Tip #268 - Don't Discount CDs For Savings. Yes, CDs (Certificates of Deposits, not the music kind) currently have ridiculously low rates, I know. But they can still be part of your savings plans. Many of us in this low-interest market want the kind of returns that only stocks and high-risk investments can possibly return. But remember that those high-risk investments with potential for high returns also can have negative returns. So that stock that you were hoping would acheive a 10 percent return for the year can return a negative 3 percent instead. While a CD can return a positive 3 percent. That's a difference of 6 percentage points.
CDs certainly aren't for every person for every savings goal in every season or for ones whole portfolio. But they do have a place in most people's portfolios for many goals. For example, if you are saving for retirement, and are 30 years old, most financial experts would tell you to put a majority of your investing into stock mutual funds or something similar since retirement is so far off. Some might follow the old rule of thumb of subtracting your age from 100 and putting that percentage in stock mutual funds (70% in this case). They may advise to put a smaller percentage in bonds (maybe 20%) and a still smaller percentage in cash or guaranteed investments (maybe 10%). Well, why not look into CDs for those guaranteed investments? My credit union is paying about 3% for a 5-year CD these days. It's not much, to be sure, but it does add some nice balance to a portfolio.
Of course you don't need to follow anyone's rule of thumb with regards to investing. You need to do what is comfortable for you. I know people who like to take on a lot of risk and put nearly all of their money for their retirement into stock mutual funds. I also know some people who are quite conservative who tend to hold more a higher percentage of CDs and government bonds than are recommended.
CDs are a good place to start out with your investments because you will earn greater returns than a savings account or money market account. You will be tying up your money for a certain amount of time, though, which is why you get the greater return. CDs are guaranteed by the FDIC so you cannot lose any money if the bank goes under. If you belong to a Credit Union, that is a great place to start with CD savings since they tend to be more flexible with penalities for withdrawing early on a CD. And if you don't belong to a credit union, you should consider joining one.
CD's might also have a place in your college fund portfolio. While many people in the past few years socked money away in their 529 plans that lost money, the 5-year CDs had rates of 4% and 5%. Doesn't sound so bad, does it? Better than the negative returns many experienced but not as good as the 10% or 12% than many hoped would be the case. Remember college savings isn't all that long of a time frame (18 years at most). And if the rates are in negative territory, there is not too much time for them to recover before your son or daughter goes off to school.
Just because CDs aren't a high-risk, high-return investment, doesn't mean that it's not right for you. Low risk, low return investments have their place in many people's portfolios, too. And while they are not as hip, cool, or sexy as stocks and mutual funds, they are sometimes a better choice.
Consider what you are saving for, how long you have to save for your investment, how much risk you are willing to undertake, and what other investments you have in your portfolio to see if there's a place for CDs among your investments.
In Real Life (IRL) - I really like CDs. I have some knowledge about stocks. I have some knowledge about mutual funds, and I am not scared or inexperienced in investing in either one of those. And during the early 1990's some stocks and mutual funds were my best friends, giving me great returns. But I never let go of the "guaranteed" CDs. Sure they were returning 5% when stocks were giving me 12%, 15% or even 20%. But they gave me some sense of stability and added balance to my portfolio.
When we started saving for college, I put a fair percentage in CDs. They were returning over 5% when I started these 5- and 7-year CDs. With only an 18 year time-frame from the first time I invested for my daughter's college to a much shorter time-frame now (only 10 years away), CDs actually seem like a good choice to me for that short time period. About 75% of our daughter's portfolio is earning 4%-5% for college. And while I know full well that I'd be singing a different tune if the stock market were soaring now rather than declining, I am still happy earning a lesser percentage in return for peace of mind.
Our retirement portfolio also has a higher-than-suggested-by-the-experts proportion in CDs. We have about 40% of our retirement in CDs and similar guaranteed investments even though our retirement is still 20 years away. It's a percentage I feel comfortable with at this stage in our lives and with the state of the economy. And yes, I know inflation can sometimes outpace CD returns, but stocks can have bad years so I pick what I consider the lesser of two risks for the time frame I am investing for. Others may choose differently.
Another reason I like CDs is because we found out we are able to "back invest" in our education and retirement CDs at our Credit Union (Navy Federal Credit Union) during a grace period, which we can invest in CDs that we already have open. This is a great option since we have some CDs with a few years left on them that are paying over 5%! (This is why I love credit unions!) It's a deal we only found out about last year, but we have been able to add to both our retirement account and education accounts this past year, and plan to do so while we still have these good rates.
So consider CDs carefully. They can be a valuable tool in many investment portfolios. For other ideas on how to spend less money or save some up, check out Frugal Fridays.
***Please note that I am not a financial advisor nor a financial planner. I am just one person who is interested in saving and investing money. My thoughts are my opinions only. You should seek qualified investment advice from a professional before you invest.
Showing posts with label Retirement. Show all posts
Showing posts with label Retirement. Show all posts
Friday, August 6, 2010
Wednesday, December 30, 2009
Old Age Is Something To Save For And Look Forward To
Tip#219 - Old Age Is Something To Save For And Look Forward To. Many people do not want to save for the future because they either do not know what the future will bring or because they think the future as an elderly person is not worth saving for. But with people living longer and longer, old age is not what it used to be. Seventy years of age today is what 50 years of age used to be a long time ago.
Have you ever looked at pictures of your grandparents or great-grandparents from 50 years ago? If you are lucky enough to have photographs that are dated and notated you may be surprised that people who look like they are 75 years old are actually only in their 50s. Now compare those photographs to pictures from today of people in their 70s. Besides the hair dye and stylish clothes on the people in today's photos making them look much younger, today's elderly are generally much more active. In fact, look at all of the active adult communities springing up around the country for people 55 and older. With people's lives being extended, their active years get extended too.
So what does all this have to do with finances? If people are living longer, then they have to have money to live on when they are older. And while many people are still active well into their 70's and 80's, many are unwilling or unable to work or if they are able to work they may not be able to work full time. It is this last quarter or fifth of our lives that we are saving for. Statistically, most of us will live to our 70s and beyond. And conceivably many of us will be living active lives - going out to eat, playing tennis or swimming, traveling, and doing many of the same things that we do today. So there is no reason to deny that it is necessary to save for the old age. And it's not something to dread but rather to look forward to.
In Real Life (IRL) - I mentioned last week that we are spending our spontaneous winter vacation in Florida. Although I tried, words cannot adequately describe the people we meet, the activities we participate in, and the conversations we have. But all exaggerations aside, it is actually quite refreshing to watch octegarians who are playing tennis and spend time with people in their seventies who go dancing weekly. Observing these eldery folk living their lives to the fullest has made me realize that their lives are evidence against all of those naysayers who think we'll all be sitting around doing nothing when we're old so we shouldn't bother to save for our future. In addition to anecdotal evidence, actuarial tables show that most Americans will be around until their 70's. So we really should begin saving for our life after our working years.
This week I talked to two women in their 80s who just came back from taking a cruise. I observed women and men playing with their grandchildren in the pool, on the beach, and on the playground. I saw elderly folk going on nature walks. I saw old people taking photographs and working on stained glass artwork. I saw pictures of a couple's first great-grandchild. But the highlight of my week was meeting a gentleman who was celebrating his 70th wedding anniversary with his wife. Just watching these folks has renewed my dedication to saving money for my retirement. Getting old is not something to dread. But instead it can be a time to look forward to - to slow down and enjoy life. And having the money to spend during that last quarter of our lives will only make our elder years more enjoyable.
Have you ever looked at pictures of your grandparents or great-grandparents from 50 years ago? If you are lucky enough to have photographs that are dated and notated you may be surprised that people who look like they are 75 years old are actually only in their 50s. Now compare those photographs to pictures from today of people in their 70s. Besides the hair dye and stylish clothes on the people in today's photos making them look much younger, today's elderly are generally much more active. In fact, look at all of the active adult communities springing up around the country for people 55 and older. With people's lives being extended, their active years get extended too.
So what does all this have to do with finances? If people are living longer, then they have to have money to live on when they are older. And while many people are still active well into their 70's and 80's, many are unwilling or unable to work or if they are able to work they may not be able to work full time. It is this last quarter or fifth of our lives that we are saving for. Statistically, most of us will live to our 70s and beyond. And conceivably many of us will be living active lives - going out to eat, playing tennis or swimming, traveling, and doing many of the same things that we do today. So there is no reason to deny that it is necessary to save for the old age. And it's not something to dread but rather to look forward to.
In Real Life (IRL) - I mentioned last week that we are spending our spontaneous winter vacation in Florida. Although I tried, words cannot adequately describe the people we meet, the activities we participate in, and the conversations we have. But all exaggerations aside, it is actually quite refreshing to watch octegarians who are playing tennis and spend time with people in their seventies who go dancing weekly. Observing these eldery folk living their lives to the fullest has made me realize that their lives are evidence against all of those naysayers who think we'll all be sitting around doing nothing when we're old so we shouldn't bother to save for our future. In addition to anecdotal evidence, actuarial tables show that most Americans will be around until their 70's. So we really should begin saving for our life after our working years.
This week I talked to two women in their 80s who just came back from taking a cruise. I observed women and men playing with their grandchildren in the pool, on the beach, and on the playground. I saw elderly folk going on nature walks. I saw old people taking photographs and working on stained glass artwork. I saw pictures of a couple's first great-grandchild. But the highlight of my week was meeting a gentleman who was celebrating his 70th wedding anniversary with his wife. Just watching these folks has renewed my dedication to saving money for my retirement. Getting old is not something to dread. But instead it can be a time to look forward to - to slow down and enjoy life. And having the money to spend during that last quarter of our lives will only make our elder years more enjoyable.
