Where to Save for Retirement

where to save for retirementWhere to save for retirement should include tax-deferred vehicles. Currently they have two forms.

One is the individual retirement account (IRA). Given the innovative nature of the financial services industry, there are a growing number of those. Essentially the funds put into the IRA are tax deductible in terms of reporting one’s income to the IRS. The maximum amount depends on the particular kind of account. Within the account, the money deposited and the funds earned on the investments are not taxable until you withdraw them. Ideally, that is done at a time when you are older and your income is less. That will reduce your tax liability, both on the principal and the capital gains, dividends, and interest.

Anyone earning income, including a student, can open a type of IRA. Banks providing IRAs facilitate automatic monthly deposits from a checking account. That locks in regular savings. The amount can start out low, for example, $50 a month. Then it can be increased over time.

The second common tax-deferred retirement vehicle is the 401(k) sponsored plan for employees and the Simplified Employee Pension (SEP) plan for the self-employed. Both workers and the self-employed can also simultaneously have IRAs.

The 401(k) is a voluntary retirement plan. No one has to participate. Workers who do can have automatically deducted from their gross pay up to $17,500 annually. Sometimes the employer will match a portion of that. As with the IRA, both the initial funding and the wealth it generates are tax-deferred until they are withdrawn.

With the SEP, the self-employed can contribute up to 25 percent of net earnings to a total of $52,000.

All these tax-advantaged approaches require a realistic assessment of how much you can save. Premature withdrawals from some plans can incur both a penalty and the principle and earnings will be taxed at one’s current income level. If you are in your peak earning years, that can be high. Therefore, it makes common sense that when you are financing college tuition for your children, you would probably commit less.  As those responsibilities lessen, you can increase the amount.

In addition, the investments have to be managed. You can do that yourself if you have the expertise. Or, you will assign a financial advisor to oversee the investments. That professional partners with you in managing your investments. You cannot be passive. For example, both of you should be aware when changes should be made. As you age, your portfolio should contain less a percentage of equities, including in the form of mutual fund stock accounts, than when you were in your 30s.

Along with tax-advantaged strategies, you should also pay attention to what banks provide for both building and protecting wealth in vehicles such as savings accounts, money market funds, and certificates of deposit (CDs). They are all guaranteed by the Federal Insurance Deposit Corporation (FDIC). However, the tradeoff could be what is known as the “inflation risk.” The rate of return might not keep up with inflation. That could be reduced by shopping around for a higher than average rate of interest. Online-only banks often provide those premium rates. They can do that because their fixed costs are lower than those of brick-and-mortar banks, which are burdened with real estate and live tellers.

Another strategy for saving for retirement is the family house. Those understanding the fundamentals of residential real estate as an investment can make that an appreciating asset. Location is important. There are a number of variables associated with that. They range from a superior school system to the beginning of gentrification. Within that area you would look to buy among the lowest-cost properties. The price could be a “bargain” because the property needs renovations or cosmetic sprucing-up.

There is no predicting which combination of approaches will be most effective for funding your unique retirement dream. The key to where to save for retirement is to understand the rewards and risks of all of them.

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