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Baby boomers are retiring at a rate of 10,000 per day, and research indicates we might be on the verge of a retirement crisis.
Why? Simply put, many Americans are unprepared.
Another 26% report having less than $50,000 saved for retirement. That means over half of retirees lack sufficient retirement funds.
However, all the blame doesn’t rest on the retirees. The last decade hasn’t been ideal for investors. The 2009 stock market decline made many scared to invest in the markets at all, causing them to lose out on growth when the markets recovered.
Additionally, many panicked and cashed in their retirement accounts when investments started falling. The years following 2008 saw low interest rates, which reduced the yields of bond funds that many retirees were encouraged to purchase. Plus, we saw unemployment and slow wage growth.
Whether you are 65 or 25, it’s time to start saving for retirement. Be proactive. Know your options.
We’re going to cover:
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Retirement plans come in all shapes and sizes, and selecting the best one for you can be confusing.
We’ve put together five key questions to help you determine what type of plan is best.
If you think you’ll want to start withdrawing your money right when you retire, traditional IRAs and most employer-sponsored retirement plans are a good fit.
These require you to take distributions once you reach 70 1/2 years old. These distributions are a percentage of your account’s value, and are based on life expectancy tables created by the IRS.
However, if you have savings or other investments and do not need to withdraw from your retirement account right away, Roth IRAs do not have an age requirement. You can leave your money alone and let it continue to grow for as long as you want.
You must also consider if you think you may need early access to your account. For example, Roth IRAs allow you to withdraw your original funds at any time for any reason. So, if you contributed $25,000 over the past 10 years and it’s grown to $50,000, you can withdraw the $25,000 without a penalty.
A Roth IRA is a nice way to have both a retirement account and emergency fund.
The time at which taxes are paid is one of the biggest differences in retirement accounts. Do you want a tax break now or later? Individual financial circumstances will determine which is more advantageous.
Some plans allow your contributions to be pulled from your paycheck before taxes are taken out, lowering your current taxable income. However, since your contributions were not taxed initially, the funds will be taxed as ordinary income when they are withdrawn later.
On the other hand, some plans are designed so that your contributions are taxed now, and certain contributions (i.e. Roth IRA) are not deductible on your current tax return. However, when the funds are withdrawn during retirement they are completely tax-free.
Yes. Contributions are restricted and capped with certain plans.
For example, if you earn more than $117,000 as a single person or $184,000 as a married couple, the amount you can contribute to a Roth IRA is reduced.
It’s important to know the limits and restrictions before selecting the best retirement account for you.
Many corporations select retirement options for employees in addition to making contributions on their behalf too. Self-employed individuals don’t have this luxury.
However, you do have some worthwhile options. A SIMPLE IRA, SEP IRA and Solo 401(k) all have significantly higher contribution limits than traditional and Roth IRAs, allowing you to make up for the funds that others receive from their employers.
Yes. Any retirement account can be passed down to heirs.
However, if this is your intention you may want to consider a plan where your contributions are taxed up front. That way, your heirs can have your account tax-free.
Keep in mind, though, that distributions are still based on life expectancy. Your heirs cannot let your account grow forever.
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So what is the best retirement option?
The truth is there is no one-size-fits-all option. A good retirement plan is rarely made up of a single product.
Instead, a diverse package of income sources structured to meet your financial goals is ideal. What should be part of your package? Well, that depends on you and your goals.
We’ve put together five products we think are helping Americans achieve a comfortable retirement.
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IRAs emerged as a popular option decades ago when pension plans started to decline. They allow employees to take control of their retirement savings, and gain some tax advantages.
Here’s a quick summary of the different types of IRAs, including the two most popular, traditional and Roth.
The traditional IRA plan gives you an upfront tax break, if you qualify. If you don’t, you can still open a non-deductible IRA.
If you do qualify, investment earnings are not taxed as long as the money stays in the account. Funds are taxed at the time of withdrawal at your current tax rate.
If you think you are in a higher tax bracket now than you will be when you retire, a traditional IRA is ideal.
IRAs are also great for people who do not have access to an employer-sponsored retirement plan since they are easy to set up and there are many IRA providers to choose from.
Roth IRA plans are best if you think you may be in a higher tax bracket when you retire than you are right now, or if you think you might need access to your money before retirement. There’s no upfront tax break, but your withdrawals will be tax-free.
However, Roth eligibility is limited by your income. If you earn too much, you may not qualify. If this is the case, however, you can still open one through a backdoor Roth.
Early withdrawal rules are much more lenient than with traditional plans. Contributions can be withdrawn at any time with no penalty or tax, but withdrawing your earnings early will come with penalties.
SEP IRA plans are mainly used by small business owners that want to avoid the costs of operating a traditional plan. Employers get a tax deduction for contributions they make on behalf of employees, and both employers and employees can give their retirement stash a boost because contribution limits are much higher.
