Although one of the most important aspects of personal financial planning, retirement investment options can be confusing at first glance and it is sometimes tempting to put off important decisions to a later date. Putting off a decision about choosing a retirement plan for too long is not a good idea.If you are one of those people it’sa big mistake to wait, because the earlier you put pension provisions in place the greater benefit you will receive from them.
Whether you are a business owner, entrepreneur or everyday Joe or Joanna employed on a salary, everyone needs to plan for those retirement years.
So here’s a jargon-busting guide to help you choose the right pension provision.
Take the right advice
The first and probably most important tip for understanding pension investments is to make sure you take the best advice.If you have a personal financial advisor he or she may be the right person for your business or day-to-day financial planning, but might not be the most qualified when it comes to long-term retirement planning.Fisher Investments have a long history of providing specialist advice on retirement planning and their founder’s publication ’99 Retirement Tips from Ken Fisher’lays out no nonsense advice in plain language.Essentially a walk-through from the basics to more detailed ideas that you might never have considered; Fisher’s tips have been the basis of successful retirement plan programs for countless people.
Different retirement plans
The main choices for us in the US are traditional IRA retirement savings plans, 401k defined contribution plans and Roth plans. Each of these will have different advantages on an individual basis when it comes to questions such as how money is distributed and contribution limits that are placed on each scheme.
An Individual Retirement Account (IRA) is a private retirement account that isn’t connected with an employer. This is probably the most flexible option that gives you the most independence. It works like this. You contribute a certain amount of pre-tax dollars into an account that is used to invest in a pool of assets. Banks and other financial institutions that make relatively low risk investments such as in stocks, bonds and mutual funds, hold the accounts.
The big advantage of an IRA is that all the money you contribute is tax deductible. However, although contributions are tax free, distributions in retirement are taxed as ordinary income at your normal tax rate.
These accounts are similar to IRAs because contributions are pre-tax. The main difference is that they are usually employer sponsored, with employees having a portion of his or her wages paid directly to the 401(k) account. This ‘defined contribution’ plan not only has a contribution from you, but also from your employer. When a defined amount of pre-tax dollars from your monthly pay is used as a contribution, the money is matched by your employer up to a certain amount.
The same advantages applies to 401(k)s as to an IRA in the fact that contributions are pre-tax, with the additional benefit of added employer ‘free money’ contributions. The disadvantage is that the plan is tied to your employer, meaning there are costs associated with its management. Taxes are also due when you start withdrawing money, but they could be levied at a lower rate when you retire than at the height of your earning power.
The contributions to this type of retirement plan are made after tax and you do not have to pay taxes when you withdraw your money. The benefit is for those whose tax rate is lower when investing begins than it is when they retire, and there are generally less restrictions on withdrawals.However, there are income eligibility limits and your contributions don’t reduce your taxable gross income in the same way as a 401k or IRA does.
This employee-sponsored option combines the features of the Roth IRA and tradition 401(k) plans; for those who are eligible it can be the best option.Contributions are once again made after-tax, but all contributions and earnings can be withdrawn at any time free of tax or any other penalty. For young workers who are currently in a lower tax bracket but who expect to be placed in a higher bracket when they are retired this option can really make sense.
Ultimately, the range of retirement plans and other investment vehicles available means the advice of a qualified financial advisor is advisable.
It is only by having all the information that those wishing to make sure they are comfortable in retirement can be confident of making the right choice for their own unique circumstances.