Tuesday, November 3, 2009
Get Ready For Open Season - Part 2
Saving Money Tip #204 - Get Ready For Open Season – Part 2. In this series we are discussing getting prepared for the open season enrollment that usually occur in places of employment this time of year. In Part 1 of this series, we discussed health care options. Today we will discuss the 401(k). For those who are not too familiar with the 401(k), it is a vehicle offered by many companies so that their employees will put money away for retirement. In days long gone, most companies offered what was called a pension or a defined benefit plan. After an employee put in a certain number of years of service, he would be eligible to receive a certain amount of money (defined benefit) when he reached retirement age. The more years of service the employee put in, the higher his benefit would be. A generation ago, many people did not have to worry about saving for retirement because their company often did it for them and guaranteed that they would receive a set amount of money at retirement age. Employees didn’t have to worry about how the stock market was doing or what the ups and downs for the economy were, they knew they were getting x number of dollars at a certain age with which to retire on.
Sadly, those days are mostly long over. Most companies have done away with the traditional pension plan, and instead, today, offer the 401(k) plan. The 401(k) plan puts the responsibility of saving for retirement on the employee. If you don’t contribute to a 401(k) or do other savings on your own, you will not have money to retire (other than Social Security from the government). A 401(k) is considered a defined contribution plan because there is no guaranteed benefit, the system is based on contributions. By law for 2009, a person cannot contribute more than $16,500 annually to a 401(k) – a bit more if you are over 50. (A company, however, can restrict that contribution even further. They may say you can only put in up to 15% of your salary or you can put in a maximum of $10,000 per year. There are some laws the company has to follow regarding how much can you put in.) Most companies will offer some type of match as an incentive for you to make contributions. It might be a dollar for dollar match on the first 3% of your salary that you put in. Or it might be a 25% match for everything you put in. Most companies have one or maybe two investment firms that they use to handle their employees’ 401(k) investments.
When you receive your 401(k) information consider it carefully. Unless you want to be working well into your 70’s or however long you live, you really want to put money away for retirement no matter your age now. The earlier you start to invest, the more your money will accumulate. And 401(k) plans make it easy to invest. Money that you contribute to the plan comes out pre-tax just from your paycheck just like health insurance co-payments through your company do. This will lessen your tax burden at tax time. You will not be required to pay tax on these contributions until you are of retirement age or take the money out. This allows you to have more money up front for investing. In addition, any money that the company matches you is “free” money. If they offer a dollar for dollar match on the first 3% of contributions, and you turn it down, you are essentially turning down a 3% salary raise.
Don’t make the mistake of some people I know and not invest because you don’t understand what a 401(k) plan is, because you don’t trust it, or because retirement is a long time off. Once you start making the contributions you will adjust to your salary that you do receive, so that you won’t even miss the money that much. But at year-end, and especially after a few years go by, you will be amazed at how much you have saved.
Make sure you look over your investment choices carefully before making decisions. Most companies offer an a la carte selection with stock mutual funds, bond mutual funds, some money market accounts, and possibly some company stock. If retirement is more than 20 years away, you can afford to have your money in higher risk investments like stock mutual funds, but if you are not comfortable with that level of investing yet, then go ahead and put some of it in a money market account, or put only a smaller portion of it in some stock mutual funds. Some people like to be conservative with their contributions and use their company match for the riskier investments. Overall, I like a balanced approach with a mix of investment types, but for new investors, you need to do what is comfortable for you.
Many companies will offer some investment seminars so you can learn more about risk, or you can read through some other blog posts I have done on retirement topics here and here. I have also discussed it in other places in my blog - look in the retirement category. But one piece of advice I strongly give is whatever you do, invest in your 401(k), at a minimum up to the company’s match. Unless you are drowning in debt and are thousands and thousands of dollars in the hole, there is no reason not to be contributing, and even then I might contribute up to the company match.
In Real Life (IRL) – I have mentioned many times on this blog that when I was first introduced to the 401(k) at my workplace, it held little interest for me. After all, I was 22 and retirement was very far off. But an older co-worker who was close to retirement age urged me to at least contribute up to the company match which was dollar for dollar on the first 3%. So that is what I did the first year I was eligible. After that first year, I was advised by my dad to up my contributions to the full amount I was allowed, which was 13% of my salary. And I did that, too. I will be frank with some dollar figures here. I started that job making under $20,000. I became eligible to invest in the 401(k) after one year of service. I worked at that company for 9 years, and left the company making approximately $37,000. So I saved between 3% and 13% of my salary of between $20,000 and $37,000 for 8 years. My company upped the match to 4% at some point in there. I have not done a thing with the money I put into that company’s 401(k) since I left the company 11 years ago. When I checked that account at the end of last quarter I was $18 shy of $75,000 in that account.
So by putting between $600 per year to $4800 per year into an account for 8 years and having the company match some of that money I have built up a savings for retirement of $75,000. Not bad for a quick decision at open enrollment time. Had I not done this, the hundreds of dollars I would have gotten each year minus taxes that I would have paid on it could have easily gotten eaten up in entertainment, eating out, and frivolous spending. Instead, I started a nice little nest egg for retirement.
Your company is not going to be saving for your retirement anymore, so why not start doing it for yourself this enrollment season? At the very least, put in at least as much as the company will match, and if you are able and willing, put in the maximum your company will allow.
Sadly, those days are mostly long over. Most companies have done away with the traditional pension plan, and instead, today, offer the 401(k) plan. The 401(k) plan puts the responsibility of saving for retirement on the employee. If you don’t contribute to a 401(k) or do other savings on your own, you will not have money to retire (other than Social Security from the government). A 401(k) is considered a defined contribution plan because there is no guaranteed benefit, the system is based on contributions. By law for 2009, a person cannot contribute more than $16,500 annually to a 401(k) – a bit more if you are over 50. (A company, however, can restrict that contribution even further. They may say you can only put in up to 15% of your salary or you can put in a maximum of $10,000 per year. There are some laws the company has to follow regarding how much can you put in.) Most companies will offer some type of match as an incentive for you to make contributions. It might be a dollar for dollar match on the first 3% of your salary that you put in. Or it might be a 25% match for everything you put in. Most companies have one or maybe two investment firms that they use to handle their employees’ 401(k) investments.
When you receive your 401(k) information consider it carefully. Unless you want to be working well into your 70’s or however long you live, you really want to put money away for retirement no matter your age now. The earlier you start to invest, the more your money will accumulate. And 401(k) plans make it easy to invest. Money that you contribute to the plan comes out pre-tax just from your paycheck just like health insurance co-payments through your company do. This will lessen your tax burden at tax time. You will not be required to pay tax on these contributions until you are of retirement age or take the money out. This allows you to have more money up front for investing. In addition, any money that the company matches you is “free” money. If they offer a dollar for dollar match on the first 3% of contributions, and you turn it down, you are essentially turning down a 3% salary raise.
Don’t make the mistake of some people I know and not invest because you don’t understand what a 401(k) plan is, because you don’t trust it, or because retirement is a long time off. Once you start making the contributions you will adjust to your salary that you do receive, so that you won’t even miss the money that much. But at year-end, and especially after a few years go by, you will be amazed at how much you have saved.
Make sure you look over your investment choices carefully before making decisions. Most companies offer an a la carte selection with stock mutual funds, bond mutual funds, some money market accounts, and possibly some company stock. If retirement is more than 20 years away, you can afford to have your money in higher risk investments like stock mutual funds, but if you are not comfortable with that level of investing yet, then go ahead and put some of it in a money market account, or put only a smaller portion of it in some stock mutual funds. Some people like to be conservative with their contributions and use their company match for the riskier investments. Overall, I like a balanced approach with a mix of investment types, but for new investors, you need to do what is comfortable for you.
Many companies will offer some investment seminars so you can learn more about risk, or you can read through some other blog posts I have done on retirement topics here and here. I have also discussed it in other places in my blog - look in the retirement category. But one piece of advice I strongly give is whatever you do, invest in your 401(k), at a minimum up to the company’s match. Unless you are drowning in debt and are thousands and thousands of dollars in the hole, there is no reason not to be contributing, and even then I might contribute up to the company match.
In Real Life (IRL) – I have mentioned many times on this blog that when I was first introduced to the 401(k) at my workplace, it held little interest for me. After all, I was 22 and retirement was very far off. But an older co-worker who was close to retirement age urged me to at least contribute up to the company match which was dollar for dollar on the first 3%. So that is what I did the first year I was eligible. After that first year, I was advised by my dad to up my contributions to the full amount I was allowed, which was 13% of my salary. And I did that, too. I will be frank with some dollar figures here. I started that job making under $20,000. I became eligible to invest in the 401(k) after one year of service. I worked at that company for 9 years, and left the company making approximately $37,000. So I saved between 3% and 13% of my salary of between $20,000 and $37,000 for 8 years. My company upped the match to 4% at some point in there. I have not done a thing with the money I put into that company’s 401(k) since I left the company 11 years ago. When I checked that account at the end of last quarter I was $18 shy of $75,000 in that account.
So by putting between $600 per year to $4800 per year into an account for 8 years and having the company match some of that money I have built up a savings for retirement of $75,000. Not bad for a quick decision at open enrollment time. Had I not done this, the hundreds of dollars I would have gotten each year minus taxes that I would have paid on it could have easily gotten eaten up in entertainment, eating out, and frivolous spending. Instead, I started a nice little nest egg for retirement.
