What You Need To Know About Your Retirement
people know they want to retire someday but
do not have a clear idea on how they will finance
their retirement. This article looks at some
of the factors you need to consider when thinking
about your retirement from a financial perspective.
Planning has Changed
In the not-too-distant past, individual retirement
accounts and 401(k) plans did not exist. The
classic retirement model was based primarily
on Social Security benefits and monthly employer
pension checks. Furthermore, retirement savings
did not have to last as long because people
did not live as long as they do today. In addition
to longer life expectancies, tomorrow’s
retirees will lead a more active lifestyle.
This means that retirement will be more costly
for tomorrow’s retirees.
take a closer look on how the retirement landscape
Security. Social Security’s
lack of viability seems to make news daily.
The average annual Social Security retirement
benefit was about $11,000 in 2004. Even if
you receive this average annual Social Security
retirement benefit, you probably want to have
more than an annual $11,000 retirement income.
To make matters worse, this average annual
Social Security retirement benefit may decrease
by the time you want to retire. This is because
in the future, retirees will be receiving
more Social Security retirement benefits than
what active workers are paying into Social
Security. As a result, your Social Security
retirement benefit may be less than what you
Pension Plans. Not too long ago,
most workers were covered under an employer’s
traditional defined benefit plan. Under these
traditional pension plans, a retired worker
would receive a monthly pension payment for
the joint lives of the worker and his or her
spouse, with a survivor benefit paid to the
worker’s surviving spouse. The amount
of the worker’s monthly pension payment
was typically based on the number of years
of service with the employer, multiplied by
the worker’s average annual compensation
over a specific number of years.
contrast, most of today’s retirement plans
are defined contribution plans. In contrast
to the traditional pension plan, a defined contribution
plan consists of contributions you make to your
employer’s plan, as well as any employer
contributions made to the plan on your behalf.
Because a large part of your employer’s
plan will consist of your own contributions,
the amount of your retirement benefits will
depend significantly on the amount of contributions
made to the plan.
It is never too late and it is never too early
to start saving for retirement. Consider the
following four investors:
Investor contributes $5,000 each year in their
401(k) plan for ten years. After ten years,
none of the Investors make any additional contributions
to their 401(k) plan. Assuming a 7% annual return,
how much money will each Investor have at age
25-year-old Investor will have $570,712 at
35-year-old Investor will have $283,428 at
45-year-old Investor will have $140,757 at
55-year-old Investor will have $ 69,904 at
example shows it is never too early to start
saving in a 401(k) plan.
Where the Free Money Is
When planning for retirement, you need to know
the two primary sources of free money: the government
and your employer.
Money from the Government. When you
make a contribution to your 401(k) plan, the
government gives you two gifts. First, assume
you are in a 30% income tax bracket (combined
state and federal). In this case, for every
dollar you make as a 401(k) contribution,
your paycheck will only be reduced by 70 cents.
Second, your investments within a 401(k) plan
grow tax-deferred. You do not pay taxes on
the earnings on your contributions until you
begin taking distributions at retirement.
This leaves more of your money to compound
through the years. Consider the Investors
in the above example. If the same Investors
make $5,000 in contributions annually for
ten years in a taxable investment, and the
earnings are taxed at 30% (that is, earnings
are not tax-deferred), the Investors would
have the following amounts at age 65:
25-year-old Investor will have $278,663
at age 65.
35-year-old Investor will have $169,858
at age 65.
45-year-old Investor will have $103,536
at age 65.
55-year-old Investor will have $ 63,110
at age 65.
you can see, your nest egg will be considerably
larger if it is allowed to grow tax-deferred
until your retirement as shown in the “Start
Saving Now” section of this article.
Of course, when you begin taking withdrawals
from your 401(k) plan during your retirement,
you will have to pay income taxes on the
amount of your withdrawals. Many workers,
however, will be in a lower income tax bracket
when they retire compared to their current
income tax bracket. This makes the tax-deferral
nature of 401(k) earnings a good deal for
Money from Your Employer. Another
common source of free money is your employer.
It is common for an employer to make a matching
contribution to your 401(k) plan based on
the amount of contributions you make to the
401(k) plan. For example, an employer may
provide a matching contribution of 50 cents
for every dollar in contributions that you
make up to 5% of your income. If you want
to take full advantage of the employer matching
contribution, you would have to contribute
5% of your salary into the 401(k) plan.
example, if you are earning $40,000 a year,
you would have to make at least $2,000 in
401(k) contributions ($40,000 x 5%). By making
a contribution to a 401(k) plan in an amount
equal to 5% of your salary, in addition to
the $2,000 in contributions you make, the
employer will make an additional $1,000 in
a matching contribution on your behalf.
these retirement tips is a great starting point
to thinking about your retirement. The next
step is to develop a retirement strategy. To
help get you started, you should read the article
a Retirement Game Plan.”