Retirement Plan Basics
When it comes to investing for retirement, everyone has a different style and time line. Some people prefer to concentrate only on retirement plans and IRAs. Others tend to favor
personal, non-retirement investments. Most people focus on retirement in their 30-something years, blending personal and retirement plan investments to come up with a cohesive
plan.
But too many people put off thinking about retirement investing until their 40's and then realize they need an active investment program, one that will really and truly fund a
secure retirement.
If you want to accumulate enough assets and income for a stress-free retirement and long-term financial security, start planning now.
As a general rule (and all general rules are subject to exceptions), during the retirement years you'll spend 60 to 80% of your pre-retirement income to maintain the same standard
of living. This is a major goal for anyone, at any income level. It takes personal effort, discipline, and commitment to get the job done. So, how do you even begin to meet your
retirement needs?
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The Big Picture
A comfortable retirement requires advance planning and goal pre-retirement income for life), you'll need to see how your sources of income will fit together.
Like most people, you'll have income from Social Security, retirement plans and other tax-deferred retirement accounts. There will also likely be other investments you can draw
from to fund your retirement. You might also choose to work during retirement. Here's how you might fund your retirement.
Social Security is an automatic retirement program, and law determines your participation and level of contributions. Another source is retirement plans and accounts, and that's
often more within your control; many such plans are funded partially (401(k) account)or completely by individuals (IRA accounts). When it comes to personal investments, you are
completely in charge of setting money aside for retirement. Another source is to keep working, full- or part-time. It's your call.
How to Accumulate Money on Which to Retire
Once you've set your income goal (e.g., 60 to 80% of pre-retirement income) and determined how much Social Security you'll receive, then you can see what else you need to accumulate.
Before you decide where to put your retirement dollars, you need to know how and when you're going to save them.
Pay Yourself First
One way to invest for retirement is not to budget for it. If you try to budget a portion of your salary for retirement savings, this item will always be at the bottom of the list.
Why? All other expenditures will either have a more immediate, short-term benefit or may seem to be more urgent. It's just human nature.
There are two ways to approach saving:
1. Pay yourself first. Make sure money
for retirement investing comes off the top, not the bottom,
of your income. With one caveat: if you're paying high
interest on credit card debt and getting no income tax
deduction, it may be best to clear up your debt situation
first.
2. Make the saving process automatic so you
don't even have to think about it. How? Try setting
up automatic withdrawals from your paycheck or your
checking account that go directly into a retirement
plan, IRA or other personal savings and investments.
And, with some retirement contributions, you can get the
added benefit of having the contributions reduce your taxable
income for that year. You may not even miss the money you're
putting away - you may pay less income tax that year.
Start Saving Yesterday
With retirement funding it's really important to start saving as soon as possible.
The sooner you set up an automatic savings plan, the more you'll have at retirement.
Here are some examples that illustrate the advantages of saving early and often.
Scenario One
Starting at age 20, Jane put $2,000 a year of her salary into a Roth IRA (a retirement
account that can potentially be income tax-free). At ages 21 and 22, she again
added $2,000 each year. Then she stopped making contributions. If those three
contributions generate a return of 10% per year, she'll have $247,616 by the
time she's 60!
Scenario Two
John waited until age 40 to make his first $2,000 contribution. Then he made
$2,000 contributions faithfully every year for 19 years. Based on a 10% per year
return like Jane's, John would only have $128,005 almost 50% less at age 60.
This example with a hypothetical annual return shows the power of saving earlier
so your money can work for you longer. We're not trying to discourage people
over 20 from investing. Instead, we want you to see how important it is to save
and invest as much as possible, as soon as possible.
Choosing the Right Kinds of Investments
Answering these questions will help you find the right investments:
 How
much risk is associated with your portfolio?
How
are your investments spread out and diversified?
When
will you need to turn an investment into cash?
How
easy will it be to turn your investments into cash?
What
are the income tax consequences of your different investment options?
What
costs are associated with each investment?
How
do your investments defend you against future inflation?
Do
you understand what you're investing in?
Every investment has its pros and cons. So what are the right investments for
you?
Investing for Growth
Naturally you want your investments to grow in value. The earlier you start investing,
the more time you have for that growth to happen. The later you start to invest,
the more pressure you'll feel to look for fast growth.