Your company is not going to be saving for your retirement anymore, so why not start doing it for yourself this enrollment season? At the very least, put in at least as much as the company will match, and if you are able and willing, put in the maximum your company will allow.
Thursday, September 24, 2009
Save Now For Retirement
Saving Money Tip #191 - Save Now For Retirement. I’m going to speak in general terms here. People in the US live approximately 80 years on average. From age 0 to 20 your parents take care of you, paying for your needs. From age 20 to 60 you work, paying for your own needs and that of your children, if you have any. From age 60 to 80 you don’t work, so who pays for your needs? Well, the idea is that you will pay for your non-working years from your working years. And that is why if you are between ages 20 and 60 and you are working, you should be putting aside money for when you won’t be working. Now I know not everyone follows this predictable pattern. Some might go to school until age 25. Others might work until 65. Some might live to 75, while others will live to 95. Again, I am speaking in general terms about why it is necessary to save for retirement.
If you want to not be working in your elderly years (or not working as hard) then you need to put aside money for that time now. It would be great if we all started that saving for retirement at age 20 – not only does it give us many years to save up, but it also takes advantage of the magic of compounding. However, I understand that not all of us were aware that it was necessary to save for retirement fresh out of high school or college. And we may find ourselves to be age 45 without having saved a dime. If that’s the case, then we can hope start saving furiously now and/or plan to work a bit longer maybe until age 65 or 67. It is never to late to start. I have done many other posts on retirement. One of which has you calculate how much you will need to save each year to live comfortably in retirement. The truth is nobody can accurately predict how much you will need. If your house will be paid off by the time you retire, that is a big expense that you don’t have to account for. If you plan to sell your big house in the northeast of the country and move to the south where real estate is cheaper, then you may be pocketing a big amount of money. If you are 60 and in good health and love to work, then you won’t need as much as someone who wants whittle their days away on a tropical beach.
The point is, in general, the approximately 40 years we are working needs to pay for about 60 years of living. And that is why we should be saving. I have heard people say that retirement is a modern notion and that years ago we didn’t need to do all of this retirement planning. That is true. But years ago, much of the country lived on farms, and multi-generations lived together with the younger generation taking care of the older generation when they couldn’t plow the fields any more. If you don’t anticipate moving in with your children, then you need to take care of yourself and start saving now.
In Real Life (IRL) – I’ve been reading lots of financial forums lately, and I have seen some people write that they are not planning to save for retirement. Their feeling is that they are going to live for now because they don’t know if they will even be alive in retirement. Or, they think that retirement planning was dreamed up by the financial industry earn fees on all of our investments. Or that retirement is a modern notion that has no basis in history. And while any or all of those ideas might be partially true, it doesn’t change the fact that there is a good possibility that most of us will be alive well into our 70’s or 80s, that we will need money to live on whether the investment company we choose is making income off us or not, and that while retirement might be a modern notion, we are living in today’s world that is much different than that of the past.
I know when I started my first “real” job at almost age 22 I laughed when the human resources person told me about retirement benefits they offered. To me, retirement savings was something my father who was in his fifties should be doing, not me, a young person in my twenties. When my co-worker advised me a year later when I began to qualify for the company’s 401(k) benefits, that I should at least invest up to the match my company was giving me, I listened. After that I began to talk to more people and learned not only about the tax benefits of putting money away for retirement, but also the financial benefits I would receive for starting to put money away early and consistently, taking advantage of compounding interest and good habits that had me continue putting money away for twenty more years.
If you didn’t have someone in real life advise you about saving for retirement, take my advice, the sooner you start putting money away, the less work you will need to do when you are older and possibly not in the position to be working. There are usually tax benefits to retirement savings, and the earlier you start, the more you will accumulate and the longer time you have to let the magic of compounding work for you. Use your working years to save for the years when you don’t want to be working.
Thursday, May 7, 2009
Why It's Important To Save For Retirement
Tip #134 - Why It’s Important To Save For Retirement. Most people begin their working lives at about age 20 – plus or minus a few years. At age 20, people have an overall life expectancy of about 80 years old. So when you being working you have, on average, 60 more years to live. If you work until the day you die, you don’t have to save for retirement. But most people do not want to or won’t be able to work until they are 80 years old. In that case, you need to save for retirement. Think of it this way – from age 20 to age 80 is 60 years’ worth of living expenses. If you only want to work (or are only able to work) for 40 of those years, then you will have 20 years with no income. So 40 years’ worth of paychecks needs to cover 60 years’ worth of expenses. And that is why you need to put money away from each paycheck to fund your retirement. It is that simple.
It seems funny to save for retirement when you are fresh out of college, but the earlier you get started on this habit the better, as you have longer time to save and time for interest to compound. But let’s forget interest for a moment and take inflation out of the equation. Let’s go over a very simple example of why you need to save for retirement. Suppose you make $50,000 per year from age 20 until age 60. That is $50,000*40 (years) or $2 million total. From age 60 to age 80 you do not want to work, so your income for those 20 years is $0 total. How do you live for those 20 years? We’re not going to count on Social Security. If it comes, it will be a nice bonus and you can do something special with it. But let’s assume it doesn’t. You need to live on some of that $2 million dollars that you earned over the previous 40 years. So let’s say, from age 20 to age 60 you live on only $40,000, saving $10,000 per year for retirement. That means from age 20 to age 60 you will live on $40,000 ($1.6 million dollars total). And from age 60 to age 80 you will live on $400,000 total or $20,000 per year ($400,000/20). That might be okay. Expenses are often cheaper in retirement. Hopefully, you house will be paid off so you won’t have that big expense. But maybe you want to do better, so you live on only $35,000 during your working years and save $15,000 per year for retirement which means you will have $600,000 to live on in retirement $30,000 per year, which is probably better with income being only slightly less than when you were working.
Of course this is just a very simple with many realities taken out of it. In reality, what you save will grow exponentially over the years because of compounding interest. Of course, inflation will eat away at some of that interest, too. Your income will not be steady for 60 years either. And there are really tax benefits to saving for retirement. But this basic example shows why it is important to understand why people must put money away for retirement year after year. It is not to save so you can live on a tropical island in your golden years. You are simply covering the living expenses you will have when you will not be working. And the earlier you start saving, the less you need to put away each year.
In Real Life (IRL) – When I got my first job, I remember sitting in the human resources office the first day, and the benefits specialist telling me that I would be eligible to participate in their 401(k) after 1 year of service. “Okay,” I answered not really caring one way or another. I was just interested in having an income and some health insurance. But after a year rolled around, the benefits specialist informed me that I was now eligible to put money into the 401(k), and that they would match dollar for dollar the first 3% of my salary that I put in. Because the match of “free” money sounded good to me, I put in 3% of my salary, even though saving for retirement – a good 40 or so years away - sounded a bit extreme.
During that year, I spoke to my father and an older man at work, and both of them advised me to put in as much as I could into the work retirement plan. Not only would I get a tax benefit, but I remember specifically the my older co-worker saying, “You won’t even miss the money since it comes out before you get your paycheck.” So the following year, I put in the full 13% that the company allowed. And my co-worker was right! I was saving for retirement painlessly because I didn’t even see the money that I was putting away. From that point on, I got accustomed to living on less than I earned.
I eventually started putting even more money away for retirement in an IRA account and then when my children were born and I worked part-time or not at all, I stopped contributing to my 401(k) altogether. Thank goodness I put money away for retirement in those early years, when I really didn’t have high expenses – I shared an apartment with friends and I had no family depending on me. I am grateful for the good advice some wiser, experienced investors gave me. I’ve written a few other posts on saving for retirement, including one that linked to a retirement calculator to figure out how much you need to save each year. But the purpose of this post is to show the very basic reason why it’s important to put money away each year for retirement. Unless you die the day you stop working, you will need money to live when you don't make an income.
It seems funny to save for retirement when you are fresh out of college, but the earlier you get started on this habit the better, as you have longer time to save and time for interest to compound. But let’s forget interest for a moment and take inflation out of the equation. Let’s go over a very simple example of why you need to save for retirement. Suppose you make $50,000 per year from age 20 until age 60. That is $50,000*40 (years) or $2 million total. From age 60 to age 80 you do not want to work, so your income for those 20 years is $0 total. How do you live for those 20 years? We’re not going to count on Social Security. If it comes, it will be a nice bonus and you can do something special with it. But let’s assume it doesn’t. You need to live on some of that $2 million dollars that you earned over the previous 40 years. So let’s say, from age 20 to age 60 you live on only $40,000, saving $10,000 per year for retirement. That means from age 20 to age 60 you will live on $40,000 ($1.6 million dollars total). And from age 60 to age 80 you will live on $400,000 total or $20,000 per year ($400,000/20). That might be okay. Expenses are often cheaper in retirement. Hopefully, you house will be paid off so you won’t have that big expense. But maybe you want to do better, so you live on only $35,000 during your working years and save $15,000 per year for retirement which means you will have $600,000 to live on in retirement $30,000 per year, which is probably better with income being only slightly less than when you were working.
Of course this is just a very simple with many realities taken out of it. In reality, what you save will grow exponentially over the years because of compounding interest. Of course, inflation will eat away at some of that interest, too. Your income will not be steady for 60 years either. And there are really tax benefits to saving for retirement. But this basic example shows why it is important to understand why people must put money away for retirement year after year. It is not to save so you can live on a tropical island in your golden years. You are simply covering the living expenses you will have when you will not be working. And the earlier you start saving, the less you need to put away each year.
