By Gary Gonzalez
Hello and welcome back to my living room. I'm retired battalion chief Gary Gonzalez, and this is episode two of my new video blog MDFR Retirement Recon. Today we're going to be covering deferred compensation and why it's such an important tool for you to utilize when planning for a healthy retirement. So let's dig right in. Back in 2017 before he retired, Chief [inaudible 00:00:44] and I had lunch together and we got to talking about the department and how the troops are doing. I asked him what retirement concerns keep firefighters up at night, and he told me that many of you are concerned that due to the ever shrinking costs of living adjustment or COLA, and for those of you hired after July 1st, 2011, no cost of living adjustment at all, the pension won't be enough to sustain the retirement lifestyle you envision for yourself. To be honest, although in the big scheme of things, being retired from the Miami-Dade Fire Department is still an envious position, your concerns do have merit and worth further consideration.
Inflation can wreak havoc on the future purchasing power of a fixed pension or one with a COLA that doesn't keep pace with it. This is especially true of course during periods of high inflation. Thankfully, most of you have never had to experience periods of high inflation in your adult lifetimes, and I hope historically low inflation continues well into your retirement years. But it is always wise to hope for the best and to plan for the worst. So what can you do today to overcome the eroding effects of inflation on your pension's future purchasing power? Well, one of the most powerful tools at our disposal is our deferred compensation plan, a supplemental retirement account that provides you the opportunity to contribute now to dramatically increase your chances of improving your future financial health later in retirement. This account can provide an income stream to help offset the erosion of inflation and its effects on your future pension payments.
Here are many benefits to consider that a deferred compensation plan offers. Your current taxable income is reduced with each dollar you contribute biweekly. This can significantly reduce the amount of tax you pay for each tax year in which you participate, while also adding pretax dollars to the potential growth of the account. Currently, the annual limit is $19,000 and a schedule to increase to $19,500 in 2020. You may be entitled to participate in the 50 and over catch-up provision, which allows you to contribute an additional 6,000 per year scheduled to increase to 6,500 next year. You may also be eligible to participate in the three year retirement catch-up provision, which allows you to double the standard contribution limit.
The earnings and growth in your account are tax deferred, so they're not subject to taxation until you take distributions after you have retired. Those distributions would be taxed as regular income and there are no age restrictions on when you can withdraw money from the account without an early withdrawal penalty. The only requirement is that you must be retired. You can potentially protect a significant amount of your final paycheck from the high tax rate that that paycheck will likely be subjected to. Here's where the catch-up provisions make sense. Even if you can't afford to contribute another dime to your plan biweekly, you can contribute as much of that final paycheck as you'd like up to the total yearly catch-up provision limits. As a side note, the catch-up provisions are not cumulative. You can only participate in one at a time.
I'd like to share with you a word of caution about taking a loan out against your deferred comp account balance. Although it seems like a good idea on the surface, you're paying yourself. When you dig a little deeper, you realize that you're going to end up getting taxed twice. Once as you pay back the loan with after tax dollars and again, after retirement when you withdraw that money from the account. So when all are set and done, you could end up paying a whole lot more than the amount of the loan that you took out. It would be worth your while to compare this cost with the cost of getting a loan outside the account.
May you sleep well with the knowledge that you have a powerful tool at your disposal to help overcome inflation as you enjoy your retirement years. This book, which I wrote for you after I retired, A Firefighter's Guide to Retiring from the Miami-Dade Fire Rescue Department, is available at no cost. Simply call the number on the screen and one will be mailed to you. It includes more information on this topic as well as many others that are important to understand before you retire. And as always, if you have any questions or concerns, feel free to contact me at Northstar Financial Planners or on my cell phone. Until next time, be safe out there.