Life Events Guides - Preparing for Retirement

Planning
Unplanned savings is better than no savings at all. But to get the most out of your retirement savings, you should figure out where you want to be and how you're going to get there.

Decide on your strategy
If you are starting your retirement savings early, you can afford to be aggressive and put money into riskier funds. If your fund loses value, you have time to let it grow again. However, if you're getting close to retirement and suddenly your investments lose 40% of their value, it will have a huge negative impact on your financial comfort in retirement.

The extra burden on women
The income gap between men and women is slowly closing - but "slowly" is the key. Women still make less than men for the same jobs. And just as saving a little early can lead to great rewards, missing out on a little income early in the savings process can create a much larger discrepancy later.

More women than men take time to raise children. This unpaid time is also time they aren't saving for retirement. They may expect that their spouse's retirement is also theirs, but divorce is so common that these expectations are often not met.

But women can't blame retirement discrepancies solely on men earning more. Surveys have shown that women tend to invest less aggressively than men. Women tend to put their money in CDs and other lower risk, lower growth investments. Their retirement funds grow more slowly and, over the course of a whole career, the difference between high risk and low risk investments can be enormous.

Mother Nature can also share some of the blame on this one. Women, on average, live seven years longer than men. On one hand, not many women will complain they get an extra seven years to live. But that's also an extra seven years to pay for. That's seven more years of living expenses that women need in retirement savings.

IRAs
An IRA is an Individual Retirement Account that allows you to save up to $3,000 per year in a tax-deferred account. Married couples with one income can put $3,000 more in a spousal IRA. If you are older than 50, you can put an extra $500 per year in your IRA to help save more quickly for your upcoming retirement. The main benefit of an IRA is that you get a tax deduction for your contributions, so the tax on this money is deferred until you withdraw it from your IRA account. Since your income will probably be lower when you retire, you likely will pay a lower overall tax on this money.

To put this in practical terms, if you save $1,000 in an IRA, and you are in the 32% tax bracket, you will save $320 on your current taxes. The tax on that income is deferred until you take the money out of the account. But since you will be retired then, your tax bracket may have decreased to 25%. So when, at age 65, you take the money out of the IRA account, you will only pay $250 in tax. While $70 of savings doesn't seem like much, you are likely to have saved much more than $1,000 by the time you retire. If you save $100,000, your savings will be $7,000!

Another potential advantage of an IRA is that you have the freedom to choose which investments you would like to make with your money. One restriction with an IRA is that you must begin taking withdrawals from your IRA by age 70 and a half.

Roth IRA
If your household income is less than $160,000, or $110,000 if you are single, you may want to contribute to a Roth IRA instead of a traditional IRA. While contributions to a traditional IRA are tax deferred, you get no current tax deductions for money put into a Roth IRA. But your money grows tax-free in a Roth IRA, so when you take out funds from the IRA, you are not taxed on that money or the interest it has earned.

Another difference between a traditional IRA and a Roth IRA is that a Roth IRA does not require you to withdraw funds from your IRA at age 70 and a half. If you are employed, you can even continue to contribute money into that account.

401(k) Plan
If your employer offers a 401(k) plan, you are being offered a great tool to start saving for retirement. A 401(k) plan allows you to take money out of your paycheck before taxes and put it into an investment account. You are not taxed on this money until you take it out of the 401(k) account, hopefully when you retire and are in a lower tax bracket.

Your employer may also provide matching funds, up to a certain percent of your income. So, for example, if your company offers 50 cents on the dollar up to 3% of your income, that means if you put $50 a month into your 401(k) account, your employer will add an additional $25 into your account. But if you earn $2000 a month, the maximum your employer will contribute is $30 a month.

The money your employer contributes to your 401(k) account is not automatically yours. You have to be "vested." To be vested, you have to stay with the company for a certain length of time according to the schedule your employer determines. After that time, any money your employer contributes to your 401(k) money IS yours.

One more important fact about 401(k) funds - if you decide to withdraw your money BEFORE you retire, you will pay a 10% penalty to the IRS AND be taxed on that money. So only withdraw money from a 401(k) as a last resort! Your employer may allow you to borrow money from your account, without penalty. You will, however, pay interest on the loan. But the interest goes right back into your account so you don't actually lose any money in borrowing. Borrowing will slow down your investment growth.

Pensions
Most pensions are funded by the employer, though some may require the employee to contribute. A pension pays a monthly benefit at retirement based on the number of years you worked for the company and your highest salary. This benefit continues for the rest of your life, and will probably provide survivor benefits as well. Some pensions also provide annual cost of living increases.

Self-Employment
Self-employment offers special challenges but also special advantages in saving for retirement. A Keogh plan is a tax-deferred retirement plan, similar to a 401(k), except that it is geared toward self-employed individuals. If you are self-employed, you can contribute up to $40,000 per year to a Keogh plan.

There are two different Keogh plans to choose from: a profit sharing plan, with a variable contribution rate and the availability of in-service withdrawals; or a money purchase plan, with a fixed annual contribution rate.

Self-employed people may choose instead to set up a Simplified Employee Pension, also known as a SEP-IRA, to which they can contribute 15% of their income, up to $40,000 a year. The SEP-IRA does not require special paperwork and annual filings, and so it is a less cumbersome alternative. Also available to small-business employers with employees are SIMPLE plans and SIMPLE 401(k) plans. Check with your tax adviser to see which type of plan would be best for you and your business.

Annuities
Annuities are financial contracts with an insurance company that provide a regular income at retirement. A deferred annuity allows you to contribute money now for use later. You are not allowed to touch this money until you reach the age of 59 and a half. When you reach retirement age, the money you have built up in your annuity will provide you regular income payments throughout your retirement.

An immediate annuity skips the step of making regular payments into an annuity fund. If you have a large sum of money, you can invest this in an annuity and receive regular payments throughout retirement.

There are no limits on how much you can contribute to an annuity. Unlike retirement accounts, the money you contribute is not tax-deductible, but the earnings on the funds are tax-deferred until you withdraw them.

Whole Life Insurance
Whole life insurance is different from term life insurance in that it's an investment. With every premium you pay, you are creating cash value in the policy. Whole life insurance can be considered a retirement investment because you can withdraw money from this account when you retire. If you cash in the policy, you'll pay tax on the difference between what you receive and the premiums you've paid. If you borrow against the cash value of the policy, you won't be taxed on what you borrow, but you'll have to pay interest at a fixed rate on the loan.