In Real Life (IRL) – When I got my first job, I remember sitting in the human resources office the first day, and the benefits specialist telling me that I would be eligible to participate in their 401(k) after 1 year of service. “Okay,” I answered not really caring one way or another. I was just interested in having an income and some health insurance. But after a year rolled around, the benefits specialist informed me that I was now eligible to put money into the 401(k), and that they would match dollar for dollar the first 3% of my salary that I put in. Because the match of “free” money sounded good to me, I put in 3% of my salary, even though saving for retirement – a good 40 or so years away - sounded a bit extreme.
During that year, I spoke to my father and an older man at work, and both of them advised me to put in as much as I could into the work retirement plan. Not only would I get a tax benefit, but I remember specifically the my older co-worker saying, “You won’t even miss the money since it comes out before you get your paycheck.” So the following year, I put in the full 13% that the company allowed. And my co-worker was right! I was saving for retirement painlessly because I didn’t even see the money that I was putting away. From that point on, I got accustomed to living on less than I earned.
I eventually started putting even more money away for retirement in an IRA account and then when my children were born and I worked part-time or not at all, I stopped contributing to my 401(k) altogether. Thank goodness I put money away for retirement in those early years, when I really didn’t have high expenses – I shared an apartment with friends and I had no family depending on me. I am grateful for the good advice some wiser, experienced investors gave me. I’ve written a few other posts on saving for retirement, including one that linked to a retirement calculator to figure out how much you need to save each year. But the purpose of this post is to show the very basic reason why it’s important to put money away each year for retirement. Unless you die the day you stop working, you will need money to live when you don't make an income.
Saturday, March 7, 2009
Think About What You Want To Do When You Retire
Tip #85 – Think About What You Want To Do When You Retire. When you are young, people ask all the time what you want to be when you grow up. Some children have known since the time they were five years old that they want to be a doctor or a teacher. Others have no idea. But people still always ask. When you are an adult, however, no one asks you what you want to do when you retire until you are almost at retirement age. And I’m sure at age twenty, most of us probably don’t know what we want to do. But then again, I’m sure there are some who know they want to buy a boat and sail around the world or others who are sure they’d be happy piddling in the garden at a home in the country when they are old and gray.
So why not think about what it is you want to do? No one will hold you to it. In fact, your ideas may change five or 10 times before you actually retire. But it doesn’t hurt to at least consider some ideas. And thinking about what you want to do or where you want to live may actually help you figure out how much you need to save for retirement. If you are sure you want to move to the South from the Northeast US, chances are your cost of living will go down. Knowing you might want to travel around the world but still keep a home in the pricey West Coast, however, will cost you a lot.
So why not think about what it is you want to do? No one will hold you to it. In fact, your ideas may change five or 10 times before you actually retire. But it doesn’t hurt to at least consider some ideas. And thinking about what you want to do or where you want to live may actually help you figure out how much you need to save for retirement. If you are sure you want to move to the South from the Northeast US, chances are your cost of living will go down. Knowing you might want to travel around the world but still keep a home in the pricey West Coast, however, will cost you a lot.
Some people think that retirement is just something to do far off in the future when you are old. However, even if retirement is years away, it is still best to have a plan - even if it is just a general idea of your likes and dislikes. Besides, most of us hope our retirement will be interesting and rewarding, so it might be fun to consider all of the possibilities. Why not try to figure out what types of things you think you'd like to do in retirement?
In Real Life (IRL) – As my parents were nearing retirement age, they knew they wanted to retire to Florida. They both had grown up in New York but had moved away when my dad took a job in Pennsylvania when he was 30. They kept in touch with their New York friends and relatives, however, and most of them seemed to be headed to the East Coast of Florida for retirement –some for year-round living and some as “snowbirds” (spending only the winters in Florida). For good or bad, many parts of South Florida are just transplanted New Yorkers. So my parents figured they’d do the same. “What’s not to like?” they thought. The weather’s warm, the pickles are sour, and there are bagel places on every corner. Plus the real estate is cheap.
So at the ripe old age of 60 my parents bought a condo in South Florida and started spending their winters in the sun. The whole culture there is unlike any other – the combination of New Yorkers, old people, and many Jews (and Italians and Cubans…) is nothing like you’ve ever seen. So much so that when I was home with my first newborn 7 years ago, I decided to write a humorous account of what my parents’ lives are like in a retirement community in “G-d’s Waiting Room.” I decided to share that story in a new blog that I just started here. The full story is already written to the tune of about 11 chapters, but I figured I’d add a little bit each day to the blog for those of you who want to read it. So please head on over and let me know what you think. It might just make you want to retire to Florida, too (or maybe not).
In Real Life (IRL) – As my parents were nearing retirement age, they knew they wanted to retire to Florida. They both had grown up in New York but had moved away when my dad took a job in Pennsylvania when he was 30. They kept in touch with their New York friends and relatives, however, and most of them seemed to be headed to the East Coast of Florida for retirement –some for year-round living and some as “snowbirds” (spending only the winters in Florida). For good or bad, many parts of South Florida are just transplanted New Yorkers. So my parents figured they’d do the same. “What’s not to like?” they thought. The weather’s warm, the pickles are sour, and there are bagel places on every corner. Plus the real estate is cheap.
So at the ripe old age of 60 my parents bought a condo in South Florida and started spending their winters in the sun. The whole culture there is unlike any other – the combination of New Yorkers, old people, and many Jews (and Italians and Cubans…) is nothing like you’ve ever seen. So much so that when I was home with my first newborn 7 years ago, I decided to write a humorous account of what my parents’ lives are like in a retirement community in “G-d’s Waiting Room.” I decided to share that story in a new blog that I just started here. The full story is already written to the tune of about 11 chapters, but I figured I’d add a little bit each day to the blog for those of you who want to read it. So please head on over and let me know what you think. It might just make you want to retire to Florida, too (or maybe not).
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.
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.
Wednesday, March 4, 2009
Know What Is Available To Save For Retirement - Part 3
Tip #82 - Know What Is Available To Save For Retirement – Part 3. In parts 1 and 2 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. We discussed the 401(k) in Part 1 and last time we discussed the traditional IRA. Today we will discuss the Roth IRA.
About 10 years ago, a variation of the traditional IRA was introduced. This IRA is called a Roth IRA. The main difference between a Roth IRA and the traditional type is that the money that you contribute to a Roth IRA is not tax deductible. That is, you pay taxes on this income before you put it into a Roth IRA.
About 10 years ago, a variation of the traditional IRA was introduced. This IRA is called a Roth IRA. The main difference between a Roth IRA and the traditional type is that the money that you contribute to a Roth IRA is not tax deductible. That is, you pay taxes on this income before you put it into a Roth IRA.
However, an advantage of the Roth IRA over traditional IRAs or traditional 401(k) plans is that all of the earnings you make inside the Roth IRA are tax-free for good. (Earnings on Individual IRAs and 401(k)s are just tax deferred – you pay taxes on the earnings when you withdraw them.) There are restrictions to this, of course. The money has to be in the account for at least 5 years and you have to be at least 59 ½ years of age to withdrawal. This means that if you put $5,000 into a Roth IRA mutual fund at age 50 and at age 60 when you withdraw it, it is worth $7,000, you don’t pay taxes on that $2,000 earnings.
Another advantage of a Roth IRA over a traditional IRA is that you can withdraw your contributions at any time without penalty – remember you already paid tax on these contributions. (Money withdrawn on a traditional IRA incurs taxes and penalties if you withdraw before 59 1/2.). Also, there are no restrictions on when you have to withdraw the money by as in a traditional IRA (where you have to withdraw the money by age 70 1/2). And like a traditional IRA, the advantage of a Roth IRA over a 401(k) is that you can direct where your investments go. You are not limited to your company’s investment choices.
One of the main reasons people invest in Roth IRAs, in addition to the advantages mentioned above, is that if they expect that their tax rate will be higher in retirement, they would rather pay taxes now, while their tax rate is lower. The main disadvantage to the Roth IRA is that you do not get a tax deduction on your contribution like you do with a traditional IRA, so you do not decrease your tax burden in the year you invest. Therefore, the Roth IRA is best used if you are in a lower tax bracket now but expect to be in a higher bracket when you withdraw the money. Another disadvantage to the Roth IRA is that it is not available to people above a certain income threshold.
In the last segment of this series, we will discuss in which of the different retirement options to invest – the 401(k), the traditional IRA, or the Roth IRA or a combination. (If you are self employed, you can invest in a SEP IRA. Your contributions are limited by how much income you make and are detailed here.)
In Real Life – When I first started contributing to an IRA, only a traditional IRA was available. Then in 1997, the Roth IRA was introduced. At the time IRA contributors were allowed by law to convert our traditional IRA into a Roth IRA if we wished. I was advised to do so since I was in a low tax bracket. Therefore, I converted all of my traditional IRAs to Roth IRAs and I paid taxes I owed on them. Nowadays, you can choose each year whether to invest in Roth (if you qualify), a traditional IRA or a combination of both as long as the combined contribution does not exceed $5,000 (or $6,000 if you are 50 or over). (If you are below a certain income level, you can also convert your current traditional IRA to a Roth IRA and in 2010 even those with high incomes can convert Individual IRAs to Roth).
Currently, I put the maximum I can ($5,000) per year in a Roth IRA and I have ceased contributing to the traditional IRA. I was advised that because I am in a lower tax bracket and since the future tax rate is unknown and may very well be higher when I retire, that it would be wise to invest in a Roth IRA over the traditional IRA. Also, because the earnings in the Roth are tax-free, I decided to contribute to a Roth IRA. However, everyone has to look at his or her own situation to see what is right for them. We will discuss all of the retirement vehicles as a whole in the next post.
Tuesday, March 3, 2009
Know What Is Available To You To Save For Retirement – Part 2
Tip #81 - Know What Is Available To You To Save For Retirement – Part 2. In part 1 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) that you set up on your own (or a SEP IRA if you are self-employed). Last time we discussed the 401(k) in detail. Today we will discuss the IRA, of which there are two types – the traditional IRA and the Roth IRA.
An IRA is available to individuals to invest in on their own – they are not set up through your place of employment like a 401(k) is. However, like a 401(k), you can invest in various accounts such as mutual funds, CDs, or money market accounts under the “IRA” heading.
As mentioned above, there are two types of IRAs available in the US – the traditional IRA and the Roth IRA. Today we will focus on the traditional IRA. There are some advantages to investing in a traditional IRA over a Roth IRA or a 401(k) or a not-retirement vehicle, but there are some disadvantages, too. Let’s discuss the traditional IRA in detail:
Currently, you can invest up to $5,000 per year in a traditional IRA (or if you are 50 years of age or older, you can invest $6,000 per year). If you put money away into a traditional IRA, you may be able to deduct that amount from your taxable income each year. In other words, if you put $5,000 into your IRA, then when you or your tax preparer do your tax returns for the year, $5,000 would get deducted from your income to figure out the amount you would be taxed on. However, this tax deduction is subject to some restrictions. It is not allowed if you have a 401(k) or similar retirement plan at work and you make above a certain income. (Note: if you don’t qualify for the tax deduction, you can still contribute to a traditional IRA without the tax deduction.)
If you qualify for this tax deduction, please note that when you withdraw this money in retirement, you will need to pay taxes on that $5,000 at that time. This is called tax deferment. You are essentially delaying payment of your taxes until you retire. Like the 401(k), this is beneficial if you think you will be in a lower tax bracket when you retire.
Another benefit to the traditional IRA is that interest you earn on the account is tax deferred as it is in the 401(k); that is, you don’t pay taxes on earnings until you withdraw the money from the account at retirement. If you had saved this money on your own and not in an IRA account, you would be paying taxes on distributions on a yearly basis.
A benefit of the IRA over the 401(k) is that you can invest the money in almost any investment account that you want. You are not limited to accounts that your company offers. So if you prefer to invest in a mutual fund in Vanguard, you are able. If you want to put the money in a CD at your credit union, you can do that as well, whereas, with your 401(k) you are limited to the investment options that your company offers.
However, there are disadvantages to the traditional IRA, too. You cannot make withdrawals before age 59 ½ and if you do, you will be subject to penalties (there are some exceptions). And at the other end, you must start taking out some minimum withdrawals from your traditional IRA account by the time you reach 70 ½ years. If you don’t start withdrawing this money by that time, you would be subject to hefty fees. Furthermore, a traditional IRA might not be appropriate for you if you expect that your tax rate will be higher when you retire than it is now. In that case, a Roth IRA, which we will talk about in Part 3 of this series, might be more appropriate.
In Real Life (IRL) – As soon as I started working, my dad advised me to start putting money into an IRA. (In order to contribute to an IRA, you must make an income.) At the time only a traditional IRA was offered (not Roth IRAs), and even though my company offered a 401(k), my salary was low enough that I still qualified for the tax deduction. Although I was only 22 years old, my dad told me the earlier I start putting money away for retirement, the better. Trust me when I say, it sounded ridiculous at that time to be saving for retirement, which was about 40 years away. But being that he is older and wiser than I am in all things money, I took his advice. The contribution limit at the time was only $2,000, so that is what I invested.
Now that 20 years have passed (wow!) since then, I am so glad I listened to him and made the maximum contribution each year into an IRA account. Starting in 1989 through 2001 I put in $2,000 annually. After that the limits increased to $3000 from 2002-2004. The maximum allowed was $4,000 from 2005-2007 and since 2008 it is at $5,000. By putting money in this account over the years, I have built up over $70,000 in my IRA accounts. They are in a mix of mutual funds and CDs.
By taking advantage of IRAs on my own and 401(k)s at work, I have been able to sock away a few hundred dollars per month for retirement. By doing this, I have received tax advantages to this savings and have been able to build up my retirement fund slowly so it will be large enough for me to retire. As part of the whole retirement package, IRAs, as well as 401(k)s are worth investigating as a place to invest your money.***
***As is always the case with posts I write on this blog, I am not a financial advisor of any sort. I am just a person who has invested money over the course of 20 years. Any investments you make should be discussed with a competent investment professional.
An IRA is available to individuals to invest in on their own – they are not set up through your place of employment like a 401(k) is. However, like a 401(k), you can invest in various accounts such as mutual funds, CDs, or money market accounts under the “IRA” heading.
As mentioned above, there are two types of IRAs available in the US – the traditional IRA and the Roth IRA. Today we will focus on the traditional IRA. There are some advantages to investing in a traditional IRA over a Roth IRA or a 401(k) or a not-retirement vehicle, but there are some disadvantages, too. Let’s discuss the traditional IRA in detail:
Currently, you can invest up to $5,000 per year in a traditional IRA (or if you are 50 years of age or older, you can invest $6,000 per year). If you put money away into a traditional IRA, you may be able to deduct that amount from your taxable income each year. In other words, if you put $5,000 into your IRA, then when you or your tax preparer do your tax returns for the year, $5,000 would get deducted from your income to figure out the amount you would be taxed on. However, this tax deduction is subject to some restrictions. It is not allowed if you have a 401(k) or similar retirement plan at work and you make above a certain income. (Note: if you don’t qualify for the tax deduction, you can still contribute to a traditional IRA without the tax deduction.)
If you qualify for this tax deduction, please note that when you withdraw this money in retirement, you will need to pay taxes on that $5,000 at that time. This is called tax deferment. You are essentially delaying payment of your taxes until you retire. Like the 401(k), this is beneficial if you think you will be in a lower tax bracket when you retire.
Another benefit to the traditional IRA is that interest you earn on the account is tax deferred as it is in the 401(k); that is, you don’t pay taxes on earnings until you withdraw the money from the account at retirement. If you had saved this money on your own and not in an IRA account, you would be paying taxes on distributions on a yearly basis.
A benefit of the IRA over the 401(k) is that you can invest the money in almost any investment account that you want. You are not limited to accounts that your company offers. So if you prefer to invest in a mutual fund in Vanguard, you are able. If you want to put the money in a CD at your credit union, you can do that as well, whereas, with your 401(k) you are limited to the investment options that your company offers.
However, there are disadvantages to the traditional IRA, too. You cannot make withdrawals before age 59 ½ and if you do, you will be subject to penalties (there are some exceptions). And at the other end, you must start taking out some minimum withdrawals from your traditional IRA account by the time you reach 70 ½ years. If you don’t start withdrawing this money by that time, you would be subject to hefty fees. Furthermore, a traditional IRA might not be appropriate for you if you expect that your tax rate will be higher when you retire than it is now. In that case, a Roth IRA, which we will talk about in Part 3 of this series, might be more appropriate.
In Real Life (IRL) – As soon as I started working, my dad advised me to start putting money into an IRA. (In order to contribute to an IRA, you must make an income.) At the time only a traditional IRA was offered (not Roth IRAs), and even though my company offered a 401(k), my salary was low enough that I still qualified for the tax deduction. Although I was only 22 years old, my dad told me the earlier I start putting money away for retirement, the better. Trust me when I say, it sounded ridiculous at that time to be saving for retirement, which was about 40 years away. But being that he is older and wiser than I am in all things money, I took his advice. The contribution limit at the time was only $2,000, so that is what I invested.
Now that 20 years have passed (wow!) since then, I am so glad I listened to him and made the maximum contribution each year into an IRA account. Starting in 1989 through 2001 I put in $2,000 annually. After that the limits increased to $3000 from 2002-2004. The maximum allowed was $4,000 from 2005-2007 and since 2008 it is at $5,000. By putting money in this account over the years, I have built up over $70,000 in my IRA accounts. They are in a mix of mutual funds and CDs.
By taking advantage of IRAs on my own and 401(k)s at work, I have been able to sock away a few hundred dollars per month for retirement. By doing this, I have received tax advantages to this savings and have been able to build up my retirement fund slowly so it will be large enough for me to retire. As part of the whole retirement package, IRAs, as well as 401(k)s are worth investigating as a place to invest your money.***
***As is always the case with posts I write on this blog, I am not a financial advisor of any sort. I am just a person who has invested money over the course of 20 years. Any investments you make should be discussed with a competent investment professional.
Monday, March 2, 2009
Know What Is Available To Save For Retirement - Part 1
Tip #80 - Know What Is Available To Save For Retirement – Part 1. In the past we have discussed different kinds of savings and investment accounts. But today let’s talk specifically about how to put the money away toward retirement – that is what type of investment vehicles you can use to save for retirement.
In the US, these are the 3 main retirement vehicles for saving:
1. A 401(k) at work (or 403(b) if you work for a non-profit)
2. An Individual Retirement Account (IRA) that you set up on your own (or a SEP IRA if you are self-employed).
3. Traditional pension plan
Let’s talk about number 3 first. A traditional pension plan is a defined dollar amount that a company provides for its employees’ retirements after they have worked there for a certain number of years. This type of plan has started to disappear from the corporate scene in the US. And because it’s not something an employee actively participates in, rather it’s money the company provides automatically to its employees, we will not discuss it any further. If you know your company will provide a pension for you when you retire, then make sure you consider that source of funds when figuring out any additional amount you need to save to retire. Otherwise, let’s concentrate on the other two main retirement vehicles in which individuals take an active role.