But be careful. When you're eager to catch up, it's easier to ignore the warning
signs of an investment that's too risky. A high rate of return usually involves
greater risk. The best ways to minimize risk is to start investing as soon as
possible and consider securities with low levels of risk.
Also, you may be able to take more risks when you're younger because you may
still have time to bounce back from investment setbacks. But in general, a high
level of risk isn't healthy for anyone.
If you're looking for growth over time, stocks and mutual funds that own stocks
have generally performed better than bonds and bond funds. However, there will
always be periods of volatility. Instead of trying to 'time the market,' the
more years you can invest, the more likely you are to reach your goals without
the need for unusually high returns. That way, you'll come out closer to the
historical average (about 11%), through good times and bad.
Investing for Income
Once you've accumulated your retirement nest egg, you may want to switch from
growth to income-producing investments. Bonds, money market instruments, some
types of savings accounts or certificates of deposit can produce more income
or bring you a regular source of income. Stock dividends can be a source, too.
However, with increased life expectancies, and the impact of inflation over time,
you may still need to invest for some growth, too, during your retirement years.
Investing in Retirement Plans
Tax-deferred retirement plans and accounts allow your investments to grow faster.
A tax-deferred investment is one that isn't subject to income tax until you take
distributions. And with a Roth IRA you may pay no income tax on distributions
at all.
Why does a tax-deferred investment grow faster than a non-deferred one? It's
no mystery. If the IRS suddenly announced that you didn't have to pay income
tax, your take-home paycheck would go up, and you'd have more money to spend
and save. That's how it works with tax-deferred retirement plans and accounts.
You are not subject to income tax until you take money out until you take a distribution.
By contrast, if you pay income tax on your non-tax-deferred investments during
the growing years, there's less money to grow.
If you are an employee, you may participate in a plan (such as a 401(k) plan)
where your employer makes contributions to partially or fully match your contributions.
This gives you a strong incentive for adding retirement dollars to the plan.
Your employer's money can clearly help you reach your retirement goals.
Even if you wanted to put every dollar you had into retirement plans and accounts,
you couldn't. There are legal limits on the annual contributions you can make.
The limits vary considerably.
Remember that you're investing in retirement plans and accounts for the long
term. Some plans may allow participants to take loans on the money in their account,
but these are retirement plans, not ATMs. Taking money out of your retirement
plan now can seriously reduce the size of your retirement nest egg: you won't
have all those assets working for you.
And another thing: If you take withdrawals before age 59½, you may have to pay
penalties.
Also, distributions from retirement plans and accounts are generally subject
to income tax at ordinary income tax rates. Sometimes Roth IRA proceeds are income
tax-free. There are two main classes of income tax: ordinary and long-term capital
gains. Ordinary income tax rates are higher (the federal rates are from 15% to
39.6%). Long-term capital gains rates range from 8% to 20%.
Investing Outside Retirement Plans
Personal investments are generally invested in stocks, bonds, mutual funds, and
savings accounts just like retirement plans and accounts. But your personal assets
may include a wide variety of other things, like business interests, real estate,
precious metals, and annuities-even life insurance.
All these choices come with greater complexity. Yearly income from these investments
may be subject to ordinary income tax. If you sell them, you may be taxed at
the ordinary income tax rate or the long-term capital gains rate, depending on
the asset and how long you've owned it.
Any income, such as dividends or interest (except for interest from some bonds),
is taxed each year. And your income tax on any profit from selling these investments
could be at the lower long-term capital gains rate.
Finding the right investments and managing them isn't easy. Depending on your
income, professional advice is often well worth the cost. Just be sure that your
financial advisor isn't more interested in making a commission by selling you
a particular series of mutual funds than on growing your money.
Remember: Objective advice from an experienced and independent investment advisory
service or advisor puts your needs first.
Monitoring Investments
Your investments won't take care of themselves. You need to put some effort into
staying on top of them, making sure you're still on the path to meeting your
retirement needs.
Keep this in mind: Investing to meet your retirement needs is a lifetime pursuit.
Start as soon as possible. Research your investments and educate yourself. Pay
attention to the costs as well as the performance of your investments. In a surprisingly
short time, you'll reap significant rewards like peace of mind and a secure retirement.
For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.
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Charles M. Bloom, Registered Principal offers securities
and advisory services through Centaurus Financial, Inc. - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - Member FINRA and SIPC.
The information contained in this web site is neither an offer nor solicitation of any security or service.
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