401K, IRA, Simple IRA, SEP-IRA, Solo-401k, Annuities & CD's
How to Plan for Retirement
Many people think that their social security and work pension will be all they need for retirement. Others may realize that they need more of a retirement nest egg, but have no idea how to create one. There are many products available to invest your money in for your future, but it is essential that you understand the basics about retirement planning before you decide what to do with your money.
How Much Money Will You Need?
The first step in retirement planning is to figure out how much money you will need. You can find many online calculators that will give you a total, but you need to know how to calculate the right number.
The dollar figure that you need for retirement is unique to each person based on the answers to several questions. You need to sit down and figure out the answers so that you can know how much you will require for living expenses without a job.
- When do you want to retire? For many, they will want to retire as soon as they reach retirement age for social security. Others plan to work longer, while others hope to retire early to enjoy their later years. When you plan to retire has a direct impact on how much money you will need to live.
- How much have you saved? If you have been saving for several years, you will need to invest less than someone just starting out.
- What other sources of income will you have? You can add in your expected social security benefits and any other pension plans or retirement benefits that you expect to have when you retire. This money will lessen the amount you need to put into a savings plan.
- How much will you withdraw once you retire? This will reduce the amount that your money is making after you have retired. Some people can live off of the interest along with their social security while others may use some of the principle each year.
- How will you pay for your care as you age? If you plan to invest in long-term care insurance, you will have to figure in those premiums. However, they will cover much of the cost of your care when you need assistance. Otherwise, you will need to calculate the cost of an assisted-living facility or in-home companion as you begin to need more care.
- What bills will you have once you've retired? Your house may be paid off, but you may also have other expenses such as a new car. Other factors are the kind of lifestyle you want to live. Do you want to travel or pick up a new hobby? You may want to buy a second home for retirement.
- What is the expected growth rate of your money? You may need to talk with a financial advisor or look at different investment portfolios to answer this question. Generally, the younger you are when you begin investing, the more aggressive you can be with your money. What this means is that money you invest has a greater chance of earning you a higher percentage of return. Of course, this also means there is a higher risk, which is why people nearing retirement should select safer investment options.
Once you answer these questions, you will have a foundation on which to work. You can find several good retirement calculators online and it is beneficial to try more than one. AARP and CNN Money are two sites that have an online calculator that you can use.
What are Your Options?
Once you have an idea how much money you will need, you need to learn about the types of retirement plans you can choose. You have two basic options: either hire a financial planner or do the investing yourself. There are benefits to both; you have to decide what works for you.
Some people like total control of their finances; handling all of their own investments is one way to retain that control. However, this can be time-consuming and frustrating as you watch your money suffer losses as well as profits along the way. If you enjoy managing investments and making money increase, do-it-yourself investing could be the way to go.
Financial advisors are the best choice for the majority of people. They handle the day-to-day details of the money and send you quarterly or annual reports. They will work to maximize your profits and suggest the best investment strategy for your age and goals. Even if you choose to work with an advisor, it pays to understand the basics about investing so that you can make informed decisions instead of completely relying on their advice.
Types of Investment Accounts
You have several options on how you want to invest your money. You should have some idea before you go to an advisor or begin investing on your own. Each option has its advantages and disadvantages.
This is perhaps the most well-known retirement plan. It was created in 1978 when Congress passed the Tax Reform Act. Part of this act included the ability for employees to use their earnings to save money that was tax-deferred for retirement.
When you participate in a 401k plan, the amount you are investing comes out of your paycheck before you get it. The employer usually contracts with an investment company to handle the money with input from the employee. Each company differs on the investment plans they offer and may include detailed selections or general choices such as level or risk.
The employee designates how much money they want to invest in the plan and this can be adjusted each year. Some employers will provide a match up to a certain percent of your salary. For instance, if you invest three percent of your salary, the employer will also donate three percent or they may donate half at one and a half percent. This allows your money to double and grow even faster, and it is one of the biggest benefits to investing in a 401k plan.
