Planning for Retirement While You Are Still Young
Retirement probably seems vague and far off at this stage of your life. Besides, you have other things to buy right now. Yet there are some crucial reasons to start preparing now for retirement.
You’ll probably have to pay for more of your own retirement than earlier generations. The sooner you get started, the better.
You have one huge ally – time. Let’s say that you put $1,000 at the beginning of each year into an IRA from age 20 through age 30 (11 years) and then never put in another dime. The account earns 7 percent annually. When you retire at age 65 you’ll have $168,514 in the account. A friend doesn’t start until age 30, but saves the same amount annually for 35 years straight. Despite putting in three times as much money, your friend’s account grows to only $147,913.
You can start small and grow. Even setting aside a small portion of your paycheck each month will pay off in big dollars later. Company retirement plans are the easiest way to save. If you’re not already in your employer’s plan, sign up.
You can afford to invest more aggressively. You have years to overcome the inevitable ups and downs of the stock market.
Developing the habit of saving for retirement is easier when you are young.
Estimate How Much You Need to Save for Retirement
Now that you have a clearer picture of your retirement goal, it’s time to estimate how large your retirement nest egg will need to be and how much you need to save each month to buy that goal. This step is critical! The vast majority of people never take this step, yet it is very difficult to save adequately for retirement if you don’t at least have a rough idea of how much you need to save every month.
There are numerous worksheets and software programs that can help you calculate approximately how much you’ll need to save. Professional financial planners and other financial advisors can help as well. At the end of this booklet, we provide some sources you can turn to for worksheets.
Regardless of what source you use, here are some of the basic questions and assumptions the calculation needs to answer.
How much retirement income will I need?
An easy rule of thumb is that you’ll need to replace 70 to 90 percent of your pre-retirement income. If you’re making $50,000 a year (before taxes), you might need $35,000 to $45,000 a year in retirement income to enjoy the same standard of living you had before retirement. Think of this as your annual “cost” of retirement. The lower your income, generally the higher the portion of it you will need to replace.
However, no rule of thumb fits everyone. Expenses typically decline for retirees: taxes are smaller (though not always) and work-related costs usually disappear. But overall expenses may not decline much if you still have a home and college debts to pay off. Large medical bills may keep your retirement costs high. Much will depend on the kind of retirement you want to enjoy. Someone who plans to live a quiet, modest retirement in a low-cost part of the country will need a lot less money than someone who plans to be active, take expensive vacations, and live in an expensive region.
For younger people in the early stages of their working life, estimating income needs that may be 30 to 40 years in the future is obviously difficult. At least start with a rough estimate and begin saving something -- 10 percent of your gross income would be a good start. Then every 2 or 3 years review your retirement plan and adjust your estimate of retirement income needs as your annual earnings grow and your vision of retirement begins to come into focus.
How long will I live in retirement?
Based on current estimates, a male retiring at age 65 today can expect to live approximately 17 years in retirement. A female retiring today at age 65 can expect to live approximately 20 years.
These are average figures and how long you can expect to live will depend on factors such as your general health and family history. But using today’s average or past history may not give you a complete picture. People are living longer today than they did in the past, and virtually all expert opinion expects the trend toward living longer to continue.
What other sources of income will I have?
Since October 1999, Social Security has been mailing statements to workers age 25 and older showing all the wages reported and an estimate of retirement, survivors and disability benefits. You can also request a statement by visiting the Social Security Administration’s Web site or by calling 1.800.772.1213 and requesting a free Social Security Statement.
How To Prepare For Retirement When There’s Little Time Left
What if retirement is just around the corner and you haven’t saved enough? Here are some tips. Some are painful, but they’ll help you toward your goal.
Will you have other sources of income?
For instance, will you receive a pension that provides a specific amount of retirement income each month? Is the pension adjusted for inflation?
What savings do I already have for retirement?
You’ll need to build a nest egg sufficient to make up the gap between the total amount of income you will need each year and the amount provided annually by Social Security and any retirement income. This nest egg will come from your retirement plan accounts at work, IRAs, annuities, and personal savings.
What adjustments must be made for inflation?
The cost of retirement will likely go up every year due to inflation -- that is, $35,000 won’t buy as much in year 5 of your retirement as it will the first year because the cost of living usually rises. Although Social Security benefits are adjusted for inflation, any other estimates of how much income you need each year – and how much you’ll need to save to provide that income – must be adjusted for inflation. The annual inflation rate is 2.2 percent currently, but it varies over time. In 1980, for instance, the annual inflation rate was 13.5 percent; in 1998, it reached a low of 1.6 percent. When planning for your retirement it is always safer to assume a higher, rather than a lower, rate and have your money buy more than you previously thought. Retirement calculators should allow you to make your own estimate for inflation.
What will my investments return?
Any calculation must take into account what annual rate of return you expect to earn on the savings you’ve already accumulated and on the savings you intend to make in the future. You also need to determine the rate of return on your savings after you retire. These rates of return will depend in part on whether the money is inside or outside a tax-deferred account.
