The last third of our lives can be spent in that state commonly referred to as "retirement." However, for a good number of people, retirement is something that is permanently in the future. There are those who leave their primary job only to find something else that engages them in such a way that they cannot yet retire.
Before you retire, typically you subsist on a couple of checks from your primary employer. After retirement, you can often get checks from a number of different sources, of which these will include Social Security, corporate pension, and possibly a part time job.
The biggest check that you ought to strive to attain is a check from your investment accounts. You have likely spent a great many years contributing to these investment accounts, teaching yourself that you cannot dip into them. It is time, then, for your mindset to change. This is, after all, the reason the investment accounts were set up, for you not to worry too much.
Primary Source of Income
Yes, you and your investments are going to be your primary source of income. Investments can take the form of an employer pension to which you contribute, your 401k, your various IRA accounts, and others. Realistically, traditional pensions have largely become outdated. Social Security is still alive and well, but will not be your primary source of income. More about Social Security later.
Investments are simply money you place in various accounts that are then used by other individuals or companies and they get a various return on your investment. Such returns are then placed back into your account as interest, or you are given a dividend check. This way, money that is placed in such accounts continues to grow and compound annually. Obviously, the sooner you start, and the greater the rate of return, the more money you will have upon retirement.
The purpose of investing is to fill your retirement bucket.
How to Invest.
Investing is putting money aside at predetermined times, and continuously, into an account.
If you have fifteen years prior to retiring and you put $100 into an account at 6%, you will have accumulated $6,977. If you put $1,000 into an account at 6%, you will have accumulated $69,770 at the end of fifteen years.
Let us say that you find a better fund, one that gives you a return of 10%. With $100 per month, your account balance will be $7,744 after fifteen years. With $1,000 per month, the balance will be $77,440.
As you can see, the more you put in, at a higher rate of return, the faster your account will grow.
That is investing in a nutshell.
To be ready for your retirement, it is wise to find a couple of investment vehicles, because not every vehicle will give a consistently high rate of return. By diversifying, you will maximize your money, making full use of the economy, inflation (this is one area where inflation can help), and minimize the risk of losing everything, should it all be in one account.
How to Make Money
401k. The opportunities for you to invest, prior to retirement, are great. Take advantage of anything that your employer offers, especially if they offer a matching opportunity. This means that if you put in a certain amount of money into your retirement account, your employer will match up to a certain amount. This is essentially free money. This can be part of a 401(k) or a 403 (b) plan offered by your employer. Taking advantage of a retirement fund matching program is one of the smartest ways possible to make money, because you essentially double your investment prior to any sort of rate of return. Therefore, if you typically add $1,000, and your employer matches this, you are adding $2,000 to your fund.
Self-Employed and Small Business Owner Accounts. For those of you who are business owners or self-employed, you can set up your own qualified retirement plan and make tax deductible contributions to it. Each plan has set limits in terms of just how much you can contribute, but whenever possible, it is wise to contribute the maximum that you can possibly afford, because as your money compounds, you MAKE more money on your investments. It is good advice to talk to a tax advisor when setting up a retirement account as they can guide you through any possible pitfalls. These sorts of retirement accounts can also come in handy when you have officially "retired" but want to run a side business and want to keep contributing to your retirement account. If you were to retire at 62, and live until you are 82, and are fascinated with running your business, there is no reason for you to hang up your spurs just so that you can avoid some tax penalties for earning money after retirement.
IRAs (Individual Retirement Account). You are limited in terms of your annual contribution to an IRA, but as you add to it each year, this begins to add up. Some IRA;s make your contributions tax deductible, meaning that you do not pay tax on them right now, but will have to pay tax when you take a cash disbursement after you have retired. The good thing about an IRA contribution being tax deferred is that for every $2,000 you contribute, you see a savings of over $500 when you are in a 28% tax bracket. Essentially, that means that it cost you $1,500 to put $2,000 into your account. That is one way to make money right away. By leaving the money in the IRA, you continue to compound and make money that is returned to the account.
Roth IRA's are newer and may be a better choice for some people, because the money, when a cash disbursement is taken, is NOT taxed. Now, you do not get a tax deduction up front as in the previous example, but this might not be as serious a concern for you. However, the money does compound, it is tax free, and you usually never have to pay taxes on it as long as it has been in the account over five years. Rules and regulations apply to all of these choices, so be fully informed before you make a decision. However, it is good to know what some of the choices are, so that you can ask educated questions of your tax advisor.
