Investing for Retirement

People are living to be older than they did even just a few generations ago. As a result, they either need to work longer or save more so they can enjoy a carefree and active retirement. Unless you can count on a large inheritance, you will need to find some way to supplement your Social Security income or company pension.

Social security
There is a great deal of talk about there not being enough Social Security after the year 2047 or so. The reality is that by that time the surplus Social Security trust is expected be used up, and retirees will have to rely on the current workforce to pay their Social Security.

The problem is that with a growing number of retired people that workforce will only be able to come up with about 75% of what will be needed to support them. This, on top of the fact that most companies are rapidly doing away with pension plans, means that you need to take retirement savings seriously and do more than your parents and grandparents did.

Ways to save for retirement
Three major ways to save for retirement are through a company sponsored 401k plan, a traditional Individual Retirement Arrangement (IRA) or a Roth IRA. There are advantages to all of them with very few minor disadvantages to some.

The first advantage is realized each and every payday. When you automatically have money withdrawn from your pay to fund your 401k account, that money comes from your pre-tax income. So contributing 6% of your salary does not reduce your take home pay by as much. The contribution is tax deductible, and taxes on the savings are deferred, meaning they don’t need to be paid until you withdraw the money. At your retirement income, that tax rate will also usually be significantly lower than your current tax rate. Be cautioned though that any money withdrawn before the age of 59 ½ will not only be taxed at your current tax rate, but also penalized another 10%.

401K Plan
One of the smartest investments for retirement is a company 401k plan. It is wise to contribute as much as possible, especially when considering some employers will match your contribution up to a certain percent. That is free money, working to give you a bigger base of principle and earning you more interest. Also, with most 401k plans you can choose how your money gets invested. The plan administrator has many fund options such as stocks for younger investors who have the advantage of time and can afford to take more risks. Employees closer to retirement age can choose 100% guaranteed accounts if they want to avoid any risk at all.

Traditional IRA
The same tax regulations apply to a traditional IRA since they are funded with pre-tax, or tax deductible dollars. There are also maximum amounts that can be contributed each year, $4,000 per year starting in 2005. If you are over 50, you are allowed to make larger, “catch up” payments to your IRA each year. There are also restrictions on how much you can contribute to an IRA if you are also part of a 401k plan. If you and your spouse file taxes separately, then the IRA can be in your spouse’s name to avoid some of the restrictions.

Roth IRA
The Roth IRA on the other hand is funded with post tax dollars. You will not get a tax deduction in the year you make the contribution, but the account may never be taxed again, including the earnings on the investment. To get to use your Roth IRA tax-free, then you must have had the account for at least 5 years and be over 59 ½ years of age. There are a few qualifying expenses that allow you to use the money without penalty before retirement age. These include major medical expenses, some education expenses and even the down payment on your first home.

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