It’s important to choose realistic annual returns when making your estimates. Most financial planners recommend that you stick with the historical rates of return based on the types of investments you choose or even slightly lower.
How many years do I have left until I retire?
The more years you have, the less you’ll have to save each month to reach your goal.
How much should I save each month?
Once you determine the number of years until you retire and the size of the nest egg you need to “buy” in order to provide the income not provided by other sources, you can calculate the amount to save each month.
It’s a good idea to revisit this worksheet at least every 2 or 3 years. Your vision of retirement, your earnings, and your financial circumstances may change. You’ll also want to check periodically to be sure you are achieving your objectives along the way.
”Spend” for Retirement
Now comes the tough part. You have a rough idea of how much you need to save each month to reach your retirement goal. But how do you find that money? Where does it come from?
There’s one simple trick for saving for any goal: spend less than you earn. That’s not easy if you have trouble making ends meet or if you find it difficult to resist spending whatever money you have in hand. Even people who make high incomes often have difficulty saving. But we’ve got some ideas that may help you.
Let’s start with a “spending plan” -- a guide for how we want to spend our money. Some people call this a budget, but since we’re thinking of retirement as something to buy, a spending plan seems more appropriate.
A spending plan is simple to set up. Consider the following steps as a guide, but you may want to use a computer program.
Income. Add up your monthly income: wages, average tips or bonuses, alimony payments, investment income, unemployment benefits, and so on. Don’t include anything you can’t count on, such as lottery winnings, or a bonus that’s not definite.
Expenses. Add up monthly expenses: mortgage or rent, car payments, average food bills, medical expenses, entertainment, and so on. Determine an average for expenses that vary each month, such as clothing, or that don’t occur every month, such as car insurance or self-employment taxes. Review your checkbook, credit card records, and receipts to estimate expenses. You will probably need to track how you spend cash for a month or two. Most of us are surprised to find out where and how much cash “disappears” each month.
Include savings as an expense. Better yet, put it at the top of your expense list. Here’s where you add in the total of the amounts you need to save each month to accomplish the goals you wrote down earlier on the 3” x 5” cards.
Subtract income from expenses. What if you have more expenses (including savings) than you have income? Not an uncommon problem. You have three choices: cut expenses, increase income, or both.
Cut expenses. There are hundreds of ways to reduce expenses, from clipping grocery coupons and bargain hunting to comparison shopping for insurance and buying new cars less often. The section that follows on debt and credit card problems will help. You also can find lots of expense-cutting ideas in books, magazine articles, and financial newsletters.
Increase income. Take a second job, improve your job skills or education to get a raise or a better paying job, make money from a hobby, or jointly decide that another family member will work.
Tips. Even after you’ve tried to cut expenses and increase income, you may still have trouble saving enough for retirement and your other goals. Here are some tips.
- Pay yourself first. Put away first the money you want to set aside for goals. Have money automatically withdrawn from your checking account and put into savings or an investment. Join a retirement plan at work that deducts money from your paycheck. Or deposit your retirement savings yourself, the first thing. What you don’t see, you don’t miss.
- Put bonuses and raises toward savings.
- Make saving a habit. It’s not difficult once you start.
- Revisit your spending plan every few months to be sure you are on track. Income and expenses change over time.
Avoid Debt and Credit Problems
High debt and misuse of credit cards make it tough to save for retirement. Money that goes to pay interest, late fees, and old bills is money that could earn money for retirement and other goals.
How much debt is too much debt? Debt isn’t necessarily bad, but too much debt is. Add up what you pay monthly in car loans, student loans, credit card and charge card loans, personal loans---everything but your mortgage. Divide that total by the money you bring home each month. The result is your “debt ratio.” Try to keep that ratio to 10 percent or less. Total mortgage and nonmortgage debts should be no more than 36 percent of your take-home pay.
What’s the difference between “good debt” and “bad debt"? Yes, there is such a thing as good debt. That’s debt that can provide a financial pay off. Borrowing to buy or remodel a home, pay for a child’s education, advance your own career skills, or buy a car for getting to work can provide long-term financial benefits.
Bad debt is when you borrow for things that don’t provide financial benefits or that don’t last as long as the loan. This includes borrowing for vacations, clothing, furniture, or dining out.
Do you have debt problems? Here are some warning signs:
- Borrowing to pay off other loans.
- Creditors calling for payment.
- Paying only the minimum on credit cards.
- Maxing out credit cards.
- Borrowing to pay regular bills.
- Being turned down for credit.
Avoid high-interest rate loans. Loan solicitations that come in the mail, pawning items for cash, or “payday” loans in which people write postdated checks to check-cashing services are usually extremely expensive. For example, rolling over a payday loan every 2 weeks for a year can run up interest charges of over 600 percent! While the Truth-in-Lending Act requires lenders to disclose the cost of your loan expressed as an annual percentage rate (APR), it is up to you to read the fine print telling you exactly what the details of your loan and its costs are.
