Sunday, June 22, 2014

Do You Want to Retire?


Most everybody wants to retire. Even if you plan on working until you drop, it makes sense to have some savings. After all, you may not be able to work for as long as you expect. Once you committed to saving for retirement, where should you put it? There are many options but I will focus on the main ones.

401(k)

In a 401(k) your employer takes money directly out of your paycheck into this account. Consequently, your taxable income is reduced by however much invested. When you start withdrawing from your account in retirement, the withdrawals are taxed based on income in the year you withdraw. 

Your employer may offer a 401(k) contribution match up to a certain percentage. For example, if your annual salary is $50,000 and your employer offers a 5% match and you wanted to take full advantage of the match, you would contribute $2,500/yr (5%) and the employer would contribute $2,500/yr as well. Even if the market stayed even, you received a 100% rate of return because of the match.

Maximum Contribution: In general, you can contribute up to $17,500/yr in a 401(k). Click here for the fine print about contributions. 

Withdrawal Limitations: There is a 10% withdrawal fee if you withdraw money prior to being 59 and a half. There are some exceptions, but the bottom line is to keep your retirement savings in your account until you are 59 a half or older. The government actually makes you start withdrawing money at age 70 and a half or there are steep penalties.

How to Set This Up: A 401(k) account is through your employer, so talk to HR about getting set up.

IRA

An IRA is an Individual Retirement Account. There are two types of IRAs and the difference is the tax treatment.

*Traditional IRA – The money that you invest in this type of IRA is deducted from your taxable income in the year you invest. However, when you withdraw the money, you are taxed at your tax rate in the year you withdraw.

*ROTH IRA – The money that you invest in this type of IRA is included in your taxable income. However, withdrawals from a ROTH IRA are not taxed. That is huge. For example, if you invest $5,000 today, in 30 years at a 10% annual rate of return, theoretically you would have $87,247 in your account 30 years from now. If you are in the 25% tax bracket, you could have saved $1,250 in taxes this year if you invested in a Traditional IRA or a 401(k). However, if in retirement you are still in the 25% tax bracket, you would save $21,811.75 in taxes.

Maximum Contribution: $5,500 a year. There are some exceptions and caveats that you can check out here

Withdrawal Limits: You can always withdraw your contributions, but you run into penalties on your earnings prior to age 59 and a half. Of course you wouldn’t dare touch your retirement savings until retirement anyway J. Click here for more details on ROTH IRA withdrawal rules.

How to Set This Up: You can set this up through a variety of brokerages. I personally use Vanguard. Just click “set up an account” and choose the type of IRA you desire.

Brokerage Account

You can also set up an account with Scottrade, Etrade, Vanguard and a variety of other brokerages in order to buy stocks, mutual funds, exchange traded funds (ETFs) or bond funds. Often there is a small fee to compensate the broker for executing your requested transaction. Deciding on the right brokerage firm to use is a post for another day.

Maximum Contribution: There is no maximum contribution.

Withdrawal Limits: You are allowed to buy and sell whenever you please, but there are tax implications. If you hold your stocks for more than a year, your earnings will be taxed as long term capital gains, which is likely lower than your regular income tax bracket. If you sell before one year, your earnings will be taxed as short term capital gains.

Click here for other investment ideas that are not as traditional for retirement income. These ideas are particularly useful as an income bridge into the career you really want.

How to Set This Up: Check out the brokerages' websites, decide which looks best for you and click "open account." Or you can physically drop in at a physical office.

Are you saving for your retirement? Are you using one (or all!) of these accounts or do you have some other ideas? Remember, sharing is caring.  

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