Many people in the United States have investments. As pension plans (defined benefit plans) gave way to 401(k) (defined contribution plans), more and more people now depend on investments for their retirement. Let’s start with the difference.
Defined benefit plans were the cornerstone of retirement in the past. Employees spent decades at the same company and in return, that company put money away for the employees’ future retirement. When the employee retired, they would receive income in retirement based on their years of service and salary level. These plans still exist in many public sector jobs. Police, teachers and elected officials still have access to defined benefit plans or pensions. The risk of investing to fund the employee’s future was in the hands of the employer.
Defined contribution plans, which are 401(k), 403(b), etc., usually require the employee to save for retirement. If you are fortunate, the employer will match or provide profit sharing, thus putting some of their funds towards their employee’s retirement. Defined contribution plans are now the primary retirement benefit in the private sector. Companies moved the risk of investing and contributing to their employee.
Defined benefit plans have very strict funding requirements and investing guidelines to help assure the employer can provide the employee’s pension benefit in retirement. On the flip side, defined contribution plans have limits on the amount an employee can contribute and do not require a contribution. Employers are not required to contribute to the plan. In this way, employees must be much more responsible in funding their own retirement and must take action to do so.
What’s worse? More than a third of private sector workers do not have a plan available.
With individuals being in control of their future, what is the best way to retire successfully?
There are some simple steps to take that can help you towards a successful retirement.
First, put money away. If you are young, it may seem retirement is very far off. Time goes quickly so save as soon as possible. Try taking a small amount, say $25 from every paycheck to contribute to retirement. Even better, make your contribution a percentage of your salary so that when you get raises, your retirement does too. If you are young and not making much money yet, a Roth contribution may make sense.
A traditional retirement plan or IRA allows for a deduction on your taxes in the year you make the contribution. In retirement, money pulled from the plan will be taxed since it never was before (The IRS wants their taxes). A Roth option does not allow the participant to deduct the contribution in the year it is made. However, qualified money pulled from the Roth in retirement is not taxed so all growth is tax-free. This can be a huge advantage if the money is kept in an account from age 29 to age 60. An account value of $4,000 held for 31 years and earning 8 percent annually would be worth $43,470.68, which in a Roth would not be taxed when take in retirement. Please know that there are guidelines to when and how you can take money from retirement accounts without penalty. Speak to an advisor before making major investment or retirement choices.
Be sure to save in a plan if the employer makes a matching contribution. Twenty-five percent of firms in America don’t offer an employer match so take advantage if your employer does. It’s the best, fastest return on your money.
If you leave a company, don’t pull they money from the plan and use it. Penalties and taxes apply, and you lose all the growth potential. Rather, if you have several defined contribution plans at various employers, to better track and allocate, pool them together in one employer plan or IRA.
If you don’t have a retirement plan at your employer, you can still contribute to a self-directed IRA or Roth and have it done automatically. You can have money sent directly from your bank account every month. Be sure to deduct any traditional IRA contributions from your taxes in the year they are made, if this applies.
If you are maxing out your contributions to your retirement plan but find you should save more, depending on your income, you or your spouse may be able to put money into a traditional or Roth IRA. Also, you can always open and fund a taxable account. You may not receive tax advantages, but it does leave more freedom to pull from the account when needed.
The most important thing is to keep retirement planning in the forefront over your lifetime. Sitting down with an advisor to plan how much, when and how for retirement, can be an empowering and comforting meeting. The earlier you plan the easier it is to make changes or adjustments to get you where you want to be in your golden years.