The key to recognizing just how expensive these loans can be is to focus on the total cost of the loan – principal and interest. Don’t just look at the monthly payment, which may be small, but adds up over time.
Handle credit cards wisely. Credit cards can serve many useful purposes, but people often misuse them. Take, for example, the habit of making only the 2 percent minimum payment each month. On a $2,000 balance with a credit card charging 18 percent interest, it would take 30 years to pay off the amount owed. Then imagine how fast you would run up your debts if you did this with several credit cards at the same time. (For more information on handling credit wisely, see the Resources section below.)
Here are some additional tips for handling credit cards wisely.
- Keep only one or two cards, not the usual eight or nine.
- Don’t charge big-ticket items. Find less expensive loan alternatives.
- Shop around for the best interest rates, annual fees, service fees, and grace periods.
- Pay off the card each month, or at least pay more than the minimum.
- Still have problems? Leave the cards at home or cut them up.
How to climb out of debt. Despite your best efforts, you may find yourself in severe debt. A credit counseling service can help you set up a plan to work with your creditors and reduce your debts. Or you can work with your creditors directly to try and work out payment arrangements.
Facts Women Should Know About Preparing For Retirement
Women face challenges that often make it more difficult for them than men to adequately save for retirement. In light of these challenges, women need to pay special attention to making the most of their money.
For more information, call the Employee Benefits Security Administration at 1.866.444.3272 and ask for the booklets Women and Retirement Savings, Taking the Mystery Out of Retirement Planning, and QDROs: The Division of Retirement Benefits through Qualified Domestic Relations Orders (for example, divorce orders). Also call the Social Security Administration at 800.772.1213 for their booklet What Every Woman Should Know, or visit the agency’s Web site.
Saving for Retirement
Once you’ve reduced unnecessary debt and created a workable spending plan that frees up money, you’re ready to begin saving toward retirement. You may do this through a company retirement plan or on your own -- options that are covered in more detail below. First, however, let’s look at a few of the places where you might put your money for retirement.
- Savings accounts, money market mutual funds, certificates of deposit, and U.S. Treasury bills. These are sometimes referred to as cash or cash equivalents because you can get to them quickly and there’s little risk of losing the money you put in.
- Domestic bonds. You loan money to a U.S. company or a government body in return for its promise to pay back what you loaned, with interest.
- Domestic stocks. You own part of a U.S. company.
- Mutual funds. Instead of investing directly in stocks, bonds, or real estate, for example, you can use mutual funds. These pool your money with money of other shareholders and invest it for you. A stock mutual fund, for example, would invest in stocks on behalf of all the fund’s shareholders. This makes it easier to invest and to diversify your money.
Choosing where to put your money. How do you decide where to put your money? Look back at the short-term goals you wrote down earlier – a family vacation, perhaps, or the down payment for a home. Remember, you should always be saving for retirement. But, for goals you want to happen soon – say, within a year -- it’s best to put your money into one or more of the cash equivalents — a bank account or CD, for example. You’ll earn a little interest and the money will be there when you need it.
For goals that are at least 5 years in the future, however, such as retirement, you may want to put some of your money into stocks, bonds, real estate, foreign investments, mutual funds, or other assets. Unlike savings accounts or bank CDs, these types of investments typically are not insured by the federal government. There is the risk that you can lose some of your money. How much risk depends on the type of investment. Generally, the longer you have until retirement and the greater your other sources of income, the more risk you can afford. For those who will be retiring soon and who will depend on their investment for income during their retirement years, a low-risk investment strategy is more prudent. Only you can decide how much risk to take.
Why take any risk at all? Because the greater the risk, the greater the potential reward. By investing carefully in such things as stocks and bonds, you are likely to earn significantly more money than by keeping all of your retirement money in a savings account, for example.
The differences in the average annual returns of various types of investments over time are dramatic. Since 1928, the average annual return of short-term U.S. Treasury bills, which roughly equals the return of other cash equivalents such as savings accounts, has been 3.7 percent. The annual return of long-term government bonds over the same period has been 5.2 percent. Large-company stocks, on the other hand, while riskier in the short term, have averaged an annual return of 11.3 percent.
Let’s put that into dollars. If you had invested $1 in Treasury bills in 1928, that $1 would have grown to approximately $20 today. However, inflation, at an annual average of 2.2 percent, would have eaten almost $6 of that gain. If the $1 had been invested in government bonds, it would have grown to over $63. But invested in large-company stocks, it would have grown to over $6,495. None of these rates of returns is guaranteed in the future, but they clearly show the relationship between risk and potential reward.
Many financial experts feel it is important to save at least a portion of your retirement money in higher risk -- but potentially higher returning -- assets. These higher risk assets can help you stay ahead of inflation, which eats away at your nest egg over time.
