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Home : Your Finances : Saving & Investing : Retirement Planning

Retirement Planning

Retirement may seem like it's way off in the future, and it's therefore easy to convince ourselves that we don't have to worry about it anytime soon.

But the problem with that thinking is that by the time we feel a need to start planning for our golden years, there may not be enough time to accumulate a substantial "nest egg". In fact, according to a June 2006 survey by the Center for Retirement Studies at Boston College, 43% of Americans will not have enough saved to maintain their standard of living in retirement. When it comes to retirement planning, the best tool you've got going for you is time. So the sooner your start saving, the better.

Let's look at an example:

Age of person when contributions begin

25 years

40 years

Starting Salary

$40,000

$40,000

% of salary contribued to retirement fund

5%

5%

% of contributions matched by employer

50%

50%

Average annual salary increase

2%

2%

Annual rate of return on investments

9%

9%

Age at retirement

65 years

65 years

Amount saved at retirement

$1,311,696

$313,646

As you can see, the only factor that was different in this scenario was the age at which contributions began. If a person starts saving at 40 years of age, he could save $313,646 by the time he retires at age 65. But by starting contributions at the age of 25, the amount saved at retirement jumps to $1,311,696.

Retirement Plans

Years ago, many employees could count on a pension and Social Security to fund their retirement. Today, the stability and future of Social Security are in question and only 20% of Americans are eligible for a pension (Source: June 2006 survey by the Center for Retirement Studies at Boston College).

So many individuals are participating in voluntary retirement plans such as Individual Retirement Accounts (IRAs) or plans offered through employers, such as the 401(k) plan. Similar to the 401(k) plan are the 457 plan for employees of local and state government agencies, and the 403(b) plan for employees of non-profit organizations.

401(k)

A 401(k) plan is a tax-deferred defined contribution plan. You select the amount you want to contribute, and the money is automatically deducted from each paycheck on a pre-tax basis. Most plans give you several options for investing the money and creating a diverse portfolio that may include stocks, bonds, annuities and/or self-directed brokerage accounts. Since the money is tax deferred, the taxable income you will report to the IRS is lower. For example, if you earn $50,000 a year and contribute $5,000 of your earnings to your employer's 401(k) plan, you'll report only $45,000 of earnings. When you withdraw your money from the plan you will have to pay tax on the contributions and any earnings.

One of the biggest benefits of these plans is that many employers will match some or all of the employees' contributions. So, for example, if you put $2000 into your 401(k) each year and your employer matches 50% of employee contributions, you'll receive another $1000 in contributions each year!

It should be noted that employers usually require you to be vested (employed with the company for a specified number of years) before you can collect the matched portion of the contributions. If you leave the company before you are fully vested, you may have to forfeit all or some of the contributions that your employer made. Of course, the money that you contributed yourself is yours.

Because this is a retirement plan, the money can generally be withdrawn only for the following reasons:

  • Termination of employment
  • Disability
  • Reaching age 59 ½ (or 55 in some cases)
  • Retirement
  • Death

It is important to note that if money is withdrawn before reaching age 59 ½ the IRS may issue a 10% early withdrawal penalty.

Some 401(k) plans allow you to take out a loan from the plan contributions, usually up to 50% of your vested account balance. The reason for the loan is usually restricted to: (1) education expenses for yourself, spouse, or child; (2) to prevent eviction from your home; (3) to pay un-reimbursed medical expenses; or (4) to buy a first-time residence. Loan payments are generally deducted from your paycheck. When the loan is repaid, the savings are restored, plus interest.

If you change jobs, you may have the option to roll over your money into your new employer's 401(k) or to put the money into an IRA.

To learn more about 401(k) plans, visit www.401k.org.

For a 401(k) calculator, go to:
http://www.mycalculators.com/ca/401kcalcm.html or http://www.bankrate.com/brm/calculators/retirement/401k_retirement_calculator.asp

IRA

Another way to save for retirement is through an IRA (Individual Retirement Account), which you can set-up through a bank or brokerage house. There are two main types of IRAs: the Traditional IRA and the Roth IRA.

Traditional IRA Profile

  • Tax deductible contributions (depending on income level)
  • Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
  • Withdraws begin at age 59 ½ and are mandatory by 70 ½.
  • Taxes are paid on earnings when withdrawn from the IRA.
  • Available to everyone; no income restrictions.
  • All funds withdrawn (including principal contributions) before age 59 ½ are subject to a 10% penalty (subject to exception).

Roth IRA Profile

  • Contributions are not tax deductible
  • Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
  • No mandatory distribution age
  • All earnings and principal are 100% tax free if rules and regulations are followed.
  • Available only to single-filers making up to $95,000 or married couples making a combined maximum annual income of $150,000.
  • Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions)