Understanding Retirement Planning Options

Once you start talking about retirement planning, you will hear many opinions. There are so many options to consider that you may get stalled.

Remember that just because a particular strategy works for someone else, does not mean it will work for you.

Retirement planning scenarios are dependent on your age, your current financial situation, the plans available to you through work, and what you want to get out of retirement after you stop working full-time.

Let’s look at the options and explore them a bit further:

Annuities and Company Defined Benefits –

The basic concept of an annuity is that it will provide a guaranteed income for as long as you live.

If you work for a company that offers a ‘company-defined benefit pension’, or annuity, program, you might see a calculation that averages your final 3-5 years of salary and provides 75% of the resulting number as an annual retirement payment (presuming you retire at a certain age with a certain number of years of service). Most employers no longer offer these programs because they are expensive to administer.

However, in many cases you can purchase an annuity through a financial services company. You make payments into the program and in exchange you get a guaranteed monthly payment beginning when you retire.

These programs can be ‘fixed’ or ‘variable’.

In the case of ‘fixed’ payments, you get a certain amount of money every month and in some cases, you can arrange to have a cost of living increase included in case you need more money to accommodate a higher cost of living.

‘Variable’ programs calculate payments based on the current price of stocks and bonds.

Your payments may be more attractive, but the cost of variable programs has also risen, so you should consider the tradeoffs carefully before you decide on a program.

You can purchase annuities that include a death benefit for a beneficiary so that they will continue to receive monthly payments after your death.

Defined Contribution Plans – These plans are more popular today because it does not cost your employer as much to administer the plan.

The plan allows you or your employer to contribute up to a certain amount into a retirement account until you retire from the company.

In some plans, your employer will make the contribution; in others both the employer and the employee will contribute to the account and in some cases, only the employee will contribute.

When you retire, you have the option to take a lump sum payout or to buy an annuity that allows you to receive payments over a period of time.

If your company allows you to move funds around in your account to protect yourself from the stock market ups and downs, that is great.

If the company manages the funds and you have no choice, you may find that your retirement funds are not well managed or protected.

Let’s go into a bit more detail on some of the company offered and/or company managed programs your employer may provide:

401(k) – With a flexible 401(k) that depends on your contribution to grow, your employer will provide a list of funds in which you can invest, and you choose from that list.

Your contribution is deducted from your pay check before taxes.

If your employer matches your contribution, they will split the contribution they make so that they are putting the same percentages in the same accounts as the accounts to which you contribute your pre-tax monies.

If you are only just beginning to contribute to your plan and you want to make up for lost time, you can consider getting more aggressive with your investments in hopes that they will grow faster.

If you are in your twenties you may be able to take a bit more risk.

Here is what “Money” magazine suggests for the various levels of risk (based on the number of years you have before your planned retirement):

Aggressive (High Risk Investment) 35 or more years until retirement
50%–large cap stocks
15%–mid cap stocks
15%–bonds
10%–small cap stocks
10%–international stocks

Moderate (Medium Risk Investment) 20 years until retirement
35%–large cap stocks
35%–bonds
10%–mid cap stocks
10%–small cap stocks
10%–international stocks

Conservative (Low Risk Investment) within 10 years of retirement
40%–bonds
30%–large cap stocks
10%–mid cap stocks
10%–international stocks
10%–cash

Roth IRA – A ‘Roth’ IRA is basically a savings program. You can make non-deductible contributions up to a certain limit.

If you need to borrow against or withdraw money from a Roth IRA, you can do so without taxation under certain circumstances.

Unlike the standard IRA, you can contribute to a Roth IRA after age 70 and a half.

Maximum contributions are limited to either a) the numbers in below or, b) 100% of your earned income, less than contributions to standard IRA accounts.

The annual dollar limits are as follows:

Under age 50 Age 50 or Over Taxable Year

$4,000 $5,000 2006
$4,000 $5,000 2007
$5,000 $6,000 2008

After 2008, the annual allowable contribution will be adjusted to accommodate cost-of-living increases.

Standard (Traditional) IRA – A Traditional IRA is basically a savings plan. You can make tax deductible contributions up to an annual limit.

Taxes are paid when you withdraw money from the fund.

Any withdrawals you make before age fifty nine and a half are penalized. After that, you can make withdrawals without penalty. You MUST begin making withdrawals by age seventy and a half.

Simple IRA – These are employer plans that are tax-deferred with higher limits than a traditional or Roth IRA.

These plans are usually available in small companies with 100 employees or less.

These IRAs are portable so if you leave the company, you can take it with you, and you are 100% vested from the time you begin to make contributions.

You can contribute up to $10,000 in these accounts, annually.

Roth Designations in 401(k) – Beginning in 2006, you can designate a sum of money to be deposited by your employer into a Roth IRA. This money will be taxed before deposit.

However, Congress has only provided for this opportunity from 2006 through 2010. Unless this legislation is made permanent or extended, you will only be able to leverage this method of savings through 2010.

Section 457 Plans – Section 457 of the Tax Code provides guidelines for government employees and all tax-exempt organizations, except churches.

Eligible organizations include:

Charities Religious orders and organizations
Educational entities Labor unions and trade associations
Foundations Private hospitals
Farmers’ coops Fraternal orders

If you are employed by one of these agencies or organizations, you can make pre-tax depositions in an eligible 457 plan. Taxes are paid when you withdraw the money from the account.

You can defer the lesser of a) 100% of your salary or, b) $15,000 (in 2006).

After 2006, the eligible amounts will accommodate cost-of-living increases with a $500.00 per year bump in the eligible amount, applied each year.

You can withdraw funds from your account at age fifty nine and a half, or when you leave the company (in which case you can rollover your account to another account with your new employer), or if you have an emergency situation.

Otherwise, you can leave the funds in your account until you are seventy and a half, but you must begin withdrawals at seventy and a half.