Tips on How to Save Smart for Retirement
Which assets you want to invest in, of course, is your decision. Never invest in anything you don’t thoroughly understand or don’t feel comfortable about.
Reducing investment risk. There are two main ways to reduce risk. First, diversify within each category of investment. You can do this by investing in pooled arrangements, such as mutual funds, index funds, and bank products offered by reliable professionals. These investments typically give you a small share of different individual investments and will allow you to spread your money among many stocks, bonds, and other financial instruments, even if you don’t have a lot of money to invest. Your risk of losing money is less than if you buy shares in only a few individual companies. Distributing your investments in this way is called diversification.
Second, you can reduce risk by investing among categories of investments. Generally speaking, you should put some of your money in cash, some in bonds, some in stocks, and some in other investment vehicles. Studies show that once you have diversified your investments within each category, the choices you make about how much to put in these major categories is the most important decision you will make and should define your investment strategy.
Why diversify? Because at any given time one investment or type of investment might do better than another. Diversification lets you manage your risk in a particular investment or category of investments and decreases your chances of losing money. In fact, the factors that can cause one investment to do poorly may cause another to do well. Bond prices, for example, often go down when stock prices are up. When stock prices go down, bonds often increase in value. Over a long time -- the time you probably have to save for retirement -- the risk of losing money or earning less than you would in a savings account tends to decline.
By diversifying into different types of assets, you are more likely to reduce risks, and actually improve return, rather than by putting all of your money into one investment or one type of investment. The familiar adage “Don’t put all your eggs in one basket” definitely applies to investing.
Deciding on an investment mix. How you diversify -- that is, how much you decide to put into each type of investment -- is called asset allocation. For example, if you decide to invest in stocks, how much of your retirement nest egg should you put into stocks: 10 percent … 30 percent …75 percent? How much into bonds and cash? Your decision will depend on many factors: how much time you have until retirement, your life expectancy, the size of your current nest egg, other sources of retirement income, how much risk you are willing to take, and how healthy your current financial picture is, among others.
Your asset allocation also may change over time. When you are younger, you might invest more heavily in stocks than bonds and cash. As you get older and enter retirement, you may reduce your exposure to stocks and hold more in bonds and cash. You also might change your asset allocation because your goals, risk tolerance, or financial circumstances have changed.
Rebalancing your portfolio. Once you’ve decided on your investment mix and invested your money, over time some of your investments will go up and others will go down. If this continues, you may eventually have a different investment mix than you intended. Reassessing your mix, or rebalancing, as it is commonly called, brings your portfolio back to your original plan. Rebalancing also helps you to make logical, not emotional, investment decisions.
For instance, instead of selling investments in a sector that is declining, you would sell an investment that has made gains and, with that money, purchase more in the declining investment sector. This way, you rebalance your portfolio mix, lessen your risk of loss, and increase your chance for greater returns in the long run.
Here’s how rebalancing works: Let’s say your original investment called for 10 percent in U.S. small company stocks. Because of a stock market decline, they now represent 6 percent of your portfolio. You would sell assets that had increased and purchase enough U.S. small company stocks so they again represent 10 percent of your portfolio.
How do you know when to rebalance? There are two methods of rebalancing: calendar and conditional. Calendar rebalancing means that once a quarter or once a year you will reduce the investments that have gone up and will add to investments that have gone down. Conditional rebalancing is done whenever an asset class goes up or down more than some percentage, such as 25 percent. This method lets the markets tell you when it is time to rebalance.
The Power of Compounding
Power of Compounding
Regardless of where you choose to put your money – cash, stocks, bonds, real estate, or a combination of places – the key to saving for retirement is to make your money work for you. It does this through the power of compounding. Compounding investment earnings is what can make even small investments become larger given enough time.
You’re probably already familiar with the principle of compounding. Money you put into a savings account earns interest. Then you earn interest on the money you originally put in, plus on the interest you’ve accumulated. As the size of your savings account grows, you earn interest on a bigger and bigger pool of money.
This chart provides an example of how an investment grows at different annual rates of return over different time periods. Notice how the amount of gain gets bigger each 10-year period. That’s because money is being earned on a bigger and bigger pool of money.
Also notice that when you double your rate of return from 4 percent to 8 percent, the end result after 30 years is over three times what you would have accumulated with a 4 percent return. That’s the power of compounding!
The real power of compounding comes with time. The earlier you start saving, the more your money can work for you. Look at it another way. For every 10 years you delay before starting to save for retirement, you will need to save three times as much each month to catch up. That’s why no matter how young you are, the sooner you begin saving for retirement, the better.
Using Employer-Based Retirement Plans
Does your employer provide a retirement plan? If so, say retirement experts…..grab it! Employer-based plans are the most effective way to save for your future. What’s more, you’ll gain certain tax benefits. Employer-based plans come in one of two varieties (some employers provide both): defined benefit and defined contribution.
