Overall, most people don't have enough money saved to last until retirement. A recent Boston College study as reported by the NY Times (3/5/2015, section B1) stated that the average head of household aged 55 to 64 "had only $ 104,000 in retirement savings. ".
Gone are the days when you could receive pension checks during your golden years thanks to defined benefit plans offered by employers. The majority of private companies today offer some sort of defined contribution plan, including 401 (k), which has shifted the burden of saving and managing your money for retirement to you. To encourage you, for example, your employer can contribute up to 50% of your membership fee, if you invest at least 6% of your annual salary. Some may or may not contribute less.
You feel good to have a 401 (k) plan. However, as soon as you examine the high costs and the limited number of funds available in your plan, you realize that creating a nest egg for your retirement feels more like a dream than a reality. Plus, you're happy to defer your taxes now, as they may be lower when you retire. However, the current trend of tax growth indicates that you could end up paying more taxes than you expect.
Here are five ways to check your financial health and the vital elements of your plan.
1. A pension plan is as good as its funds. If your plan offers a limited number of mutual funds, your chances of creating a great diversified portfolio decrease. Some plans only offer a handful of mutual funds, while others offer a better variety of funds, including exchange-traded funds (ETFs) with a much lower cost and greater diversification. You can spend a lot of time crafting a solid and fit investment policy. However, without proper funds in your 401 (k) plan, it would be difficult to mitigate portfolio risk and meet your financial goals.
2. Cost is a big factor that could make or break your future nest egg. Mutual funds generally have high management fees. Actively managed mutual funds have much higher fees than stock indexes which are passively managed. In addition to commissions and management fees, your plan may impose an annual maintenance fee for a low balance. A higher cost simply means a lower return on your plan.
3. Not all funds are created the same. If you decide to absorb the usual high cost associated with mutual funds into your plan, you should consider their risk-adjusted return. A Sharpe Ratio measures the performance of a fund relative to its risk. Comparing different funds for their performance does not reveal the risk taken to produce the return. In addition to a Sharpe ratio, you can use other risk metrics like Alpha and R Squared to value your plan's funds. Alpha measures the performance and ability of the fund manager to create return. R Squared measures how close or far a fund is to its benchmark. Financial websites like Yahoo and Morningstar Tools should help you choose which funds are available in your plan based on different risk measures.
4. Your employer is not contributing to your 401 (k). When there is no contribution from your employer to your plan, there is no need to invest in the plan. By investing in a restricted plan, you end up paying too much without any benefit from your employer. You are encouraged to look for a better tax-deferred alternative for your 401 (k) plan.
5. Long acquisition schedule. If your plan has a long vesting schedule, when you leave your current job, you may need to forgo some or all of your employer contributions. Some plans may have a lump sum vesting schedule, which means that unless you are employed for a certain number of years, you are not entitled to your contributions. employer.
If you realize you have a poor 401 (k), you have several alternatives to consider saving for retirement.
IRA or Roth IRA
The Individual Retirement Account (IRA) is a tax-deferred retirement account available to people with earned income. Unlike a 401 (k) opened and provided by your employer, you open your own IRA or Roth IRA account with a financial institution or custodian. Within your IRA or Roth IRA, you can invest in stocks, mutual funds, ETFs, and certain other assets. An IRA or Roth IRA helps individuals save and invest money for retirement. With a traditional IRA, the contribution is usually tax deductible since you defer taxes into the future. Whereas for the Roth IRA, you pay taxes now and your withdrawals are tax-free upon retirement. For Roth IRA, there are certain eligibility requirements.
You can contribute to your Traditional and Roth IRAs up to $ 5,500 (for 2014 and 2015), or $ 6,500 if you are 50 or older at the end of the year; or your taxable compensation for the year. According to the Internal Revenue Code (IRC), if you are single or the head of a household with an adjusted gross income (AGI) of $ 61,000 or less, you can contribute to your IRA with a maximum contribution limit. Or if you are eligible married or widowed with a modified AGI for $ 98,000 or less, you can contribute up to your contribution limit amount. Your deduction may be limited if you (or your spouse, if you are married) are covered by a workplace pension plan and your income exceeds certain levels.
You can only contribute to an IRA or Roth IRA if you have earned income. According to IRC, the following are qualified for earned income; wages, salaries and tips, union strike pay, long term disability benefits received before minimum retirement age and net earnings from self-employment.
However, if you are not working, but you are married to someone who is, you can open the Spousal IRA which could be funded by your working spouse for your retirement.
To guarantee a better retirement fund, an annuity is a valuable asset to consider in your retirement portfolio. An annuity is a contract issued by an insurance company that pays a stream of income for a period of time or life. Annuities can be immediate or deferred. An immediate annuity begins its payment stream as soon as it is opened. Conversely, deferred annuity payments do not begin until a later date in the future. You can fund your annuity contract with a lump sum payment when you open it, which is called Single Premium Annuity, or you can pay now and add more in future periods.
Annuities fall into three main types; Fixed income, indexed to shares and variable. A fixed income annuity earns you income based on fixed interest for as long as your fund lasts. It works like a CD, money market, or bond. An equity-indexed annuity like the fixed annuity offers a guaranteed minimum return while offering upside potential by investing in the stock market.
Unlike fixed income and indexed equity annuities which guarantee the principal, a variable annuity contains a sub-account that could lose the principle when investing in stocks, mutual funds, bonds, real estate, commodities. and other assets. Variable annuities seek a higher return by investing in a wide range of risky assets.
Common characteristics of annuities
There are different types of annuities (i.e. fixed, deferred, variable), but they mainly share the following common characteristics:
Annuities are financial assets. You can buy them as an investment vehicle separately or in your IRA and any type of retirement plan that qualifies as a 401 (k) plan. Since they are tax-deferred vehicles, an early withdrawal at age 59 and a half would result in a 10% penalty by the IRS. However, insurance companies typically allow 10-20% of principal to be withdrawn each year without penalty. An annuity has a declining fee schedule for an early withdrawal called a surrender charge. Usually it's heaviest in the early years; an annuity may charge 7% for the withdrawal in the first year, the second year 6% and decreases to zero percent in year 7, for example.
You can invest as much as you want in annuities, unless it's part of your IRA or 401 (k) plan, which is limited to the amount allowed. Some insurance companies may limit your annuity investment to a large amount like $ 5 million.
Advantages and disadvantages of annuities
One of the benefits of annuities is their tax-deferred feature which helps you save for retirement as much as you want. An annuity contract can provide you with income for life depending on the payment options you can choose. Some can guarantee income for the rest of your life (or your single life), or your life and that of your spouse, also known as married life. If one of your investment goals is to receive income, you should consider an annuity for your retirement portfolio.
Annuities have certain disadvantages such as fees, expenses and commissions. Profits and withdrawals are taxed as ordinary income compared to lower rates for long-term capital gain. Your money is blocked. While you can withdraw your funds early, your withdrawals are subject to an early redemption fee. Also, like any other retirement plan, you must pay a 10% penalty fee to the IRS before the age of 59 and a half. Additionally, annuities are not guaranteed by the FDIC. Therefore, the financial guarantee given by an insurance company is supported by the solvency and financial strength of the carrier.
Annuities could improve your retirement portfolio. However, there are more details that should be considered before making a decision on annuities as a viable asset for your retirement portfolio.
If your current 401 (k) plan is poor with a high cost and limited funds that do not meet your investment goals and needs, you should seek help from professional financial advisers. The stakes are just too high to run your retirement plan as a 'do it yourself' project.