When a couple makes the decision to live exclusively on the salary of one spouse or partner, they may take the time to review their monthly cash flow and cut out any unnecessary expenses prior to making it official. However, a topic that is likely to be put on the back burner is the issue of retirement – specifically, how to save for two on the income of one.
Planning and saving for retirement as a one-income household presents its own unique challenges. Thankfully, there are a few planning tools available that are specifically designed with this group in mind.
There will certainly be competing financial priorities along the way. However, if saving an ample amount toward retirement is at the top of your list of financial priorities, then putting as many dollars as possible into your 401(k) account each year is the best place to start. Though it can be a tall task for those in their twenties and thirties who have not yet reached their highest income earning years, it is important to make maximum 401(k) contributions as early as possible. In 2021, that annual limit is $19,500.
Once you have reached the cap on contributions to your 401(k) plan, contributing to an individual retirement account (IRA) on behalf of your spouse is a great next step. Typically, the Internal Revenue Service (IRS) requires that anyone contributing to an IRA have earned income in the year that they make the contribution. However, the one exception to that rule is the provision for the usage of a spousal IRA. A spousal IRA is a strategy that allows a working spouse to contribute to an IRA on behalf of a non-working spouse.
Currently, savers younger than 50 years old are permitted to contribute a maximum of $6,000 per year to an IRA. And those older than 50 are allowed an additional $1,000 catch-up contribution – for a total of $7,000.
If you were to invest those IRA contributions each year and managed to earn a conservative 5% average annual return, it would be reasonable to assume that you could put away an additional $500,000 or more toward your retirement nest egg by the end of a 35-year career. This does not even take into consideration future increases to the annual contribution limits attributable to occasional cost of living adjustments.
For high-income households earning above the IRS limits and excluded from receiving a tax deduction for contributions made to a traditional IRA, it may be a good idea to consider utilizing the back-door Roth IRA conversion strategy. This strategy allows one to take advantage of the fact that while there is a limitation on who can contribute to a Roth IRA directly, there is neither an income limit on contributing to a traditional IRA nor income restrictions on converting an existing traditional IRA to a Roth IRA.
Thereby, a high-income individual could first contribute to a traditional IRA then, almost immediately, convert it entirely into a Roth IRA. By utilizing this strategy, that 35 years’ worth of $500,000+ savings in the above example would all be allowed to come out of the account as tax-free income in retirement. These tax-free withdrawals can be especially beneficial to a high-income household who is not eligible to receive a tax deduction for contributions made to a traditional IRA.
Regardless of your income level, Social Security will likely play a large part in your overall retirement income plan. It is critical that the working spouse accrue the necessary 40 credits to qualify for a full Social Security benefit in retirement. And while this may sound like a no-brainer, for those who work outside of the United States for an extended period, or for anyone who is self-employed, it is not so cut-and-dry.
As long as the working spouse has paid enough into the system to qualify for a benefit, the non-working spouse would be eligible to begin receiving a spousal benefit at retirement age as well. The spousal benefit can be as much as half of the working spouse’s monthly benefit payment, depending on their age at retirement.
For one-income households, the age at which Social Security benefits are claimed becomes far more consequential. For a worker or their spouse who chooses to begin benefits at age 62 – the moment they first become eligible – their monthly benefit payment would be reduced by 25%. However, with some careful planning, and by waiting until at least the full retirement age of 67, both spouses can lock in a sizeable income stream that will last the rest of their lives.
This means that while it is certainly possible that in a two-income household both spouses could be working well into their 60’s or 70’s, it is very important that the working spouse in a one-income household set their sights on a realistic retirement date, and plan accordingly. Delaying retirement by even just one year leads to increased benefit payments, an extra year of saving, and more time for those savings to compound in the markets.