Defined Benefit Plans. These plans pay a lump sum upon retirement or a guaranteed monthly benefit. The amount of payout is typically based on a set formula, such as the number of years you have worked for the employer times a percentage of your highest earnings on the job. Usually the employer funds the plan---commonly called a traditional pension plan---though in some plans workers also contribute. Most defined benefit plans are insured by the federal government.
Defined Contribution Plans. The popular 401(k) plan is one type of defined contribution plan. Unlike a defined benefit plan, this type of savings arrangement does not guarantee a specified amount for retirement. Instead, the amount you have available in the plan to help fund your retirement will depend on how long you participate in the plan, how much is invested, and how well the investments do over the years. The federal government does not guarantee how much you accumulate in your account, but it does protect the account assets from misuse by the employer.
In the past 20 years, defined contribution plans have become more common than traditional retirement plans. Employers fund most types of defined contribution plans, though the amount of their contributions is not necessarily guaranteed.
Workers with a retirement plan are more likely to be covered by a defined contribution plan, usually a 401(k) plan, rather than the traditional defined benefit plan. In many defined contribution plans, you are offered a choice of investment options, and you must decide where to invest your contributions. This shifts much of the responsibility for retirement planning to workers. Thus, it is critical that you choose to contribute to the plan once you become eligible (usually after working full time for a minimum period) and, even if you are automatically enrolled in the plan, to contribute as much as possible. Invest wisely – review your plan investment options and revisit your choices at least once a year.
How To Make The Most Of A Defined Contribution Plan
Tax Breaks. Even though you may be responsible for funding a defined contribution plan, you receive important tax breaks. The money you invest in the plan and the earnings on those contributions are deferred from income tax until you withdraw the money (hopefully not until retirement). Why is that important? Because postponing taxes on what you earn allows your nest egg to grow faster. Remember the power of compounding? The larger the amount you have to compound, the faster it grows. Even after the withdrawals are taxed, you typically come out ahead.
The tax deduction also means that the decline in your take-home pay, because of your contribution, won’t be as large as you might think. For example, let’s assume you are thinking about putting $100 into a retirement plan each month and that the rate you pay on income taxes is 15 percent. If you don’t put that $100 into a retirement plan, you’ll pay $15 in taxes on it. If you put in $100, you postpone the taxes. Thus, your $100 retirement plan contribution would actually reduce your take-home pay by only $85. If you’re in the 25 percent tax bracket, the cost of the $100 contribution is only $75. This is like buying your retirement at a discount.
Vesting Rules. Any money you put into a retirement plan out of your pay, and earnings on those contributions, always belong to you. However, contrary to popular belief, employees don’t always have immediate access to the money their employer puts into their pension fund or their defined contribution plan. Under some plans, such as a traditional pension plan or a 401(k), you have to work for a certain number of years ---- say, 3 ---- before you become “vested” and can receive benefits. Some plans vest in stages. Other defined contribution plans, such as the SEP and the SIMPLE IRA, vest immediately. You have access to the employer’s contributions the day the money is deposited. No employer can require you to work longer than 7 years before you become vested in your retirement benefit.
Be aware of the vesting rules in your employer’s plan.
Make sure you know when you’re vested. Changing jobs too quickly can mean losing part or all of your retirement benefits or, at the very least, your employer’s matching contributions.
Retirement Plan Rights. The federal government regulates and monitors company retirement plans. The vast majority of employers does an excellent job in complying with federal law. Unfortunately, a small fraction doesn’t. For warning signs that your 401(k) contributions are being misused and other information on protecting your retirement benefits, visit EBSA’s Web site or call EBSA’s toll-free number at 1.866.444.3272 and request the booklet What You Should Know About Your Retirement Plan.
Retirement Planning For Employees In Small Companies
If you don’t have a plan available at work, encourage your employer to start one. Many small employers believe their workers prefer higher salaries or other benefits, and they believe the rules are too complex and the costs too high.
Mention the following benefits:
For more information, contact EBSA at 1.866.444.3272 and request Choosing a Retirement Solution for Your Small Business, SIMPLE IRA Plans for Small Businesses, SEP Retirement Plans for Small Businesses, 401(k) Plans for Small Businesses, Automatic Enrollment 401(k) Plans for Small Businesses, Profit Sharing Plans for Small Businesses, or Payroll Deduction IRAs for Small Businesses.
Types Of Defined Contribution Plans
The following are some of the most common types of defined contribution plans. For a more detailed description and comparison of some of these plans, visit www.dol.gov/elaws/pwbaplan.htm.
401(k) Plan. This is the most popular of the defined contribution plans and is most commonly offered by larger employers. Employers often match employee contributions.
403(b) Tax-Sheltered Annuity Plan. Think of this as a 401(k) plan for employees of school systems and certain nonprofit organizations. Investments are made in tax-sheltered annuities or mutual funds.
SIMPLE IRA. The Savings Incentive Match Plan for Employees of Small Employers is a simpler type of employer-based retirement plan. There is also a 401(k) version of the SIMPLE.