The two main retirement vehicles in the US for individuals to save are the 401(k) and the IRA. By putting money “in an IRA” or “in a 401(k)”, you are actually earmarking the money for retirement. But within this vehicle, the money can be saved in a CD, a mutual fund, or other account of your choosing that we discussed earlier. However, better than putting retirement money in a CD or mutual fund on your own, by saving it through a 401(k) or an IRA you can take advantage of tax incentives that the US government gives us for saving toward retirement. Today we will talk about the 401(k).
Many places of employment offer its employees retirement savings plan called a 401(k). (A 403(b) is a similar plan for non-profit companies so if that is what you have at work, this information is essentially the same). By saving for retirement “in a 401(k)” you are taking advantage of saving the money pre-tax. For example, if you get paid $50,000 per year and want to save 10% of it for retirement in the 401(k) that your company offers, you will be putting away $5,000. And you do not pay taxes on that $5,000 until you take it out at retirement. Instead you pay taxes only on $45,000 ($50,000 total income -$5000 401(k) contribution). How you invest this money in a 401(k) is up to you within the parameters set up your company. Your company might offer you 8 mutual funds and a money market account through a private investment firm as options to invest your money “in a 401(k).”
As I just mentioned, one of the benefits of the 401(k) is that the taxes are deferred on the money that you invest. So as I said in my example the $5,000 comes out of your gross salary and you don’t pay taxes on it (until you pull it out at retirement) and can invest the full amount. Whereas, if you want to save $5,000 for retirement on your own, you would first be paying taxes on that $5,000, effectively reducing the amount you can invest. Or, another way of looking at it is if you are in the 15% tax bracket, you would need to earn about $5,883 ($5,883-$883 [$,5883*15% taxes]=$5000) in order to invest $5,000.
Also another benefit of the 401(k) is that the earnings on your investment grow tax-free until you take them out at retirement. That means if you invest $5,000 in a money market fund within a 401(k) plan and earn 3% ($150) the first year, then you do not have to pay taxes on that $150 until you retire. If you were to invest $5,000 on your own in a money market fund and make $150, then you would have to pay taxes on those earnings each year you made them. If you expect to be in a lower tax bracket when you retire this can be a huge benefit.
Another benefit of the 401(k) is that many companies “match” what you invest. That is, they may put in the exact amount into your 401(k) account that you put in. Or they may partially match what you put in. For example, many companies will match dollar for dollar the first 3% of your salary that you put in to your 401(k). Back to our example, if you make $50,000 and put in $5000, then the company would match dollar for dollar the first 3% of your salary that you put in (or $1500). So by putting in $5,000 you will automatically have $6,500. (There may be rules about how long you have to stay employed at the company to keep their “match”). Some companies may match 50% of all of your contributions. So if you make a $5000 contribution then they will put in $2,500 into your account. These types of benefits cannot be beat. The company is essentially paying you to invest.
The negatives of the 401(k) plans are that you are limited to where you can invest your money. You have to put the money in one of the choices that your company provides. Some companies have many choices and/or better choices than other companies. The other drawback is that you are limited in the amount that you can invest. Federal law puts a dollar amount limit ($16,500 in 2009) that you can put into a 401(k) each year, but your company may make stricter limits such as only 15% of your salary as the maximum you can put in. In that case, someone making $50,000 would only be allowed to invest $7,500 per year.
If you are going to invest in your retirement (and it is one of the most important savings you can do), then I highly recommend checking out your company’s 401(k) or 403(b) plan. And at the minimum, invest the full percentage needed to take advantage of the company’s match
A few years ago a variant of the 401(k) was introduced called the Roth 401(k), although I don’t believe it is offered as many places as the regular 401(k). The difference with the Roth 401(k) is that you pay taxes up front on the money you invest. Also, earnings on the money you invest are completely tax-free instead of tax deferred. This option is appealing to people who are in a low tax bracket now but expect to be in a high tax bracket when they retire.
In Real Life (IRL) – I started investing in my company’s 401(k) one year after I started working at my first job out of college, which is when I became eligible. I was about 22 years old. I only put in 3% of my salary since retirement was “so far away”, but I wanted to take full advantage of the company match, which was dollar for dollar on the first 3%. The following year I wised up after talking to one of my co-workers who was older and more experienced in investing. He suggested putting the maximum that I could into my 401(k). I took his advice and invested 13% of my salary, which was the most that my company would allow. I don’t remember what type of allocation I did, other than it was a mix of mutual funds and probably some stable money market account.
Since only one of my real life friends know about this blog, I feel pretty comfortable sharing the worth of that 401(k) to show you how quickly this money can build. I worked at that company for exactly 9 years. The first year I worked there I made $19,500. I made no contributions to the 401(k). The second year I worked there I made about $20,500 and I contributed 3% of my salary. The following years (years 3-9) I contributed the full 13% that my company allowed me to contribute. When I left that company I was making about $40,000. This means I invested $600 the first year I contributed the 401(k) and between $3000 and $5,000 per year for the following 7 years that I contributed. I left that company about 10 years ago and today that 401(k) is now worth $66,000, The money was taken out of my paycheck along with my taxes and health insurance contribution so I did not even see the few hundred dollars per month that I contributed for 8 years. And because I never saw the money, I didn’t miss it.
If your company offers a 401(k), be sure to look into it as a means for your retirement investing. If nothing else, at least try to put in as much as the company will match.***
***As is always the case with posts I write on this blog, I am not a financial advisor of any sort. I am just a person who has invested money over the course of 20 years. Any investments you make should be discussed with a competent investment professional.
In the US, these are the 3 main retirement vehicles for saving:
1. A 401(k) at work (or 403(b) if you work for a non-profit)
2. An Individual Retirement Account (IRA) that you set up on your own (or a SEP IRA if you are self-employed).
3. Traditional pension plan
Let’s talk about number 3 first. A traditional pension plan is a defined dollar amount that a company provides for its employees’ retirements after they have worked there for a certain number of years. This type of plan has started to disappear from the corporate scene in the US. And because it’s not something an employee actively participates in, rather it’s money the company provides automatically to its employees, we will not discuss it any further. If you know your company will provide a pension for you when you retire, then make sure you consider that source of funds when figuring out any additional amount you need to save to retire. Otherwise, let’s concentrate on the other two main retirement vehicles in which individuals take an active role.
The two main retirement vehicles in the US for individuals to save are the 401(k) and the IRA. By putting money “in an IRA” or “in a 401(k)”, you are actually earmarking the money for retirement. But within this vehicle, the money can be saved in a CD, a mutual fund, or other account of your choosing that we discussed earlier. However, better than putting retirement money in a CD or mutual fund on your own, by saving it through a 401(k) or an IRA you can take advantage of tax incentives that the US government gives us for saving toward retirement. Today we will talk about the 401(k).
Many places of employment offer its employees retirement savings plan called a 401(k). (A 403(b) is a similar plan for non-profit companies so if that is what you have at work, this information is essentially the same). By saving for retirement “in a 401(k)” you are taking advantage of saving the money pre-tax. For example, if you get paid $50,000 per year and want to save 10% of it for retirement in the 401(k) that your company offers, you will be putting away $5,000. And you do not pay taxes on that $5,000 until you take it out at retirement. Instead you pay taxes only on $45,000 ($50,000 total income -$5000 401(k) contribution). How you invest this money in a 401(k) is up to you within the parameters set up your company. Your company might offer you 8 mutual funds and a money market account through a private investment firm as options to invest your money “in a 401(k).”
As I just mentioned, one of the benefits of the 401(k) is that the taxes are deferred on the money that you invest. So as I said in my example the $5,000 comes out of your gross salary and you don’t pay taxes on it (until you pull it out at retirement) and can invest the full amount. Whereas, if you want to save $5,000 for retirement on your own, you would first be paying taxes on that $5,000, effectively reducing the amount you can invest. Or, another way of looking at it is if you are in the 15% tax bracket, you would need to earn about $5,883 ($5,883-$883 [$,5883*15% taxes]=$5000) in order to invest $5,000.
Also another benefit of the 401(k) is that the earnings on your investment grow tax-free until you take them out at retirement. That means if you invest $5,000 in a money market fund within a 401(k) plan and earn 3% ($150) the first year, then you do not have to pay taxes on that $150 until you retire. If you were to invest $5,000 on your own in a money market fund and make $150, then you would have to pay taxes on those earnings each year you made them. If you expect to be in a lower tax bracket when you retire this can be a huge benefit.
Another benefit of the 401(k) is that many companies “match” what you invest. That is, they may put in the exact amount into your 401(k) account that you put in. Or they may partially match what you put in. For example, many companies will match dollar for dollar the first 3% of your salary that you put in to your 401(k). Back to our example, if you make $50,000 and put in $5000, then the company would match dollar for dollar the first 3% of your salary that you put in (or $1500). So by putting in $5,000 you will automatically have $6,500. (There may be rules about how long you have to stay employed at the company to keep their “match”). Some companies may match 50% of all of your contributions. So if you make a $5000 contribution then they will put in $2,500 into your account. These types of benefits cannot be beat. The company is essentially paying you to invest.
The negatives of the 401(k) plans are that you are limited to where you can invest your money. You have to put the money in one of the choices that your company provides. Some companies have many choices and/or better choices than other companies. The other drawback is that you are limited in the amount that you can invest. Federal law puts a dollar amount limit ($16,500 in 2009) that you can put into a 401(k) each year, but your company may make stricter limits such as only 15% of your salary as the maximum you can put in. In that case, someone making $50,000 would only be allowed to invest $7,500 per year.