SEP IRAs are also great for sole proprietors since they can open one just for themselves. SEP rules are very specific, though. So review the guidelines carefully to avoid trouble with the IRS.
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is similar to employee-sponsored 401(k) plans, but is designed for small companies (fewer than 100 employees) and self-employed individuals. It differs from the SEP IRA in that employees are allowed to contribute via salary deferral and catch-up contributions are allowed.
Your funds can be rolled into a traditional IRA after two years of participation in the SIMPLE IRA. While a good option for self-employed individuals, SEP IRAs might be a better choice because they have higher contribution limits.
A note of caution: Withdrawing from a SIMPLE IRA within the first two years can bring a staggering 25% penalty in addition to regular income taxes.
Spousal IRA accounts are great for low-income or married couples with only one person working. Both married partners can contribute to their own IRAs if they file a joint tax return. Both accounts can be funded by the working spouse’s income.
A self-directed IRA is for experienced investors that want to include other investments, such as real estate, in their plan. Other IRAs are limited to common strategies, such as stocks, bonds and mutual funds.
You’ll need a trustee or custodian who specializes in the types of investments you are including in the account. While the potential for higher returns is greater, there are some risks. Be sure to weigh the pros and cons before making your decision.
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HSAs are a great way to save for medical emergencies while reducing your taxable income. You can open one through your insurance provider or financial institution.
You decide how much you will contribute each year, but you can’t exceed government-mandated maximums. Your money is invested in mutual funds, stocks or other investments just like a retirement plan.
Participants receive a debit card or checks that can be used to pay eligible medical expenses, including co-pays, deductibles or qualified expenses that are not covered by your plan. If you don’t use the money, it continues to roll over year after year.
Contributions are no longer allowed once you are 65 years old and enrolled in Medicare. However, you can still use the money you’ve contributed.
You can withdraw the money for non-medical reasons. But, you’ll have to pay tax on it and a penalty if you are under 65.
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Pensions are not as popular as they used to be, but many municipal and government employees still have them available. If you are one of the few, consider yourself lucky. They are essentially the easiest retirement plan out there because very little is required of you.
Employers contribute all the money and the funds are managed by financial experts. Employees simply stay at their job long enough to qualify and retire.
The downside is that you may feel locked in to a company because you don’t want to lose your pension. Another disadvantage is that pension payments do not adjust for cost-of-living. So, the amount you get when you first retire is the same monthly payment you’ll be getting at 80 or 90.
Many pension participants find they need to invest in other strategies to supplement.
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If you want a Roth-like structure, but make too much money to qualify, a non-qualified deferred contribution plan is a good option.
This plan allows high-income individuals to defer part of their income until some time in the future. This means the employee will get the income later (i.e. during retirement) and may reduce the taxes the employee pays on that income if they are in a lower tax bracket when the deferred income is withdrawn.
Advantages are that there is no income or contribution limits and the investment options are diverse.
One key disadvantage is that employees must schedule distributions on a specific date, and they must stick to that date regardless of whether they need the funds or if it is a good time to withdrawal. There are no early withdrawal provisions.
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An annuity is an insurance product that is used to boost your savings, protect what you saved, and generate a future stream of income. They are often used to supplement other retirement plans.
Two main types of annuities are income and deferred.
Deferred annuities are similar to other retirement plans in that they are a tax-deferred investment. Deferred variable annuities are more appropriate for long-term plans or people who can handle market fluctuations since they are susceptible to market fails.
Conservative investors often go with deferred fixed annuities. They have a guaranteed rate of return for a certain number of years.
Like other retirement plans, withdrawals from deferred annuities are subject to a 10% IRS penalty if taken out before age 59 1/2.
Income annuities are more suitable for investors that are near retirement. They offer a guaranteed income for life or a set period. You invest now, and can select to receive a lump sum upon retirement or payments on a monthly, quarterly or annual basis.
Income annuities are predictable and reliable, and often allow investors to be a little more risky with their other plans since they have a guaranteed source of income.
You can also pay an additional amount to guarantee a cost-of-living increase during retirement.
Whether you are nearing retirement or you just entered the workforce, making the right investment choices now will determine your lifestyle during retirement.
According to the Social Security Administration, social security benefits will need to be cut by 23% in 2033. That means the government will only be able to pay 77% of scheduled social security benefits by 2033.
“This is the first generation to face saving for retirement on their own,” says Elyse Foster, principal, Harbor Financial Group, Inc. “I believe early on there was a lack of information on the importance of saving early and often. The assumption seemed to be ‘you are on your own.'”
Take control of your future. Get educated. Invest wisely.
How are you saving for retirement? Let us know in the comments!
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