Retirement, Are You Saving Enough
As and investor, you are overwhelmed with advice in newspapers, magazines, and mailings discussing what to invest in for a successful retirement nest egg, when to start saving for retirement and who to invest with. There are millions of people who realize that an investment portfolio for retirement is necessary, but do they really understand the investment instruments and the amount they must invest for tomorrow? The subject of retirement is a fascinating area but it also could be a fuzzy subject without the correct amount of knowledge, understanding and professional guidance.
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The number one question of concern for individuals facing retirement issues is whether or not they have enough annual income to retire. In 2001, only 63% of workers said they felt confident they would have enough money to live comfortably in retirementjust one year later, that figure was 72%. (www. smartmoney. com) With the baby boomer generation nearing retirement in the up coming years there are numerous questions that need to be answered before they can flat out retire. Have they been saving enough for their retirement or will they fall short in the later years of their lives?
The average baby boomer must realize that they will have more time to enjoy the abundance they are accustomed to and they will need the income to do so. According to the Society of Actuaries, baby boomers can expect to live well into their 80,s and many will live well into there 100s and beyond. That means someone who quits working at 65 may be looking at spending 35 years in retirement. (www. aol. sageonline. com) The worst news about the increase in life expectancy is that people are not saving enough to maintain their high standards of living and they must adjust accordingly.
So what are these people supposed to do? First, people must save as much money immediately and let go of the old notion of retirement. The basic fact is that Social Security currently makes up about 40% of a retirees income, it is now up to the individual investor to generate the remaining 60% in order to maintain the standard of living they are accustomed to. (Prosser 12) Some of the old rules of saving for retirement still apply, Michael McDonald, vice president of a national brokerage firm says the 60 to 80 percent of current income rule is still a good one.
This total usually comes from individuals Social Security, Pension from an employer, and other saving instruments. The trick to retirement is making the savings and investment part of that formula last as long as you do. Traditionally, experts have advised you to invest your savings in stocks and bonds, with the ratio of stocks to bonds gradually decreasing as you get older. The rule of thumb was to have 65% of your investment dollars in bonds by your 65th birthday. (aol. sageonline. com) This rule of thumb has changed recently in order to take into account the increase in life expectancy.
Now that your retirement money has to last longer, the experts are beginning to lean toward investing more of your money in the stock market and keeping it there further into retirement than you normally would. The most important notion that retirees must learn is that the longer you can go without dipping into your principal, the longer your money will last for you due to the rule of compounding of interest. There are numerous different techniques for people to use in order to retire comfortably and remain comfortable until their deaths.
Since deciding how much money you need for retirement is obviously a highly personal calculation, individuals must explore the many different instruments for retirement. So how should people invest today for the future and their retirement? The most crucial retirement investing advice anyone can give is really quite simple: Start early, max out your 401(k), and save as much in other accounts as you can. (www. smartmoneyuniversity. com) If people did that much they would be a lot better off then they currently are.
Even though you dont have to be a genius I order to create a substantial retirement nest egg, the more you know about investing the better off you will be in the long run. Whether you are just starting to save or nearing your retirement age, your portfolio needs a mix if investments stocks, bonds, and cash to provide the proper balance between risk and growth (www. smartmoneyuniversity. com) This will reduce your exposure to risk I you diversify your portfolio and avoid putting all your eggs in one basket.
Individuals must remember that what might be making money for them now, might not be so successful in a few years when they are about to retire. Some studies show that proper asset allocation can have more of an impact on your returns over time than the individual investments that are chosen. Remember, the number one goal for professional financial planners is to find the perfect mix between risky stocks and other types of investments that are more stable or less volatile. What are these retirement instruments and how can they help me retire with a nest egg that will last longer then me thats comfortable?
The following is a description of various ways to save for retirement. 401(k) A 401(k) is a retirement plan offered by a company as some incentive for working with the corporation. The 401(k) gives the employee the opportunity to take their pre-taxed income and invest it in different funds or accounts. The company will match the amount money put into the account by the employee with a percentage somewhere between 25 to 100% of all withholdings. There is no better return in the market available then with the 401(k). Where else are you going to earn 25 to 100% return the day the money is put into the account.
When setting up your 401(k) plan at your new job, it is important to max out the amount you can put into your plan. The financial idea of compounding interest comes into play here. The amount of money invested in the 401(k) account receives interest on a tax-free compounding basis. The benefits of compounding are evident in an example. Suppose you were to invest $100 a month in a 401(k) plan for the past 20 years. You company was matching your investment by 50%. Today you would have $184,000(assuming your account increases in value at least as well as the S&P500).
Without a company match and interest, you would have invested only $24,000 (12months x 20years x $100 = $24,000) of your own pre-taxed dollars. You return for investing in the plan is $160,000 ($184,000 – $24,000 = $160,000), the power of compounding increases as time elapses because you will be earning interest on top of interest and so on. Some other advantages of a 401(k) plan are the ability to make early withdraws from the account. This is only a benefit if the money is gravely needed because the withdraw from the account will have to be paid back with interest.