Profit Sharing Plan. The employer shares company profits with employees, usually based on the level of each employee’s wages.
ESOP. Employee stock ownership plans are similar to profit sharing plans, except that an ESOP must invest primarily in company stock. Under an ESOP, the employees share in the ownership of the company.
SEP. Simplified employee pension plans are used by both small employers and the self-employed.
Other retirement plans you may want to learn more about include 457 plans, which cover state and local government workers; and the Federal Thrift Savings Plan, which covers federal employees. If you are eligible, you may also want to open a Roth IRA.
What To Do If You Can’t Join an Employer-Based Plan
You may not be able to join an employer-based retirement plan because you are not eligible or because the employer doesn’t offer one. Fortunately, there are steps you can still take to build your retirement strength.
Take a job with a plan. If two jobs offer similar pay and working conditions, the job that offers retirement benefits may be the better choice.
Start your own plan. If you can’t join a company plan, you can save on your own.
You can’t put away as much as on a tax-deferred basis and you won’t have an employer match. Still, you can build a healthy nest egg if you work at it.
Open an IRA. You can put up to $5,000 a year into an individual retirement account on a tax-deductible basis if your spouse isn’t covered by a retirement plan at work, or as long as your combined incomes aren’t too high. Persons who are 50 or older can contribute an additional $1,000. You can also put the same amount tax-deferred into an IRA for a nonworking spouse if you file your income tax return jointly. (By the way, you don’t have to put in the full amount; you can put in less.) With a traditional IRA, you delay income taxes on what you put in and on the earnings until you withdraw the money. With a Roth IRA, the money you put in is already taxed, but you won’t ever pay income taxes on the earnings as long as the account is open at least 5 years.
Consider an annuity. An annuity is when you pay money to an insurance company in return for its agreement to pay either a regular fixed amount when you retire or an amount based on how much your investment earns. There is no limit on how much you can invest in a private annuity, and earnings aren’t taxed until you withdraw them. However, annuities present complex issues regarding taxes, fees, and withdrawal strategies that may not make them the best investment choice for you. Consider discussing this type of investment first with a financial planner.
Build your personal savings. You can always save money on your own, either in mutual funds, stocks, bonds (such as U.S. Savings Bonds), real estate, CDs, or other assets. It’s best to mark these investments as part of your retirement fund and don’t use them for anything else unless absolutely necessary.
Investing in an IRA, an annuity, or in personal savings means you are totally responsible for directing your own investments. How conservatively or aggressively you invest is up to you. It will depend in part on how willing you are to take investment risks, your age, the stability of your job, and other financial needs. Learn as much as you can about investing and about specific investments you are considering. You also may want to seek the help of a professional financial planner. Go to www.CFP.net/learn for tips on choosing a financial planner who puts your interests first.
What To Do If You Are Self-Employed
Many people today work for themselves, either full-time or in addition to their regular job. They have several tax-deferred options from which to choose.
SEP. This is the same type of SEP described earlier under employer-based retirement plans. Only here, you’re the employer and you fund the SEP from your earnings. You can easily set up a SEP through a bank, mutual fund or other financial institution.
“Keogh.” “Keoghs” are more complicated to set up and maintain, but they offer more advantages than a SEP. For one thing, they come in several varieties. Some of the varieties allow you to sock away more money --- sometimes a lot more money --- than a SEP.
SIMPLE IRA. Described earlier under employer-based retirement plans, a SIMPLE IRA can be used by the self-employed. However, generally you can’t save as much as you can with a SEP or “Keogh.”
IRA. Usually you are better off funding a SEP or a “Keogh” unless your self-employment income is small.
Annuities. See annuities under the section on What to Do if You Can’t Join an Employer-Based Plan.
Managing for a Lifetime of Financial Growth
As mentioned earlier, you probably will experience several major events in your life that can make it more difficult to start or keep saving toward retirement and other goals. The key is to have a clear plan, to stay focused on your goals, and to manage your money so that life events don’t prevent you from keeping on target.
Here are a few suggestions for saving for retirement while financially managing some common life events.
Marriage. Getting married creates new financial demands that compete for retirement dollars, such as changing life insurance needs and saving to buy a home. But it’s usually less expensive for two people to live together, thus freeing up dollars. Also, you probably still have time on your side. A spending plan is essential. Remember, every little bit helps.
Raising children. The U.S. Department of Agriculture estimates that it costs the average American middle-income family approximately $286,000 to raise a child to age 17. Furthermore, in some cases a spouse may stay out of the workforce to raise children, thus cutting into income and the opportunity to fund retirement. Having a child may alter your major financial goals, but should never eliminate them. Make the best effort you can. Also, many financial planners stress that saving for retirement should have priority over saving for a child’s college education. There are financial aid programs for college-bound students but not for retirement.
