While it is best to start a retirement plan as early as possible, it is never too late to begin planning for your retirement. Here are some of the basics for retirement planning:
If your current employer offers a retirement plan, it is most likely a defined contribution plan. This is a retirement plan where the employee makes a periodic contribution which may be matched by your employer. It is also a retirement plan where you as the employee have investment options, generally a list of mutual funds to choose from in setting your asset allocation.
401K plans are the most popular type of defined contribution plans. These plans are offered by most corporations and government entities. 403B plans are offered by not-for-profit organizations. There are also deferred compensation and profit sharing plans. If you are uncertain if your organization offers one of these plans, ask someone in human resources.
Some organizations still offer defined benefit plans, although these are generally being phased out and replaced with defined contribution plans. These pension plans are managed by outside investment managers for the organization and the employee has no say in his or her investment choices. The benefits will be paid to the retiring employee based on a formula taking into account the employee’s earnings in his or her final years as well as the employee’s number of years of service.
If your organization offers a defined benefit plan and any matching contribution, you should be contributing the maximum amount into this plan each year. You can spread this contribution out over the year. Most organizations will deduct a certain portion out of each paycheck. The great news about these plans is that any contributions you make will reduce your income tax basis. So, you will be paying taxes on an amount that is lower than your salary. Your investments also grow tax free and you pay no capital gains distribution taxes. And, you can transfer assets between any funds at any time without a fee.
Your income will be taxed after retirement when you begin to withdraw it, but it will be taxed at your post-retirement income tax rate which is generally going to be the lowest possible tax rate as your income level will go down considerably when you are retired and no longer receiving a salary.
If you are self employed, if you are an independent contractor or if your organization does not offer a retirement plan, you can still set up a traditional IRA plan which will offer you the same benefits as a defined contribution plan. If you are self employed, you can set up a special retirement account called a SEP IRA or a Simple IRA which allows you to contribute up to a larger amount of your earnings each year than a traditional IRA.
The benefits of an IRA over a defined contribution plan are that you have a much larger variety of investment choices and you or your investment advisor can manage these investments on an ongoing basis.
If you have left an employer where you had a defined contribution plan (401K) you should roll that money over to an IRA where you and your investment advisor can watch your money more carefully. You will also have many more choices rather than the short list of funds which is provided by your former company’s retirement plan. You can also make additional contributions to your plan.
We advise all individuals to seek an investment advisor for the proper guidance in making sure you are doing all of the right things to save for an early and comfortable retirement. Your investment advisor can oversee your entire financial plan and make changes to it as necessary to help you achieve your financial and retirement goals.