The disadvantages of a 401k plan are minimal and do not affect most people. There is a limit to how much you can contribute annually, but it was 17,000 for the year 2012 or 22,500 if you are over the age of 55. Many people never come close to this amount so they never max out their benefit.
Another slight disadvantage is that the employer can limit your investment options with the choices they allow. If you change jobs, you will have to decide if you want to transfer it to your new job, turn it into an IRA, or cash it out. If you choose to take the cash or at any time make a withdrawal, you will incur severe penalties.
If you decide to contribute to your employer's 401k plan, find out some information.
How long do you have to be employed before you are 100% vested? This means that you can walk away with all of your contributions. Employers usually have a scale that allows you to increase the amount for the first three to five years.
What happens when you retire? You may be able to leave the money in the account or you may have to move it to another account. Find out what restrictions the employer has on contributions or other issues.
Once you decide to contribute to the company's 401k plan, you will have to choose how to invest your money. Most plans offer a variety of investment strategies, including a mixed portfolio of higher risk and lower risk options. If you are not sure what to do, stick with these. You will still make money on some of the choices even if the others drop.
One thing to remember about your investment strategy is to consider how far you are from retirement. If you have twenty or more years, your money has a better chance to grow in a high risk portfolio. As you get close to retirement age, you may want to switch your investment to a safer set of options.
Investment Retirement Accounts (IRAs)
This is an option if your employer does not offer a 401k plan or you want to contribute more than the allowed amount. It's also a beneficial option if your 401k plan does not suit you.
One benefit of an IRA is that the money invested is tax-deferred, which allows you to invest more of it for growth. You also may be able to deduct IRA contributions on your taxes, saving you even more money.
One disadvantage of an IRA is that you can be penalized if you withdraw the money early. This means before what the government decides is retirement age. Besides a hefty penalty, you will also be taxed on the money you withdraw, which further reduces the amount you will receive.
Another limitation to an IRA is that you can only invest a certain amount of your income. This amount can change each year so you have to continually be aware of the total.
While CDs are the best known investment options for an IRA, you can also invest in stocks or mutual funds. CDs are the safest option, but they also have the lowest return on investment. Just like with a 401k plan, how you invest will depend on when you plan to retire.
If you choose to invest in stocks, you will be able to choose a type of stock just like with the 401k. You should either learn about the different stocks or work with a financial advisor that can direct you to the best investment for your money.
Another popular investment strategy is an annuity. Many people do not know about them and how they work, but they have been a reliable investment strategy for many years.
An annuity is basically money you give to an insurance company so they can turn around and give the money back to you in installments when you retire. This sounds simple, but it can be quite complicated. It sounds safe, but there are risks involved just like with any other investment.
You can pay either a lump sum or make payments over time, which is called a deferred annuity. Other options affect how much money you get back. Instead of returning your original amount paid in back to you, they can invest the money and pay you back the amount you earn (or what's left after a loss). You can get annuities that pay on death or provide spouse benefits. When you choose an annuity, you will need to figure out what you want.
A disadvantage of the annuity is that it isn't backed by the government, which means you lose the money if the insurance company goes bankrupt. It is also not dependent on inflation, and may not provide as much as the same amount does now.
Fees can be high for annuities so that you end up paying more than what you will get in return. Insurance companies do not always provide a statement of itemization to list the fees.
The amount you receive from annuities is based on your age and gender, as well as the current interest rates. This means that in times of low interest rates your return will be much lower.
You may wonder if an annuity is ever a good option. There are times when it can be beneficial to invest in an annuity. For one thing, it keeps your money for your future if you have difficulty saving on your own. It can also be a good way to diversify your portfolio if you are already investing in stocks or other options.
One disadvantage to an annuity is that you are taxed as if it was regular income, which is higher than for other investment types. This, coupled with fees, can make it an expensive investment choice.
What if You are Self-Employed?
You may wonder how to plan for retirement if you are the owner of a business. You do not have the option of an employer's 401k plan. You also have different tax responsibilities than a regular employee. However, there are options for the self-employed that allow them to save for their retirement.