Other than paying back interest for borrowing you own money, there really is no other drawbacks for having a 401(k) plan. 403(b) A 403(b) plan is very similar to that of a 401(k) plan except that this tax differed retirement plan is available to employees of educational institutions and certain nonprofit organizations. Before the 403(b) was introduced, employees were given pensions that rarely matched their salary. The option to invest in a 403(b) plan gives the employee the needed money for retirement not covered by their pension.
Unlike a 401(k) plan, participants do not have the option to invest in individual stocks. The employees do have the option to invest into accounts with insurance companies offering annuity based contracts or going directly with a mutual fund company. As with the 401(k) plan, withholdings are pre-taxed and earned interest is also tax differed until withdraw (retirement), when it is then taxed as regular income. Along with the 401(k) plan, there are tax benefits due to the pre-tax contributions. Pre-tax contributions can lower a persons tax bill, increasing the value of the money put into the account.
Suppose you were to invest $100 a month to a 403(b) plan, youve reduced you Federal income taxes by roughly $28(in a 28% tax bracket). In affect, your $100 contribution cost you only $72. As time passes the $28 saved earns interest and gets magnified as you approach retirement. Traditional IRA The Traditional IRA (Individual Retirement Account) is as account that provides the needed retirement savings for those people whose employers dont offer or dont offer enough of a retirement plan (401(k), 403(b), or pension).
An IRA is a good alternative to save for retirement if youve already maxed out your 401(k) or 403(b) plans. To provide a comfortable nest egg, people are now forced to save even more for retirement. The IRA gives people the ability to fill in the gaps in their retirement portfolio. As introduced earlier, life expectancy is increasing as well as more and more people taking forced and unforced early retirements. The IRA is key in giving these people the needed extra savings to maintain their pre-retirement life styles. The eligibility requirements of an IRA are easy to achieve.
Basically, if you have receives wages, commissions, tips, professional fees, or bonuses that are reported on your taxes then you are eligible to invest in an IRA. What separates the traditional IRA from other IRAs, which will be discussed later, is that there are no yearly income requirements. You can make as much a year a possible and still be eligible to invest in a traditional IRA. There are limits to how much a person can contribute each year. Each person can invest up to $3000 per year, per person in a household who is eligible; this number will increase to $5000 per person by the year 2007.
An advantage goes to those who are married, their limit to contribute is $3000 per spouse totaling $6000 per household. Contributions to an individuals IRA are based on pre-taxed dollars which makes it a little easier to invest because you never really see the money you invest. Full tax deductibility is an important aspect of the traditional IRA. There are disadvantages to traditional IRAs as opposed to other IRAs. Since pre-taxed dollars are invested, you will be taxed when you make withdraws. An advantage to this is you will pay taxed on your investment while in a lower tax rate while in retirement.
This does not come without penalty though, the growth earned on the investment is also taxed upon withdraw which wipes out some of the benefit of compounding interest. While approaching retirement, if a person has been contributing to an IRA, they will be required to make withdraws in April after their 70th birthday or at age 70. 5. A person cannot make withdraws before retirement without a 10 percent early withdraw fee on top of the taxes. A person could lose up to 45 percent of their investment if they withdraw money from the account early. If the traditional IRA does not seem appealing to any individual there is alternatives with IRAs.
Roth IRA The Roth IRA was created as part of the Taxpayer Relief Act of 1997 and was named after former Senator William V. Roth, Jr. The Roth IRA holds the same idea as a traditional IRA with special rules and provisions that apply to taxes, eligibility and withdraws. In order to be eligible to contribute to a Roth IRA, your annual income must be below a certain amount depending on your marriage status. If you are single, you can contribute up to $3000 per year if you make under $110,000 gross per year. If you are married, the total amount the household can invest is $6000 ($3000 per person) if the household makes under $160,000 per year.
Even though the taxes paid on a Roth IRA are non-deductible, the biggest advantage of a Roth IRA compared to a traditional IRA is the ability to have investment earnings completely escape taxation. Since contributions are post-tax, the money is already taxed so when you reach retirement and plan on making withdraws from your account they are tax-free including the growth of the account. The power of compounding here is magnified in the end and never offset with taxes reducing your withdraws. With a Roth IRA there are more advantages to take advantage of then just the taxes. There is no required age to make withdraws from your account.
If at retirement you want to exhaust your other accounts first, the Roth IRA will still accumulate interest. Making withdraws are non-reportable income and wont change your adjusted gross income which otherwise could put you into a higher tax bracket an affect other withdraws from accounts. This leaves the Roth IRA more flexible because there will be no minimum distribution requirements, so you take out what you need and let the rest grow. After age 59. 5, even before retirement, you will be able to make withdraws before retirement if the account has been open for at least 5 years.
However, the withdraw must fit the requirements of a qualified withdraw. In order for a withdraw to be considered qualified it must be as a result of a medical emergency, loss of working ability, forced retirement, etc The Roth IRA seems like it has no disadvantages but there are drawbacks of a Roth IRA to a traditional IRA. One disadvantage with the taxes is that you are paying taxes now while you are likely to be in a higher tax rate then you would be when you were in retirements. The Roth IRA doesnt offer tax deductibility leaving people to pay more taxes now.