Retirement is "the action or fact of leaving one's job and ceasing to work."
You work for decades and then retire from your active working life.
How will retiring affect your financial life?
Will you have the funds to travel, pursue a hobby or a dream, and cover your essential expenses? Retirement is a significant change in your lifestyle and financial situation. There is no more overtime, raises, or earning ability. The financial decisions you make while working will be encountered in retirement.
What retirement looks like will differ from person to person. One person may decide to stop working permanently to reduce their work hours. Another person could retire from one job and start a completely new career. Retirement doesn't have to cease your ability to earn money.
How well or poorly you manage your money before retirement impacts when you retire (age) and, for some people, where you retire (location). Before you think about retirement, ask yourself, How will retiring affect your financial life? How much will social security benefits cover your retirement expenses?
There are retirement accounts for employees, independent contractors, and self-employed people, qualifying you to pay with before-tax or after-tax dollars. You can open retirement accounts online with a brokerage firm; if you are fortunate to have an employer that offers a retirement plan (IRA or 401(k)), then all the work is done for you. However, you are responsible for managing your retirement account.
Tip: The best time to review your employee retirement plan is during your company's open enrollment period. If you are an independent contractor or self-employed, plan a time with your financial professional at the beginning of the year to discuss your retirement plan.
Different types of retirement accounts help you save for future income. We won't review every retirement plan, just the most popular for employees and self-employed.
An IRA allows individuals who earn income to save for retirement. Social security benefits will cover a portion of your costs in retirement. To live comfortably in your retirement, you may need other sources of income.
One advantage of IRAs is their tax-deferred status. The taxes owed on earnings and contributions are postponed until you withdraw from the IRA. You can open an IRA at a bank or brokerage firm and an Individual Retirement Annuity at an insurance company. The government sets annual contribution limits for the different types of Individual Retirement Accounts.
Traditional IRA
Before-tax dollars are used to contribute to a Traditional IRA. The earnings are tax-deferred until the money is withdrawn. Withdrawals from IRAs are strongly discouraged before the required minimum distribution; one, the money is supposed to be for your retirement, and two, there is a 10% penalty on early withdrawals. A withdrawal can be made without penalty at 59 1/2 years old and is required by April 1st of the following year you turn 72 years old. A required minimum distribution is mandatory after 72 years old or a risk penalty. Withdrawals are considered income and subject to taxes on earnings.
"If you deducted your contributions, tax is due on your entire withdrawal. If you didn't deduct your contributions, tax is due only on the portion that comes from earnings." - finra.org
You can continue contributing to an IRA past 70 1/2 years old if you have earned income.
Roth IRA
After-tax dollars are used to contribute to a Roth IRA. The earnings are tax-free if you follow the withdrawal rules: you are 59 1/2 years old, and the account has been active for at least five years.
A Roth IRA doesn't require the owner to withdraw money at any age; the account can be assigned to a beneficiary; you can contribute funds to a Roth IRA as long as you earn income. Roth IRAs have income restrictions related to contributions.
Which one should you choose, Traditional or Roth?
It depends on your tax position when opening an individual retirement account and what you think your tax rate will be at retirement.
401(k
401 (k) is an employer-sponsored retirement savings plan. An employer in the private sector sets up a salary deferral plan for employees to contribute to a retirement savings plan.
The 401(k) plan is self-directed, which means the employee is responsible for managing their 401(k) retirement account. The employee decides how much they want to contribute, how they would like their funds invested or reinvested, and how they would like to withdraw from the account.
The employer sets and schedules the retirement plan. The employer contracts with an investment company to design the framework and manage the 401(k) retirement plan. The employer-sponsored retirement plan offers a list of investments for the employee to choose. The employer may also contribute a portion of funds to the employee's retirement savings account, which is known as a match.
What is vesting?
Employees can transfer their 401k contributions to another retirement account or withdraw their contributions if they leave the company. However, What happens to the contributions that the employer matched?
Vesting is a term connected to the employer's contribution to your retirement savings plan called matching. The employer's match contribution to an employee's retirement savings plan is not entirely the employee's property until after a certain amount of time. Vesting doesn't happen automatically but according to the rules set up by the employer. Once vesting occurs, the employee owns the matched funds from the company.
The employer determines the employee's eligibility for participating in the retirement plan. When an employee participates in the retirement plan, the employer reports the employee's taxable income minus the deferred amount to the IRS. The tax due is postponed until the employee withdraws from the account, usually after they retire. The funds earned from your tax-deferred contributions that remain in the retirement account are also tax deferred.
What are other 401(k) like retirement plans?
457 is a retirement savings plan for public sector employees
403 is a retirement savings plan for nonprofit sector employees
Why should you participate in an employer-sponsored retirement plan?
Participate in your employer-sponsored 401(k) retirement plan because even if you don't think you have the money to spare, retirement is one of two options available after you stop working. There will come a time when you can't work and need money to live. Social security will not be enough.
Each working person should have a plan for retirement because it will happen someday for most of us. You will reach a time when you will want to stop working or be forced to stop working. You may want to postpone retirement due to your age, income, location, or health —it doesn't matter; you need to plan and prepare financially for retirement. A retirement account with a reputable brokerage firm can help you prepare for living without a regular paycheck. If you don't have a retirement plan, open a retirement account today.
Invest in your future today!
It is never too early to start financially planning for retirement!
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