With more and more people living longer, retirement period for most people became longer as well. It means that greater financial resources are required to support it. With Social Security's assets being consumed and the number of workers that will support it shrinking, we will have to rely more on our personal savings when it's time to retire. And, these days, fewer companies provide pension plans for their employees and people change jobs more often than in the past, making it less likely that they will qualify for a significant employer pension. Without a pension, how will you finance your retirement? To a large extent, the answer is up to you.
Now that we have established that your retirement is pretty much in your own hand, what do you do? There is a myriad of options to help each of us prepare. Yet, without a plan of action, many find themselves falling short when it's time to retire.
The following is a list of retirement savings plans for individuals:
401(k)
A 401(k) is a type of retirement plan that allows employees to save and invest for their own retirement. Through a 401(k), you can authorize your employer to deduct a certain amount of money from your paycheck before taxes are calculated, and to invest it in the 401(k) plan. Your money is invested in investment options that you choose from the ones offered through your company's plan. Current income tax savings are some of the biggest advantages to joining your company's 401(k) plan. The money you contribute to your company 401(k) plan comes out of your pay before income taxes are calculated. Dividends and capital gains reinvested in your company's retirement plan account will not be taxed until you withdraw them (which is ideally at retirement, when you could be in a lower tax bracket). They are taxed as ordinary income. If you withdraw them before age 59 1/2, you may owe a 10 percent early withdrawal penalty.
403 (b)
The 403(b) is a tax deferred retirement plan available to employees of educational institutions and certain non-profit organizations as determined by section 501(c)(3) of the Internal Revenue Code. Contributions and investment earnings in a 403(b) grow tax deferred until withdrawal (assumed to be retirement), at which time they are taxed as ordinary income.
Traditional IRA
A tax-deferred individual retirement account that allows annual contributions of up to $3,000 (or $3,500 if over age 501/2) for each income earner. Contributions are fully deductible for all individuals who are not active participants in employer-sponsored plans or for plan participants within certain income ranges.
Roth IRA
Roth IRA is a powerful retirement planning tool for individuals who qualify. Although your contributions aren't tax-deductible, your earnings are tax-free when you begin taking distributions. Whether you pay taxes or penalties on Roth distributions depends on your age when you make the withdrawal and how long you've held the account. If you are Under Age 591/2 and held your account 5 years or more, you can withdraw your contributions tax-free and penalty-free. Your investment earnings will be subject to Ordinary income tax unless distribution is due to your death or disability, or for a first-time home purchase ($10,000 lifetime maximum) and a 10% penalty tax applies unless the distribution qualifies as an allowed exception. Additionally, there are no required minimum distributions during the Roth IRA owner's lifetime.
Annuities
Annuities are another tax-deferred way to save for retirement. While contributions to annuities are not tax deductible, they offer three advantages over many other types of savings plans.
- You can structure an annuity to provide you with an income you can't outlive.
- Annuities do not limit the annual amount you can contribute toward your retirement.
- The annual earnings on the annuity are tax deferred.
When you buy an annuity you enter into a contract with a life insurance company. The company agrees to make payments to you and/or your beneficiary over your lifetime or a set period, usually beginning at retirement. A fixed annuity pays a set, guaranteed rate of return over a specified period. A variable annuity, as the name suggests, pays a variable rate of return, based on the overall return of the investments included in the annuity's portfolios. If you die before payouts begin, a death benefit is payable to your beneficiary.
Any annuity payment is dependent on the claim-paying ability of the issuer. An annuity may impose charges, including but not limited to surrender charges, mortality and expense risk charges, administrative fees, underlying fund expenses, and feature charges that can reduce the value of your account and the return of your investment.
With a variable annuity, you may choose investments from a family of investment portfolios (or funds) that are professionally managed to seek certain investment objectives, such as growth or income productions. These portfolios are generally include stocks, bonds and money market funds. Investment returns are not guaranteed, and you could lose money by investing in a variable annuity. Both types of annuities offer the benefits of tax-deferred compounding, automatic reinvestment of earnings, and no current taxes on dividends, capital gains, or interest.
As with most other tax-deferred savings plans, you will have to pay federal income tax on any earnings you withdraw from the annuity at retirement, or before, and withdrawals before age 591/2 may be subject to the 10% early withdrawal penalty. Also, surrender charges may apply if funds are withdrawn before the contract's surrender period has expired.