Annuities. With IRA's being limited in terms of annual contributions, and your 401(k) plan is also being maxed out, you can look at establishing an insurance annuity that will work as an additional retirement account with substantial tax savings. Much like an IRA, the earnings of such an annuity are not taxable until you begin to withdraw money during retirement.
Managing your Investments is exactly that. It is not wise to put money into your various accounts, then sit back, wait for twenty years and expect them to be fully and completely funded to your expectations. Markets change, interests change, and so do your investments. No one will care more than you do about how well your investments are doing. You may have paid someone to keep an eye on things, but an annual check with your tax advisor or investment advisor is essential. Keep a portfolio of everything, and evaluate everything on an annual basis to ensure that everything is on track.
Your portfolio requires specific steps to ensure appropriate growth. First, you want to establish your investor profile. For the purposes of this class, we will assume that you are planning for retirement, and you have specific goals and time periods in mind to meet your financial needs at specified times. For example, when you retire, you will want to plan on a certain amount of monthly income to meet your established retirement expenses. To do that, you have to watch your retirement investments very, very carefully to ensure that they are performing up to your expectations.
You will need to decide where you intend to invest your money, not which company, specifically, but what TYPE of investment. Will you want to invest in stocks, bonds, real estate, or precious metals? By choosing more than one type of investment, you diversify. Should you choose to put all of your money into one type of investment and it fails completely, you will have lost all of your savings. By diversifying, you will reduce the chances of losing all of your money. It is a safer form of investment. It is vital to ask for advice in this area, unless you are a very skilled investor. The economy will dictate whether stocks are a safe investment, or if you are better off looking at money market funds or bonds. By investing in opposites, you maximize your opportunities. That is if stocks and bonds are down, then gold and real estate usually go up. By investing a little bit in each, you better your chances of achieving growth of your money.
An indepth discussion of investing is not possible here. Books and entire classes are held on investing. What you need to know is not to merely take anyone's word that a particular investment is a good one. You need to either get professional advice, or do some investigating yourself.
By diversifying and maximizing your contributions, you will ensure the best possible results when you retire. If you only have a single IRA to which you contribute every year, you will have some savings, but not nearly enough to retire on. By looking into every possibility, and maximizing your dollar today, you will have that dollar grow exponentially into money that you can use after you retire.
Mutual funds allow you, as a small, individual investor, to combine your money with that of many other investors and have a mutual fund investigate a company to see whether they are a good investment. Your small investment might not seem like a lot to a company, but when it is added to the small investments of hundreds of other people, it can actually buy bits of the very best stocks available in some of the biggest and fastest growing companies available. Do not overlook this possibility.
Social Security was initially established in 1935 as a social insurance plan to provide supplementary income for retired or disabled individuals. A new era had come to the United States, and people were finding that with the more mobile society, they were no longer able to depend on their extended families in their time of retirement. Many such Americans were destitute and suffering in poverty. Social Security is a direct result of the Great Depression when the streets were full of elderly individuals looking for food and a place to live. In some ways, Social Security is a welfare program for retirees.
Not only does Social Security help with retirement, but it also goes into effect for workers who become disabled before the age of retirement. Additionally, children are frequently given Social Security benefits because their parents have died. Blind and disabled workers are also assisted with the Social Security program.
To draw on Social Security, you must have actually accumulated forty earning credits. Earning credits are earned at the rate of one credit for every $740 in wages and you can earn a maximum of four credits per year. Therefore, if you earn $2,960 you will contribute four credits to your account. If you earn $296,000, you will still contribute only four credits to your account. This is merely an eligibility standard. Once you meet the standard, you stop earning credits. If you do not meet the eligibility standard, you do not earn your four annual credits. That is often why individuals who may have taken time off work to go back to school, or to raise a family, find themselves a few credits shy of the required amount for full eligibility will find themselves best served if they work a little longer and earn their full number of credits.
Factors that Raise or Lower Social Security Benefits
The age at which you choose to retire can have a significant impact on your Social Security benefits. If you have your forty earning credits, and have reached the age of 62, you are eligible to begin drawing Social Security. The drawback is that your benefits will be reduced because you will be drawing for a longer period. You may choose to retire and begin drawing benefits at 62, or you may choose to wait until the full retirement age of 66 or 67 and draw your full benefits.
The system is designed to even itself out, but each person will have to make their own decision about when to retire and when to start drawing benefits. You can also defer collecting Social Security until the age of 70, at which time your benefits will continue to increase. The longer you work, the higher your benefits are likely to be.
