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Retirement Planning

Retirement funds can come from employer-sponsored programs, individual accounts, and Social Security.

Monitor your retirement accounts regularly to see how they are performing. [©Jupiter Images, 2010]
©Jupiter Images, 2010
Monitor your retirement accounts regularly to see how they are performing.

Retirement Planning

Retirement planning is the process of ensuring a financially sound life after retirement. With Americans living longer and the uncertain future of Social Security, it is more important than ever to begin saving for retirement early in adulthood. Some people dream of retiring early and others plan on working until age 65 or longer. These goals and the desired lifestyle after retirement dictate how much money will need to be saved during years of employment. Social Security, employer-sponsored savings plans and IRAs are the primary methods of saving for retirement.

Estimating Retirement Funds

Financial planners are professionals who help individuals plan for retirement by designing a specific plan based on current savings, current income and retirement goals. Alternately, individuals can use online resources to calculate retirement savings goals. The plan should account for all costs during retirement years, including housing, day-to-day living expenses, debt payments and medical costs, plus any travel and other expenses. AARP provides an online calculator to help calculate the funds needed for retirement. The U.S. Department of Labor provides a booklet and online worksheets to help with calculating retirement costs.

Social Security Retirement Funds

Social Security is one of the most common elements of a retirement plan. According to the U.S. Social Security Administration, 96 percent of U.S. workers are covered by Social Security, a system of credits earned by paying Social Security tax on income earned. Receiving full Social Security benefits requires earning 40 credits (about 10 years worth of working) and reaching retirement age. Retirement age depends on the year born, but falls between ages 65 and 67. Someone who retires as early as age 62 is eligible for benefits that are permanently reduced. Likewise, someone who delays retirement up to age 70 can earn additional benefits.

The Social Security Benefit Estimator predicts how much money an individual will receive from Social Security based on actual earnings to date and other parameters the user enters. This calculator is only for people who have already earned 40 credits.

Employer-Sponsored Retirement Plans

Employer-sponsored retirement accounts are another important aspect of retirement planning. There are several different types of employer-sponsored accounts that may be available, including:

  • 401(K) plans
  • Simple IRA plans
  • Profit-sharing plans
  • Money purchase plans
  • SEP IRA plans
  • Pensions

Depending on the type of account, either employees, employers or both can make contributions. However, certain accounts have limitations on how much an employee or employer can contribute in a given year. For example, an employer can contribute only 3 percent of the employee's compensation in a Simple IRA, while up to 25 percent is allowed in a 401(K) plan.

Individual Retirement Accounts (IRAs)

IRAs are an option for self-employed workers and when employers do not offer retirement plans. Other employees use IRAs to supplement their employer-sponsored accounts. IRAs are available through banks, credit unions and investment firms. Traditional IRAs and Roth IRAs are the two types of accounts. Both types have the same contribution limits -- currently $5,000 a year for someone under age 50 or $6,000 for age 50 and older. However, each type of IRA has other qualifying criteria that must be met. For example, contributions cannot be made to a traditional IRA beginning at age 70, while a Roth IRA has income limitations that cannot be exceeded. Individuals should work with a financial planner to help determine which type of IRA best meets their financial retirement goals.

Other Retirement Savings Options

Other sources of funds can be taken into consideration for retirement planning. Individuals commonly use standard savings accounts, Certificate of Deposits and investment accounts as part of their retirement plan. Additionally, health insurance and life insurance plans may be needed. Since Medicare is limited, it may be necessary to consider a supplemental form of health insurance, according to AARP.

Taxes and Retirement Accounts

One of the key benefits to planning for retirement is limiting taxes on income. Some types of retirement savings accounts, both employer and individual plans, can reduce taxes on income earned specifically for retirement.

The most significant tax advantage of a 401(K) plan is that contributions are made pre-tax, which makes saving for retirement more affordable for many people. Additionally, an employer often makes a matching contribution, such as 25 cents for each dollar the employee contributes up to a certain percent, which is not considered taxable income. A 401(K) plan is a tax-deferred retirement account, which means that taxes are not paid on income earned year-to-year from investments. Instead, income taxes are paid as the funds are distributed during retirement, at which time the retiree is likely to be in a lower income tax bracket.

The traditional IRA is another example of a tax-deferred account. Qualifying individuals can deduct contributions to a traditional IRA from taxable income, according to the Internal Revenue Service (IRS). Individuals who contribute to a retirement plan at work may not qualify for the deduction if their income is greater than the qualifying amounts.

Roth IRAs also have a tremendous, yet different, tax advantage. Contributions are not pre-tax like a 401(K) plan or deductible like a traditional IRA; however, neither earnings nor distributions during retirement are subject to income tax.

Assessing Risk of Retirement Accounts

Once the type of account is chosen, the money must be invested. Investors who are decades away from retirement can afford to put their money in stocks that are considered to have greater risk. As the golden years approach, investors should move a progressively greater portion of savings into more conservative investments, such as bonds, CDs and money market accounts. According to Investopedia, investors in their 20s and 30s are safe to invest 80 percent of savings in equities, while someone approaching retirement should have only 50 or 60 percent invested in equities.

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