Changing jobs. It's estimated that the average worker changes jobs more than 10 times in a working lifetime. Changing jobs often puts you at risk of not vesting in your current job, or a new job may not offer a retirement plan. Consider rolling money from an existing company retirement plan into a new company plan or an individual retirement account (IRA). Don’t cash out and spend the money, however small the amount.
Divorce. It’s important that you know the laws regarding your spousal rights to Social Security and retirement benefits. Under current law, spouses and dependents have specific rights. Remember, retirement assets may well be the biggest financial asset in the marriage. Be sure to divide those assets carefully. It’s also critical to review your overall financial situation before and after your divorce. Income typically drops for partners in the wake of a divorce, particularly for women.
Disability. A severe or long-lasting disability can undermine efforts to save for retirement. Although Social Security Disability benefits can help sustain a family if severe disability strikes, you may wish to explore the availability and cost of other forms of disability insurance.
Death. The premature death of a spouse can undermine efforts for the partner to save for retirement, particularly if there are dependent children. That’s why it’s important to check your Social Security statement to find out how much children will receive if a parent dies. Maintaining adequate life insurance is also important. Be sure that you have properly named the beneficiaries for any insurance policies, retirement plans, IRAs, and other retirement vehicles.
Coping With Financial Crises
Life has a way of throwing unexpected financial roadblocks, detours and potholes in our path. These might be large medical bills, car or home repairs, a death in the family, loss of a job, or expensive legal problems. Such financial emergencies can derail your efforts to save for retirement or other goals. Here are some strategies for managing financial crises.
Establish an emergency fund. This can lessen the need to dip into retirement savings for a financial emergency. Building an emergency fund is tough if income is tight, but every few dollars help. Fund it with pay from extra working hours or a temporary job, a tax refund, or a raise. Put the money into a low-risk, accessible account such as a savings account or a money market fund.
Insure yourself. Insurance protects your financial assets, such as your retirement funds, by helping to take care of the really big financial disasters. Here’s a list of insurance coverage you should consider buying:
- HEALTH. If you and your family aren’t covered under an employer’s policy, at least try to buy catastrophic medical coverage on your own.
- DISABILITY. Did you know you are more likely before age 65 to miss at least 3 months of work because of a disability than you are to die? Social Security Disability Insurance can pay you and your family benefits if you are severely disabled and are expected to be so for at least 12 months. (Worker’s compensation only helps if the disability is work-related.) In addition, your employer may offer some disability coverage, but you may need to supplement it with private coverage.
- RENTERS. Homeowners usually are insured against hazards such as fire, theft, and liability, but the majority of renters aren’t. Renter’s insurance is inexpensive.
- AUTOMOBILE. Don’t drive “bare.” It’s usually against the law to drive without auto coverage, to say nothing of being costly if you are in an accident.
- UMBRELLA. This provides additional liability coverage, usually through your home or auto insurance policies, in the event you face a lawsuit.
- LIFE: Having life insurance can help you or your spouse continue to save if either one of you dies before retirement. Social Security may be able to pay benefits to your spouse and/or minor children. On the other hand, you may not need life insurance if no one depends financially on you. There are many types of life insurance, with a variety of fees and commissions attached.
- LONG-TERM CARE. This insurance can help pay for costly long-term health care either at home or in a health care facility or nursing home. It protects you from draining savings and assets you otherwise could use for retirement.
Borrow. If you must borrow because of a financial emergency, carefully compare the costs of all options available to you.
Sell investments. It's usually advisable to sell taxable investments first. Try not to touch your fast growing retirement accounts. Taking money out of your retirement accounts could trigger income taxes and penalties.
If You Choose To Work With A Financial Planner
You are the one ultimately responsible for the management of your own financial affairs. However, you may want additional help along the way from a professional financial planner. A professional planner can:
For more information, call Certified Financial Planner Board of Standards Inc. at 1.800.487.1497 and request a free Financial Planning Resource Kit or visit their Web site. There you will find a personal data organizer, interview checklist, and other tools to help you select a financial planner who will put your interests first.
Monitor Your Progress
Financial planning is not a one-time process. Life, your goals, tax laws, and your financial world have a way of changing, sometimes dramatically.
- Periodically review your spending plan.
- Monitor the performance of investments. Make adjustments if necessary.
- Make sure you contribute more toward your retirement as you earn more.
- Update your various insurance safety nets to reflect changes in income or personal circumstances.
- Keep your finances in order.
Where To Go From Here
You now realize that saving for your own retirement is critical and that it is primarily your responsibility. You may get help along the way, but most of the work is going to rest on your shoulders. No one will work harder or care more about your retirement and your other financial goals than you.
Look back on those 3” x 5” cards outlining your goals. Perhaps they seem more realistic now. Even if you can’t do as much as you would like to right away, you can do something.
Think of this booklet as a starting point. Continue to educate yourself about managing your money and investing. Consider professional resources as well, such as your benefits department, financial planners, and other financial experts who can help you not only with your financial questions, but, more importantly, can help motivate you into action.