If you are going to invest in your retirement (and it is one of the most important savings you can do), then I highly recommend checking out your company’s 401(k) or 403(b) plan. And at the minimum, invest the full percentage needed to take advantage of the company’s match
A few years ago a variant of the 401(k) was introduced called the Roth 401(k), although I don’t believe it is offered as many places as the regular 401(k). The difference with the Roth 401(k) is that you pay taxes up front on the money you invest. Also, earnings on the money you invest are completely tax-free instead of tax deferred. This option is appealing to people who are in a low tax bracket now but expect to be in a high tax bracket when they retire.
In Real Life (IRL) – I started investing in my company’s 401(k) one year after I started working at my first job out of college, which is when I became eligible. I was about 22 years old. I only put in 3% of my salary since retirement was “so far away”, but I wanted to take full advantage of the company match, which was dollar for dollar on the first 3%. The following year I wised up after talking to one of my co-workers who was older and more experienced in investing. He suggested putting the maximum that I could into my 401(k). I took his advice and invested 13% of my salary, which was the most that my company would allow. I don’t remember what type of allocation I did, other than it was a mix of mutual funds and probably some stable money market account.
Since only one of my real life friends know about this blog, I feel pretty comfortable sharing the worth of that 401(k) to show you how quickly this money can build. I worked at that company for exactly 9 years. The first year I worked there I made $19,500. I made no contributions to the 401(k). The second year I worked there I made about $20,500 and I contributed 3% of my salary. The following years (years 3-9) I contributed the full 13% that my company allowed me to contribute. When I left that company I was making about $40,000. This means I invested $600 the first year I contributed the 401(k) and between $3000 and $5,000 per year for the following 7 years that I contributed. I left that company about 10 years ago and today that 401(k) is now worth $66,000, The money was taken out of my paycheck along with my taxes and health insurance contribution so I did not even see the few hundred dollars per month that I contributed for 8 years. And because I never saw the money, I didn’t miss it.
If your company offers a 401(k), be sure to look into it as a means for your retirement investing. If nothing else, at least try to put in as much as the company will match.***
***As is always the case with posts I write on this blog, I am not a financial advisor of any sort. I am just a person who has invested money over the course of 20 years. Any investments you make should be discussed with a competent investment professional.
Sunday, February 22, 2009
Put Away Money and Forget About It But Remember It, Too
Tip #75 - Put Your Money Away And Forget About It, But Remember It, Too. As you start building up your savings, you will need to manage your money. Did you put it in the right investment? Are there different accounts out there that are better? Are there the same types of accounts out there that earn more money?
There are some people who become so enamored with their money that they check their accounts each and every day. They check the balances of their savings accounts; they check the prices of the mutual funds they own; and they calculate their net worth (what you own minus what you owe) more often than some people shower. Then there are others who take a financial advisor’s advice on where to save money. And they put money in various investment accounts and do not bother to look at their statements ever. They don’t keep track of how much is in each account. And they may not even remember or quite understand where their money is located.
Which way of these is the better? Should we track our savings every day? Or should we put our money away and forget about it until we need it? Of course the answer is both.
First, we should be knowledgeable about where we put our money. If you are taking a financial advisor’s advice about where to park your money, make sure you understand every last bit about the investment – the risks involved, how much you are earning, what fees there are with the investment, and any penalties it has for early withdrawal. If you are investing your money yourself, then you should know all of these things as well. Once you understand the investment and are comfortable with the type of investment it is (money market account, mutual fund, CD, etc.), and you believe you have shopped around gotten the best rate for that type of account, then put your money in it and forget about it.
But re-evaluate it, too. Not every day. Not even every month. The most often you should be re-evaluating your accounts is once every three months. Every six months is fine, too. And at minimum, you should look at them at least once per year. It really is not necessary to look at these accounts everyday. If you do, you will end up micromanaging the accounts and second-guessing what investments you made when you were investigating where to put your money. By micromanaging them, you may get caught up in the daily fluctuations of the market and make bad decisions based on that. However, If you don’t manage the accounts at all, you may become so ignorant of what is going on in the economy and how your accounts are faring, that you may not be taking advantage of opportunities out there.
For example, suppose Joe Worker, age 32, after talking to some knowledgeable people at work decides to buy a stock mutual fund for his retirement account in a 401(k). He makes this decision because retirement is about 30 years away and he’s comfortable taking some risk with this money since it will be put away for the long term. He commits $1,200 in it per year. After he puts the money in this mutual fund, he gets a bit nervous because he’s never invested in an account that could lose money before. So what does he do? He checks the newspaper every day to see how the mutual fund is performing. Or every morning he goes online and signs into his account to see how much money is in it. And on the days he sees that there is more money in it than the day before he is happy! And on the days it is less, he is tempted to move that money out of this ‘risky’ account and put it in a money market account. What is wrong with this behavior is that Joe is now being influenced by the daily fluctuations of the stock market and is not thinking long term anymore. Remember, when he was level-headed and making the decision of where to put the money, he realized that he will not need this money for 30+ years. He knew at that time that what is important is how the stock market will do over 30 years’ time, not what it is doing on a daily basis this year. But now Joe is looking too closely at his account.
On the other hand, Susie Homemaker, age 40 put money away for a new car she plans to buy in 3 years. She put her money into a money market account earning 2% interest. She was advised by her friend that this was a safe place to put money that she will need in the relative short-term. She looks into two banks in town and picks the one with the better rate. She puts her money there and forgets all about it because she’s not really interested in investments. She’ll get the money when she needs it. A year later, however, interests rates have gone up, and while her money market account’s rate's have gone up, too, the bank across town is offering new customers an even better rate than Susie is getting. But Susie misses out on this offer because she has no interest in investments and in her mind she has put her money away to not be seen again until 3 years down the road. Susie is not actively managing her account at all and missed out on a good opportunity to make more interest on her account while having the same risk.
There is a fine line between how much managing of your accounts is too much and how much is not enough. You want to make smart decisions based on what is going on around you, but on the other hand, you don’t want to be influenced by day-to-day fluctuations. You have to find the right balance between being aware of what your money is doing, but not making decisions based on a temporary change. Strike the right balance on how much time to devote to reevaluating your investments. If you made good decisions in the first place (safe investments for the short term, investments with more risk for the long term), then I think between every 3 months to once a year should be often enough to re-evaluate where you parked your money.
In Real Life (IRL) – I relayed my story of how I first got involved in mutual funds. I was in my early 20’s and was convinced by my dad and brother that this was the way to go for my long-term money. What I didn’t tell you was that I became in love with this mutual fund. This was the early 1990’s and stocks and mutual funds were performing through the roof. At about the same time that I investment in my first mutual fund, a friend at work invested in one, too. We had so much fun checking our accounts. Everyday at work we would check the newspaper to see how our accounts performed. We made spreadsheets predicting how much money we would have if our accounts continued to perform at 15% per year for the next 20 years (ha, don’t we wish!). We both became obsessed with our accounts and the competition of which would do better. Fortunately, because it wasn’t going down, I wasn’t tempted to take the money out. But I was evaluating my investment entirely too often. How the money did on a daily basis was inconsequential. The money was long-term money, and all I really needed to be concerned about was whether this investment was right for a 30-year ride. I really didn’t need to reevaluate it more than every 6 months or every year. But I was new to investing and that’s what I did.
I’d like to say I've grown up since then, and maybe I have. But the truth of the matter is I just got too busy. With three young children, I very rarely check on what my investments are doing these days. Yes, I know the stock market has tanked in the past year. Yes, I know the economy stinks and that we are in a ‘recession”. But it truly hasn’t affected where I put my investments so many years ago. I hardly ever check them, mostly because I’m too busy rather than because it’s the right thing to do. But it is the right thing to do. I am only 41 years old. What the stock market is doing today should not bother me because I am not retiring for about 20 years. I know I made the right allocations for my retirement fund based on my age and years until retirement. And I do look at those allocations at least once a year, usually twice. But that’s it. I forget about them for the most part. Overall, I don't pay attention to daily fluctuations in my accounts (okay maybe I peeked once or twice on particularly bad stock market days). In the end re-evaluating your investments just a few times per year is the best thing you could do for your money.
There are some people who become so enamored with their money that they check their accounts each and every day. They check the balances of their savings accounts; they check the prices of the mutual funds they own; and they calculate their net worth (what you own minus what you owe) more often than some people shower. Then there are others who take a financial advisor’s advice on where to save money. And they put money in various investment accounts and do not bother to look at their statements ever. They don’t keep track of how much is in each account. And they may not even remember or quite understand where their money is located.
Which way of these is the better? Should we track our savings every day? Or should we put our money away and forget about it until we need it? Of course the answer is both.
First, we should be knowledgeable about where we put our money. If you are taking a financial advisor’s advice about where to park your money, make sure you understand every last bit about the investment – the risks involved, how much you are earning, what fees there are with the investment, and any penalties it has for early withdrawal. If you are investing your money yourself, then you should know all of these things as well. Once you understand the investment and are comfortable with the type of investment it is (money market account, mutual fund, CD, etc.), and you believe you have shopped around gotten the best rate for that type of account, then put your money in it and forget about it.