Working during retirement can affect your Social Security disbursement. Anearnings limitation that is applied to your benefits. If you earn more than the earnings limitation, Social Security will reduce your benefits by a dollar for each one or two dollars over the limit that you earn depending on your retirement age.
The earnings limit for workers who are younger than "full" retirement age (age 66 for people born in 1943 through 1954) will be $14,640. (We deduct $1 from benefits for each $2 earned over $14,640.) These earning levels will be increased with inflation every year. The earnings limit for people turning 66 in 2012 will be $38,880. (We deduct $1 from benefits for each $3 earned over $38,880 until the month the worker turns age 66.) There is no limit on earnings for workers who are 67 or older for the entire year.
This might keep you from working, but if you find something that you really enjoy doing, then it will likely be worth your while to continue working and drawing Social Security at a reduced rate to continue to supplement your income.
Rather than looking at it as if they are taking money away from you, look at it as an extra bonus while you continue to work at something you truly enjoy.
Applying for benefits requires that you have your Social Security number, your birth certificate, W-2 or self-employment tax return forms from the previous year, spouse's birth certificate and W-2 if applying for benefits as well, proof of U.S. citizenship, and the name of your bank and account number for direct deposit.
Every person will begin to draw on Social Security at different times. When the time draws near, you will be best advised to set up an appointment with the Social Security administration and ask any necessary questions. Plan on several months to process your application.
Social Security may seem like it is complicated, but at least it is relatively standard. Corporate pensions are as varied as the companies that they represent. You will have several decisions to make about your corporate pension, but you need to make absolutely certain that your decision is correct, because if it is not you may lose out on a lot of money. This is a situation where it is recommended that you consult an advisor.
Usually you have a decision to collect in one lump sum or in monthly disbursements. Even if you have been contributing to your pension for years, it is a good idea to check on a few details at this point. Is your Social Security number correct? Your name spelled right? Birth date? Your age and number of years with the company could have huge ramifications if they are in error. Before you retire is actually a good time to check all these details for accuracy.
There are times when the pension benefits have been incorrectly calculated. To ensure appropriate value for your pension, it is wise to take your last benefits statement to an independent pension administrator and have your pension benefits verified. The actuary will need to see your latest annual report, disclosure documents, and a summary plan description to run the calculations. Many pension programs are exactly on. Many are off by a thousand dollars, and some off by tens of thousands of dollars.
The amount of your pension will now be determined by your age of retirement, your current earnings, longevity with the company, and so forth. Regardless of when you leave your company, your pension will have an actual date that will allow you to draw from the fund. Until that time, it is off limits.
One common suggestion with a pension is to take the lump sum rather than an annuity. One of the problems with annuity disbursement is that if the retiree dies, then the pension ceases. If the retiree takes the lump sum and invests, that money is now under the control of the retiree and will not be lost upon death. If you choose the annuity even for one payment, you have given up your right to a lump sum disbursement, even if you really need all that money at one time for a catastrophic need.
Now, the most important bit of information about the lump sum disbursement of your pension. DO NOT ACCEPT THE CHECK YOURSELF! ROLL IT OVER INTO AN IRA. If you do not do this, you will pay a huge amount in taxes to Uncle Sam and will never see it again.
IRAs are held by an institution that reports your holdings to the IRS, and because most IRAs have not yet been taxed, the IRS wishes to keep track of it so that they get the money to which they believe themselves to be entitled.
By the time you have established your IRAs, and some investments, and you are approaching retirement, it is really a good idea to seek out an advisor who specializes in serving retirees.
It is pretty easy to get money out of your IRA if you need it. If you are not 59-1/2, then you will pay a federal penalty of 10-percent of your withdrawal, plus income tax on the amount withdrawn. This is because an IRA is a retirement account, and if you draw on it sooner, you are obviously not using it for retirement. However, if you really need the money, 10-percent is often less expensive than taking out a loan.
Between the ages of 59-1/2 and 70-1/2 there are no restrictions in withdrawing funds from your IRA account. All you have to do is report the income on your annual income tax form. Once you reach the age of 70-1/2, you will be required by the government to make regular withdrawals and pay tax on them. The penalty for not taking the mandatory distributions is a whopping 50-percent of the amount that was to have been withdrawn. This penalty is one of the worst that can be levied, so be aware of it and do not let Uncle Sam take the money that you have so assiduously saved for retirement.
IRAs are terrific, but they are not without their own unique pitfalls. Educate yourself about your retirement vehicles. You must be the expert of your own xxxx retirement.