retirement planning is expressed in a non-personal way. Unfamiliar terms like savings rates and QDIA are used and we wonder why more people are not engaged in planning for their future retirement. A personalized gap analysis delivered by someone caring who is also versed in retirement planning makes things tangible.
What is a retirement gap analysis?
In general, a gap analysis looks at the difference between where you are and where you want to be. If a gap is detected, what are the options for filling the gap? A retirement gap analysis looks at assumptions like when you would like to retire, assumptions regarding inflation rates (the rising cost of living over time), and your comfort with the trade-off between risk and return when investing your money. Assumptions around the income you will receive from Social Security and any pensions you might receive reduce the needed income from outside investments. Using those assumptions, options can be provided regarding saving more, taking on more investment risk and potentially pushing back the retirement date.
For the uninitiated this can be pretty intimidating. That’s why I feel it’s important that the retirement gap analysis be delivered by not simply a financial advisor or enrollment specialist, but a CERTIFIED FINANCIAL PLANNER™ professional or similar credential that can empathize, sympathize and personalize.
Gap analysis and tax savings
All things equal, it’s better to save in a way that reduces taxes, sometimes referred to as tax deferred. Simply put, save and invest now, let it grow and pay your taxes later. Some of your employees may not know that interest and growth on your savings that is less than a year old is taxed at their highest marginal rate, currently 39.6%. That means for every dollar earned, they keep about 60 cents. If they save in a tax-deferred retirement account, like an IRA or 401(k), they can avoid paying taxes until sometime after your 70 ½. That deferral benefit also accrues to the returns made on that money. If you are savvier, you know that you pay as much as 20% on interest and other earnings on your money held more than a year. Let’s look at this in practice.
Let’s say that you are a business owner or highly compensated employee that makes $175,000 salary. Further, let’s say that your retirement gap analysis shows that you need to save $20,000 to retire on your terms. The 401(k) allows you to save $17,500 given that your plan meets the overall testing requirements for equality of savings. If you are over 50 years old, the 401(k) plan allows you to save the additional $2500 to help you “catch-up” your savings (a maximum of $5500 in 2015). Best of all your employees have the same benefit. Many people aren’t saving because they have no idea how much they need to save and no one has made it personal. That’s where offering all employees retirement gap analysis benefits not only them but your ability to save as well. If you are the business owner. You also have the ability to add a profit sharing contribution that could ratchet your savings up to $54,000 (maximum in 2015). There are many profit-sharing savings formulas you might be able to use to create an equitable distribution. You may read our blog to get more information.
An IRA significantly reduces the savings ability. It limits savings to $5500 plus thousand dollars in retirement catch-up contributions. I find many employers that don’t really grasp the benefit they truly offer their employees.
Retirement gap analysis and your future
The greatest saving of retirement gap analysis is not running out of money in retirement. If you’re like most people you would not want to run out of money at any time in your life, much less during your retirement. Saving early in life and seeking consistent investment returns needed is a key to adequate funding without hyper savings later on. Many states like Illinois have run into pension funding problems because their investment returns did not meet expectations. Some of those expectations likely should’ve been tempered and a more conservative estimate used. Wisconsin used a more conservative estimate and has found themselves in a much better funding status.
Organizations that had pensions which use actuaries did not apply this same actuarial science for their employees when they switched to a defined contribution or 401(k) plan. While many employees don’t see saving into their pension as optional, many see the 401(k) as an option fulfilling a need that seems far off in the distance. It’s often difficult to see the future unless one makes it more tangible by using tools such as a retirement gap analysis.
Let’s assume that one day you find little need for your 401K savings because of other income sources. Eventually the government requires you to begin spending the money out of that account known as required minimum distributions. The government also allows for a portion of that to be given to charity tax-free. A great way to save money on taxes and direct your money to causes dear to you.
What can a retirement gap analysis do for you and your employees
There are many implementations of a gap analysis we could use based upon your plan’s needs. One example is the use of a risk comfort assessment. It starts the retirement gap analysis conversation by assessing an individual’s natural comfort with taking on market risk to get a desired return. You’re welcome to take the assessment to see where you stand and how this might be used to help guide the development of retirement gap analysis for you and potentially your employees. Other implementations allow for reporting back to you on how well each demographic group is doing and various actionable metrics. Given that you have other service providers in place, this can be a service that can be added without disrupting the rest of your program. Ready to learn more?
This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
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