This is a simplified employee pension that works for a one-person business. You can benefit from this plan if you work for yourself, but have no other employees. In one way, it is similar to an employer's 401k plan in that you can put away money before tax. You can use as much as 25% of your net income to fund the IRA up to a certain amount. However, the IRA cannot be a Roth IRA.
With this plan, you can contribute even if you are currently working for an employer while getting your business started. It won't interfere with your current 401k plan. You also don't have to pay into your fund until you file your tax return. This allows you to know exactly how much you can contribute. If you had a good year, you can add more to reduce your taxes since you can deduct the contributions.
The biggest disadvantage to the plan is if you should have employees in the future. You would be required to pay in the same amount for each of your employees, which could get expensive.
You can open an SEP-IRA with almost any bank or financial company. You have until you file your taxes in a given year to open the account; this includes any extensions you have been granted.
This is an ideal retirement plan if you have plenty of money to contribute. You are allowed to contribute up to a certain amount as an employee, plus you can add in the employer's portion. If you're over the age of 50, you can add even more.
You can contribute a large dollar amount to this plan and any fees that you may have to pay are low. Many financial companies don't even charge a fee. You may even be able to turn it into a Roth IRA that allows it to grow tax-free for the future.
If you need money for some reason down the road, it is possible to get short term loans against a Solo-401k. You can usually borrow up to half the balance and take five years to pay it back. However, borrowing from a retirement account is never recommended. Not all firms will allow you to borrow, so you may want to inquire before you choose the one to work with.
You can only use the instant loans option for you and a spouse with no employees. It is also not the best option if you still have another job since all contributions count for your total regardless of the kind of 401k plan.
This is the option you want to consider if you have a few employees. You can contribute as both an employer and an employee; your employer amount will be the same for all employees. As an employee, you can select how much you want to put into your account. This is a nice choice if you want to offer a retirement plan as a benefit for your employees.
This can amount up to quite a few dollars since you have to contribute a percentage of each employee's salary. However, the paperwork is easy to fill out and the plan is easy to manage if you choose this route.
You cannot choose this option if you have already maxed out your contributions at your day job. The fees are also higher if you want to make a withdrawal than for a SEP-IRA.
General Investing Tips
Regardless of the type of investment you choose, unless you are working with your employer's 401k plan, you need to select a reputable firm to handle your money. Allow them to use their expertise to advise you, but be knowledgeable enough about investing to know if you should follow their advice.
Diversify your portfolio to prevent disaster if something should happen to one type of investment. Know your timeline for investing. If you are looking at long-term investments, don't watch them every day. Expect fluctuations in the short-term, but don't lose sight of how far into the future your investments will carry you.
Your options for investing include the following with the safest option listed first:
- Savings accounts
- Certificates of deposit (CDs)
- Money market funds
- Bond-based mutual funds
- Index-based mutual funds
- Stock-based mutual funds
The ones you select for your investment will depend on how risk averse you are. Some people can handle large dips in their account and not worry, while others can't stand to see even a small drop.
Investment by the Decade
How you invest will change as you age. You can always rearrange your portfolio to suit your needs. For those in their twenties, they have years before they can consider retiring so they should be aggressive with their investments. They have the potential to see a high return on their investment down the road. They can choose higher risk stocks and other mutual funds with very little invested in bonds or CDs.
For those in their thirties and forties, they will leave most of their investments the same, except for adding a few more to bonds or CDs. As they reach their fifties, they will begin to move over more of their money to the lower risk investments and only have a small amount in the mutual funds. Once they reach sixty, they should lower their risk even more since they will not have time to recoup their losses before retirement.
How Do You Choose?
Know your financial goals for retirement and what kind of risk you are willing to work with and you will know how to invest your money. You will have to choose the type of investment based on your situation, whether you are self-employed or work for an employer. You can always combine your investment options by having a 401k plan and a self-financed IRA or annuity.
The main thing to consider is how much money you will need to live the life you want after retirement, regardless of where you invest. You want to have your needs taken care of and enjoy your life without financial worries.
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