But re-evaluate it, too. Not every day. Not even every month. The most often you should be re-evaluating your accounts is once every three months. Every six months is fine, too. And at minimum, you should look at them at least once per year. It really is not necessary to look at these accounts everyday. If you do, you will end up micromanaging the accounts and second-guessing what investments you made when you were investigating where to put your money. By micromanaging them, you may get caught up in the daily fluctuations of the market and make bad decisions based on that. However, If you don’t manage the accounts at all, you may become so ignorant of what is going on in the economy and how your accounts are faring, that you may not be taking advantage of opportunities out there.
For example, suppose Joe Worker, age 32, after talking to some knowledgeable people at work decides to buy a stock mutual fund for his retirement account in a 401(k). He makes this decision because retirement is about 30 years away and he’s comfortable taking some risk with this money since it will be put away for the long term. He commits $1,200 in it per year. After he puts the money in this mutual fund, he gets a bit nervous because he’s never invested in an account that could lose money before. So what does he do? He checks the newspaper every day to see how the mutual fund is performing. Or every morning he goes online and signs into his account to see how much money is in it. And on the days he sees that there is more money in it than the day before he is happy! And on the days it is less, he is tempted to move that money out of this ‘risky’ account and put it in a money market account. What is wrong with this behavior is that Joe is now being influenced by the daily fluctuations of the stock market and is not thinking long term anymore. Remember, when he was level-headed and making the decision of where to put the money, he realized that he will not need this money for 30+ years. He knew at that time that what is important is how the stock market will do over 30 years’ time, not what it is doing on a daily basis this year. But now Joe is looking too closely at his account.
On the other hand, Susie Homemaker, age 40 put money away for a new car she plans to buy in 3 years. She put her money into a money market account earning 2% interest. She was advised by her friend that this was a safe place to put money that she will need in the relative short-term. She looks into two banks in town and picks the one with the better rate. She puts her money there and forgets all about it because she’s not really interested in investments. She’ll get the money when she needs it. A year later, however, interests rates have gone up, and while her money market account’s rate's have gone up, too, the bank across town is offering new customers an even better rate than Susie is getting. But Susie misses out on this offer because she has no interest in investments and in her mind she has put her money away to not be seen again until 3 years down the road. Susie is not actively managing her account at all and missed out on a good opportunity to make more interest on her account while having the same risk.
There is a fine line between how much managing of your accounts is too much and how much is not enough. You want to make smart decisions based on what is going on around you, but on the other hand, you don’t want to be influenced by day-to-day fluctuations. You have to find the right balance between being aware of what your money is doing, but not making decisions based on a temporary change. Strike the right balance on how much time to devote to reevaluating your investments. If you made good decisions in the first place (safe investments for the short term, investments with more risk for the long term), then I think between every 3 months to once a year should be often enough to re-evaluate where you parked your money.
In Real Life (IRL) – I relayed my story of how I first got involved in mutual funds. I was in my early 20’s and was convinced by my dad and brother that this was the way to go for my long-term money. What I didn’t tell you was that I became in love with this mutual fund. This was the early 1990’s and stocks and mutual funds were performing through the roof. At about the same time that I investment in my first mutual fund, a friend at work invested in one, too. We had so much fun checking our accounts. Everyday at work we would check the newspaper to see how our accounts performed. We made spreadsheets predicting how much money we would have if our accounts continued to perform at 15% per year for the next 20 years (ha, don’t we wish!). We both became obsessed with our accounts and the competition of which would do better. Fortunately, because it wasn’t going down, I wasn’t tempted to take the money out. But I was evaluating my investment entirely too often. How the money did on a daily basis was inconsequential. The money was long-term money, and all I really needed to be concerned about was whether this investment was right for a 30-year ride. I really didn’t need to reevaluate it more than every 6 months or every year. But I was new to investing and that’s what I did.
I’d like to say I've grown up since then, and maybe I have. But the truth of the matter is I just got too busy. With three young children, I very rarely check on what my investments are doing these days. Yes, I know the stock market has tanked in the past year. Yes, I know the economy stinks and that we are in a ‘recession”. But it truly hasn’t affected where I put my investments so many years ago. I hardly ever check them, mostly because I’m too busy rather than because it’s the right thing to do. But it is the right thing to do. I am only 41 years old. What the stock market is doing today should not bother me because I am not retiring for about 20 years. I know I made the right allocations for my retirement fund based on my age and years until retirement. And I do look at those allocations at least once a year, usually twice. But that’s it. I forget about them for the most part. Overall, I don't pay attention to daily fluctuations in my accounts (okay maybe I peeked once or twice on particularly bad stock market days). In the end re-evaluating your investments just a few times per year is the best thing you could do for your money.
Sunday, November 23, 2008
Are You Ready For Retirement?
Tip #32 - Are you Ready for Retirement? If not, then get ready! Regardless of your age, you should be preparing for retirement. It's never too early. In your 40s? You should be preparing. 35? Not too early. You just turned 21? Perfect time to get started! The idea behind saving early for retirement is that the longer your money is in savings, the more time it has to grow. Also, if you work for 40 years of your life and save a little bit from each year, then you will be able to live on that savings when you're older and not working. If you wait to start saving, then you won't have enough or you will have to put away a lot each year. Start early and you can just put away a little each year. It's like spreading out the cost of retiring over your 40-year or so career.
I just received a brochure from my credit union, Navy Federal about how much I need to save for retirement. It was a real eye opener. I will share highlights of it with you so you can figure out approximately how much you need to retire and how much you should be saving each year. We'll go through an example. There were essentially five steps:
Step 1: Figure out how much income you need in retirement. If you live on $50,000 now, you figure out if you need to live on 75%, 85%, or 95% of your income in retirement. This depended mostly on where you expect to get your healthcare funds from in retirement. Of course these are only estimates. Let's assume 85%. That means you will need $42,500 each year in retirement ($50,000 *.85).
Step 2: Figure out what income you expect to receive in retirement. First calculate how much Social Security you will to get, based on how much you make. A person making $50,000 can expect to get $14,500 per year in retirement from Social Security. Yay, finally you get back some of that money you've been putting into the program all of your working years! You also figure out if you are getting a pension from your employer each year. We'll assume no for this example and whether you will have a part-time job in retirement. We'll assume no again. You can always change your mind on that one. Now we subtract the $14,500 from the $42,500 that we estimate we'll need in retirement. The result is $28,000. This is the amount we will need each year in retirement to live similarly as we do now.
Step 3: How much do we need to save now in order to get to this figure? The worksheet gave us different scenarios of when we expect to retire and how long we expect to live (as if we know!). The earlier you hope to retire and the longer you live means you will need to save more. The later you retire and the shorter you expect to live, the less you need. Let's err on the side of conservative. Better to have too much money than not enough. Let's assume we expect to retire at 65. If we are female and hope to live to the age of 92, we use a factor of 18.79 to calculate the savings we need. Take the $28,000 * 18.79 and we come up with $526,120. That is how much we need total for retirement.
Step 4: Figure out how much savings you have so far and how long you have until retirement. If you are 30 years old now, you have 35 years until retirement at 65. Using their chart you get a factor based on this number of years until retirement. In our example the factor is 2.4. Multipy 2.4 * the amount we have saved so far. Let's assume we haven't been too good about savings yet and we only have $20,000 saved for retirement so far. Multiply 2.4 * $20,000 and we get $48,000. We subtract this from our total needed for retirement in step 3. So we take $526,120 - $48,000 and come up with $478,120. This is our total savings goal. In other words, what we need for retirement.
Step 5: Figure out what our yearly savings should be from now on. We have 30 years until retirement. Using the factor they have in a chart, we multiply .020 * our total savings goal from the last step. So we take $478,120 * .020 and come up with $9,562.40. This is how much we should be saving each year for retirement.
I only gave bits and pieces of this retirement worksheet. But the source of it was the Choose To Save organization from the American Savings Education Council, a program of the Employee Benefit Research Institue Education and Research Fund. The full worksheet is at Choose To Save. Check it out and figure out how much you need to save for retirement.
So in this example we figured out that we need to save a bit over $9,500 per year for retirement. Sounds like a lot, doesn't it? It's essentially $800 per month. There are tax incentives to do this, though. You can save $5,000 per year in an IRA and you can put away the rest through a 401K at work if that's available to you. Regardless of how you save this money, you should keep this figure in mind when doing your budget. Retirement savings should always be a line item on your budget.
In Real Life (IRL) - I have been saving money for retirement since I turned 23. That was a year after I started my first real job out of college. My company offered a 401K plan and said the first 3% of my salary that I saved, they would match! So I saved 3% of my salary. At the time my salary was slightly less than $21,000. So I save about $600 and my company matched it. Altogether my first year of saving was about $1,200. A year or two after that, an older man at work advised me to put the maximum I could into my 401k. He said the money is taken out before you even see it so you don't miss it. So I took his advice and maxed out on my 401k which I believe was 13% of my salary. My company still matched dollar for dollar the first 3%. So essentially 16% of my salary was getting saved each year for retirement. I didn't see the money and I didn't miss it. Even though I was making under $30,000 in those first few years of my career, I was saving almost $3,000 for retirement annually. At some point in my 20's I started putting the maximum amount into an IRA, too.
When I met my husband, he too, had been putting money into his 401(k) at work. But he wasn't contributing to an IRA. I got him started on that and we've both been doing it faithfully since. I am now 41 years old so it is exactly 20 years since I started my first job. I haven't worked more than part-time in the last 7 years. Yet because I started early our retirement savings have accumulated about $300,000. We still expect to have 20 more years until retirement. Based on the worksheet, we still need to be putting away about $10,000 per year until retirement. That's okay. It's in our budget to do so. And retirement savings should be in your budget, too.
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