Retirement Planning 101

Everyone, irrespective of the amount of money they make should set aside a fixed amount of money on a monthly basis towards their retirement. There is no substitute for saving a fixed amount every month towards retirement. Retirement planning is much easier when the plan is put in place at a relatively young age and the selection of investments is well thought out and relatively safe. 

The market has created several avenues for individuals to plan for retirement. Some of the more common approaches are by investing in one of the traditional bank instruments such as CD’s, Money Market Securities and Bonds.  Many of these instruments tend to be too conservative for younger people, since the yield on these investments tends to be smaller than returns attainable in the stock market. 

Many people have retirement plans at their place of employment through either a pension plan or a qualified retirement plan such as a 401K plan. Pension plans are administered by the employer and there are no contributions made by the employee. Eligibility to receive a pension starts after the employee has been consistently employed with the employer for a minimum number of years, usually 5 years. Pension plans are not as popular as they use to be, as employers transition from pension plans to qualified defined contribution plans, such as a 401K. Non-profits, the school system and the government have different types of retirement plans, such as the 403b.      

People who are eligible for pension plans and employer sponsored qualified plans, such as the 401K or 403b plans, have a significant part of the work done for them. Hence the first place to start retirement planning is to ensure that one has a decent job. The benefits offered by companies should be factored into our total compensation. It is very hard to plan for the future if you live from pay check to pay check. The first and most important step in planning for retirement is to continue to increase our disposable income, that is, income left over after we have fulfilled all of our monthly financial obligations. 

Retirement planning should rise to the level of a necessity and we should consider saving for retirement as an obligation we have to ourselves. Saving a fixed amount of money every month is a critical step, and the sooner we begin the faster we can attain our goals. A simple rule is to invest 10% of any income we earn. Setting up an automatic withdrawal on a monthly basis from our bank account to a retirement account is an important step to take. 

Those who participate in a 401K or 403b type of plan can select amongst a number of investment choices offered by their specific plan. The selection usually includes mutual funds, money market funds, bonds etc. The employee selects a mix amongst the available selection. Many companies match a portion of the employee’s contribution; hence this is another opportunity for the employee to gain additional amounts for retirement. 

Anyone who is ineligible for a 401K, 403b or pension plan can select from other types of plans. Some plans are administered by insurance companies; annuities are a very common retirement instrument sold by insurance companies. The government also allows individuals to save through qualified plans such as the IRA. 

Annuities are usually purchased on an after tax income basis and the investments grow tax-free. There are two types of annuities, fixed annuities with a fixed growth profile and fixed benefit profile and variable annuities, with a variable growth profile and a variable benefit profile. Fixed annuities are usually invested in more conservative investments with fixed returns and variable annuities are usually invested in stocks or instruments with variable returns. Annuities are popular amongst high income earners or individuals with high net worth. The reason for this is the limitation imposed by the IRS for defined contribution plans, each year; the IRS publishes the limit that each individual can contributed to one of the available defined contribution plans. For this reason, annuities are indeed a good tax advantaged alternative, since the investments can grow tax-free. 

IRA’s can be either traditional IRA’s, which allows participants to invest pre-tax income and enjoy tax-free growth. Traditional IRAs are taxable when withdrawn and cannot be withdrawn prior to retirement without paying a penalty. ROTH IRA’s are IRA’s that allow the participant to make after-tax contributions that grow tax-free. ROTH IRA’s can be withdrawn tax-free at retirement. Each IRA type offers unique advantages. The traditional IRA allows participants the opportunity to deduct their annual contributions from their tax returns. Participants can also take out loans against their IRA. The ROTH IRA also allows participants the loan privilege and also allows withdrawals of principle contributions prior to retirement. The simplest approach to determining the type of IRA to invest in is an evaluation of one’s taxable income in retirement versus their current tax status. If an individual needs a tax break today, then they should consider the traditional IRA, if on the other hand they anticipate significant tax liabilities in retirement, they should select the ROTH IRA. However since no one can accurately predict where tax rates will be over time, utilizing a mixture of the two retirement plans is a good idea. 

The available investment instruments sold within 401K, 403b and IRA plans is so expansive. However the more common categories include: Real estate investment trusts, mutual funds, exchange traded funds, bonds and individual stocks. 

Planning for retirement through ones employer is the best and safest approach to achieving retirement goals. Individuals who need to set up a plan could use the services of financial advisors, advisors work on a fee basis. There are also brokers who work for commission and discount houses that sell mutual funds, bonds or stocks at a discount. Online brokerage houses afford individuals the opportunity to invest their money directly. There are also opportunities within both the banking and insurance industries for investment planning advice. The investment option selected by the investor should be based not only on past performance but also on the options available to the investor, with respect to returns, fees and safety of principle invested.