Finally, there is only one real key to “buying” that retirement you’ve dreamed of. It doesn’t matter whether you are still young or whether retirement is just around the corner. It doesn’t matter whether you’re in your first job, trying to save for a home, or putting a child through college.
All that matters is that you start saving…now!
This publication is presented by the:
Employee Benefits Security Administration
U.S. Department of Labor
200 Constitution Ave., NW
Washington, DC 20210
Web site: www.dol.gov/ebsa
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Certified Financial Planner Board of Standards, Inc.
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Web site: www.CFP.net/learn
Toll-free number: 1.800.487.1497
- 401(k) Plans for Small Businesses
- A Look at 401(k) Plan Fees
- Automatic Enrollment 401(k) Plans for Small Businesses
- Choosing a Retirement Solution for Your Small Business
- Payroll Deduction IRAs for Small Businesses
- Profit Sharing Plans for Small Businesses
- QDROs: The Division of Retirement Benefits through Qualified Domestic Relations Orders
- SEP Retirement Plans for Small Businesses
- SIMPLE IRA Plans for Small Businesses
- Taking the Mystery Out of Retirement Planning
- What You Should Know About Your Retirement Plan
- Women and Retirement Savings
Sample Financial Calculator Web Sites
- Taking the Mystery Out of Retirement Planning – Select “Interactive Worksheets.”
- www.kiplinger.com – Select “Retirement,” then “Tools & Calculators.”
- http://money.cnn.com – Select “Personal Finance, then “Money 101,” then “Lesson 13: Planning for Retirement.”
- www.choosetosave.org/asec – Select “Ballpark Estimate.”
- www.finra.org – Select “Investors,” then “Retirement Calculator.”
(Note: The sites above are only a sample of calculators available on the Web. The Department of Labor does not endorse a specific calculator or the products and services offered on these Web sites.)
Getting Out of Debt
- www.ftc.gov/credit – View “Knee Deep in Debt” and “Fiscal Fitness: Choosing a Credit Counselor” (Go to “In Debt?”).
Other Web sources that highlight savings and retirement planning
- http://investor.gov – View the U.S. Securities and Exchange Commission’s investor information Web site for online help with investing and consumer protection questions. Toll-free consumer information number: 1.800.SEC(732).0330
- www.mymoney.gov – This Web site is sponsored by the Financial Literacy and Education Commission, and has among its offerings the My Money Toll Kit.
- www.ftc.gov – Check out the Federal Trade Commission’s section “Consumer Protection,” including alerts on investment schemes.
- www.pueblo.gsa.gov – The Federal Citizen Information Center’s site contains text versions of hundreds of consumer publications. See the “Money” section for a list of brochures on money management and retirement planning.
- www.socialsecurity.gov – Visit the Social Security Administration’s Web site for pages on retirement. Wage earners can request a Personal Earnings and Benefits Estimate Statement or can estimate their retirement benefits online.
- www.irs.gov/ep – The IRS Web site provides tax information on IRAs, 401(k) plans, SEP and SIMPLE plans, and much more.
- www.savingsbonds.gov – The Bureau of the Public Debt’s Web site features pages on savings bonds, a savings bond calculator, and instructions for buying bonds online.
- www.fdic.gov – The Federal Deposit Insurance Corporation’s Web site offers a financial education program, “Money Smart,” a comprehensive financial education curriculum designed to help individuals outside the financial mainstream enhance their financial skills and create positive banking relationships.
- www.investoreducation.org – Investors of all ages can learn about the basics of investing at the Investor’s Clearinghouse, sponsored by the Alliance for Investor Education (AIE).
- www.aarp.org – The AARP site provides advice on a host of retirement planning issues. Link to “Money” for information on financial planning.
- www.nefe.org – Browse the Web site of the National Endowment for Financial Education (and especially the “Multimedia Access” section) for a wealth of preretirement information.
- www.jumpstartcoalition.org – Jump$tart Coalition for Personal Financial Literacy offers personal financial education materials aimed at grades K-12.
- www.consumerfed.org – The Consumer Federation of America offers several financial publications, including “66 Ways to Save Money,” and runs the America Saves campaign to encourage savings among low-to-moderate income households.
Certified Financial Planner Board of Standards Inc. is a partner in the preparation of this publication. CFP Board owns the marks CFP®, CERTIFIED FINANCIAL PLANNER™ and in the U.S., which it awards to individuals who successfully complete initial and ongoing certification requirements. Visit CFP Board’s Web site, www.CFP.net/learn, for interactive tools, polls, quizzes and eNewsletter updates about financial planning.
This publication has been developed by the U.S. Department of Labor, Employee Benefits Security Administration. It is available on the Internet at www.dol.gov/ebsa. For a complete list of EBSA publications or to order copies, call toll-free 1.866.444.3272. This material will be made available in alternate format upon request: Voice phone: 202.693.8664 TTY: 202.501.3911. This publication constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Act of 1996.