The Basics of Retirement Plans and Why You Should Have One
Retirement…that stage of life where people can indulge in hobbies. It is that time when grandparents explore the world when some people start consulting side-businesses, and it seems like it is so far away right now. People don’t even qualify to collect retirement benefits until they’re in their fifties, with a few exceptions. It can seem easy to worry about that retirement thing later.
Then you get your first adult job and they offer you a 401k. Now you have this random account, and someone is taking money from your monthly paycheck and putting it into an account, but you can’t use that money.
It can all seem very abstract, confusing, and frustrating.
Understanding all your options to ensure your future is stable does not have to be that way. It is important to think about investing in retirement sooner rather than later because the sooner you start saving, the more you will have when it is time to start living off that money.
That is actually a good place to start….
You will be living off this money
Retirement savings are meant to be the primary financial source for people once they stop pursuing full-time career work. These investments should accumulate over time to be sustainable for years, possibly decades. While pursuing hobbies or part-time jobs for extra income is common, these activities rarely make enough money to pay all the bills and sustain lifestyles on their own.
Social security is often seen as the default savings system for retirement. However, even the Social Security Administration admits on their website, “As a result of changes to Social Security enacted in 1983, benefits are now expected to be payable in full on a timely basis until 2037, when the trust fund reserves are projected to become exhausted.” In other words, Social Security will run out eventually; even with drastic government action and increasing taxes, most financial advisors strongly advise against assuming social security will be available in the future.
Starting to save in your early twenties will give you the biggest cushion for your seventies.
Your Job Probably Offers a Defined-Contribution Plan
Many employers offer retirement plans to their organization: depending on the organization, it may have it for both full-time and part-time employees. It is called a defined-contribution plan because the plan involves a set amount of money being put into a savings account. The organization has a relationship with a banking institution, and once an employee enters into an agreement with the employer, an account is opened in the employee’s name.
Every month, a percentage of each paycheck is withheld and deposited into this account, and that money is invested in the stock market on behalf of the employee, though you can often go in and change those investments.
These investments allow the amount of money in the account to grow more than just the amount being put in by the employee and employer. Most, but not all, companies and agencies will make matching deposits into this account for as long as the individual remains employed with the organization.
These are the most common types of accounts:
401(k): a tax-deferred plan usually offered by private companies to their employees
457(b): a tax-deferred plan usually offered to state and local government employees
403(b): a tax-deferred plan, sometimes called a tax sheltered annuity – offered to employees of nonprofits
There are some rules attached to this account, like most retirement plans. The money taken out of your paycheck is not taxed, but the money in that account cannot be used for a set period of time, usually when someone reaches the minimum retirement age – currently 59.5 years old. There is also an age where you are required to begin withdrawing that money – 72. It is possible to use money in a defined contribution plan before those ages, but the money used is taxed.
There are Also Defined-Benefit Plans, but Those are Becoming Rare
A defined-benefit plan is more commonly referred to as a pension plan. These are programs where the employer creates a plan based on how long an employee works for the organization, salary history, and benefits accrued during employment. Spouses can inherit pension plans. The employer assumes all risks involved in the investments. When the employee retires and reaches the age agreed upon for the benefits to be paid, the employer can pay it out in three ways:
Annuity: when discussing retirement, annuities are single-fixed payments for the rest of a former employee’s life
Lump-sum: Pays out the entire value of the plan in one payment; you get it all at once
More companies are moving away from pension plans for several reasons. They can be expensive long-term and are dependent on the company maintaining or growing, which is hard to guarantee. Some government jobs, including the armed forces, still offer defined-benefit plans.
IRAs Are Yours to Control
Having an Independent Retirement Account (IRA) is a way to supplement an existing retirement account through an employer or something to have for self-employed individuals and entrepreneurs. Like the 401ks, money put into an IRA is not taxed, but withdrawing it before approved retirement ages will require the owner of the IRA to pay taxes. There are three kinds of IRAs:
The individual makes contributions that are tax-deductible, can make investments, and not pay taxes until the money is withdrawn upon retirement
The individual makes contributions after taxes are paid, meaning there are no taxes to be paid upon withdrawal upon retirement
If an individual has a retirement account from an employer, and they cease working for that organization for any reason, the individual or employer can choose to move that money – tax-free – into an IRA, which would behave like a traditional IRA after the money is transferred
The biggest challenge for people who rely solely on an IRA for their retirement savings is they are responsible for their investments, and if they do not have time or lack interest in understanding stock investments, their savings could grow minimally. However, having a Roth IRA is a good option for younger savers, as all taxes will be paid when you need that money, and taxes generally increase over time.
You have a right to know what is being done with YOUR money. If your employer is managing your account, you can ask your human resources person questions about that account. Make sure you have login access to your traditional or Roth IRA. Keep an eye on it from time to time.
It Can be Confusing, Which is Why There Are Experts
The nuanced details of investments, taxes, deductions, and changing laws about retirement and social security can be confusing. That is why there are people who become experts in this field.
Private firms exist to facilitate people’s investments, experts work at banks, and there are tax professionals that can be hired to ensure every year. In today’s virtual world, most investment managers have online accounts for your convenience, giving you quick access to not only how much money is in your account but where that money is being invested.
Take advantage of these resources and experts! Never guess. This nest egg is incredibly valuable, and if handled correctly, can make retirement some of the best years of your life.
Investing in retirement funds allows people to take hold of their own futures. Diversifying these investments can help protect your money. The best place to get started is to open a 401k if an employer offers it, then consult with a financial expert. Some people make enough money to have one on retainer, while others more affordable ways to get advice. The most important thing is to start young and pursue your future wisely.