Thursday, March 5, 2009

Know What Is Available To Save For Retirement – Part 4

Saving Money Tip #83 - Know What Is Available To Save For Retirement – Part 4. In parts 1, 2, and 3 of this series we discussed the two main vehicles for individuals to save for retirement in the US. They are a 401(k) at work (or 403(b) if you work for a non-profit) and an Individual Retirement Account (IRA) – both traditional and Roth - that you set up on your own. In this last part of this series we will discuss when to invest in these types of retirement vehicles.

First, a disclaimer – this is not a blog about where you should invest your money – I leave that up to professional financial planners to advise clients based on their personal situations. The purpose of this series is to make known to those new to investing what is available to invest for retirment and the benefits and disadvantages of each investment vehicle. Also I will pass on what I have learned from reading financial books, magazines, classes, and investing on my own. This is not to be construed as investment advice - merely knowledge.

Having said that, if you are thinking of putting money away for retirement (and if you are not thinking about it, you should be!), the first place you should look is your 401(k) or similar plans offered at your place of employment. While the options of where to invest may be limited, most employers match what you put in to it up to some level. And that is the very minimum that you should invest. If your employer matches dollar for dollar the first 3% of your salary that you invest, then make sure you put in at minimum 3% of your salary. If they match 50 cents on the dollar for the first 6%, then put in 6% of your salary. This is free money. If you don’t put in the minimum, it’s like turning down a raise that your company offers you.

What next? Suppose you put in the percentage up to the company match and you still have more you want to invest per year for retirement (good for you!). Then what? Many financial advisors suggest putting the next amount of money into a Roth IRA if you qualify. Reasons are many – you have more choices over where your money is invested in the IRA, you can take advantage of the tax-free earnings the Roth IRA offers, you hedge your bets on tax rates being higher in retirement (with the 401(k) remember you have to pay taxes on your earnings when you retire). Other financial advisors just seem to really like the Roth for the flexibility it provides for taking your contributions out. Remember, if you are under 50 and below a certain income threshold, you can put in $5,000 per year into a Roth IRA.

If you have now fully funded your Roth IRA for the year, and you still want to invest more for retirement – then go ahead max out on your 401(k), even if the company doesn’t match anything, you still have tax deferred contributions and earnings.

Of course, this plan doesn’t appeal to everyone – those whose companies don’t offer a match in a 401(k) or for those in a very low tax bracket, the Roth may be the first place you should invest. Whereas someone making a lot of money who doesn’t qualify for a Roth may do better investing the maximum into his 401(k) with the remainder in a non-deductible traditional IRA. Wherever you ultimately decide to invest your money for retirement after you talk to a financial advisor or knowledgeable friend or family member about your situation, remember more important than where you save is that you start to save for retirement - especially when you are young. The earlier you start putting money away for retirement, the less per year you need to save. And if you are not young anymore, the best time to start saving for retirement is now.

In Real Life (IRL) – I’ve already mentioned that I started saving for retirement in my 20’s when it sounded ridiculous to me to do so. But I listened to my dad and some knowledgeable co-workers about the importance of starting early. After I got married, I convinced my husband to start putting money away each year into an IRA as well. Fortunately, he was already contributing to his 401(k). I am glad we did this because we are in our early 40's and we are well on our way to having a nice retirement nest egg. We manage to live on less than we earn and we put the balance away for retirement and other savings.

Every year, we each put $5,000 into a Roth IRA and my husband puts the maximum his company allows him to put into his 401(k). By contributing to his 401(k), the money is taken out before he gets his paycheck so we don’t even miss the money, and it reduces our tax liability! The $10,000 for the Roth IRA is a line item on our budget – we put about $800 away each month for our Roth IRAs. If you cannot afford to put away that much, you can always put away less than the maximum. The important thing is to start putting money away now for retirement, and you can always build up from there. In an earlier post I linked to a site that can give you an idea how much you will need for retirement based on your cost of living. Check it out so you can estimate how much you need to put away each year. The figures that financial folks estimate couples with average income will need for retirement are upwards of $1 million to $2 million. Putting away for retirement now will start to get you there.

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