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September 1, 2017

How a Late Retirement Could Affect Your Wallet

The term “late retirement” is often synonymous with “delayed retirement,” which suggests applying later to receive larger retirement benefits. The first chance to qualify for Social Security is when…

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Basic Retirement Investment Questions

An individual retirement account (IRA) is a type of government-regulated and defined savings account with tax benefits that help you save money for retirement. The specific tax benefits depend on the type of IRA.

The two primary types of IRA are:
  • Traditional: Contributions are tax deductible in the year they are made.
  • Roth: Contributions are invested after taxes, and those contributions and any earnings may be withdrawn in retirement tax-free. Roth IRAs are not an option for high income earners.

Other types of IRAs include the SIMPLE, or Savings Incentive Match Plan for Employees, IRA and the SEP, or Simplified Employee Pension, IRA for self-employed individuals or small business owners.

If you have earned income from a job, then you can open an IRA as long as your adjusted income is below the eligibility limit of $133,000 for 2017. If you do not earn an income but are married to someone who does, then as long as you file your federal taxes jointly you can open an account as long as your combined income falls below $196,000. You can open an IRA account online or in person at most financial services providers, which includes local banks and credit unions, brokerage firms, discount brokerages and mutual fund superstores.

In addition to any contributions you make, interest earned on the investments purchased with those contributions adds to the balance. Even if your IRA earns a low interest rate, thanks to compound interest the account will continue to grow even without additional contributions. For example, if your IRA balance of $50,000 earns five percent interest, then your IRA will grow by $2,500 to $52,500. By the next year, your balance will grow by $2,625 because you will earn interest on the original contributions plus the interest. By the third year, your interest earned will be $2,756.

An IRA’s cost depends on the financial institution holding the account. The IRA might not cost anything beyond your contribution amount. The financial institution might charge initial set-up fees of $25-$150, annual maintenance charges of $20-$50 or a termination fee of $50-$75. You might incur commission fees or transaction charges of $7-$20 when you buy or sell stocks or mutual funds in your account.

A 401(k), named after the section of tax code that created it, is an employer-sponsored retirement plan. You choose the amount to contribute from your paycheck, before taxes. Those contributions, along with any from your employer, are invested, usually in mutual funds.

The main differences between the two are eligibility, contribution limits and tax status.
  • A 401(k) is only available to employees of the plan’s sponsor.
  • Individuals can contribute much more to a 401(k). In 2017, the annual personal contribution limit is $18,000, while the IRA limit is $5,500.
  • Income invested in a 401(k) is tax-deferred, which means you won’t pay taxes on that amount until the income is withdrawn. Income invested in a Roth IRA is tax-free when withdrawn, since the income already was taxed before being put into the IRA account.

Other differences exist. For example, investment options are much more limited in 401(k) plans.

A 401(k) grows through deposits made directly from your paycheck. Your employer might also make contributions on your behalf. The performance of your investments will either increase or lower your balance. Over time, an investment portfolio with a mix of investment types will grow in value.

A 401(k) has no minimum investment requirement. An IRA technically has no minimum investment, but the financial institution you choose to open the account might require a minimum amount to start. For both investment options, there are maximum investments allowed under federal regulations.

An annuity is a contract between you and a third party, typically an insurance company, that exchanges your lump sum payment for the promise that the insurance company will:

  1. Provide an income for a certain period of time;
  2. Provide for asset growth;
  3. Provide a death benefit; and,
  4. Provide for long-term care benefits.

The cost of an annuity depends on the insurance company holding the account. Typical fees include a commission to the salesperson who sells you the annuity, underwriting fees and mutual fund management fees.

Retirement Investment Tips

The right investment for you depends on your personal circumstances. If your employer does not offer a 401(k) plan, then that investment choice is not an option available to you. You can invest in a traditional IRA, Roth IRA or both; the decision to invest in one or the other should come after you examine your present situation and predict your future circumstances. If you believe you will be in a higher income, and thus higher tax, bracket when you retire, then a Roth IRA is probably the better choice since any distributions then will not be taxed. Alternatively, if you believe your tax bracket is higher now, then investing in a traditional IRA will lower the taxes you owe currently, since the amount you contribute is tax deductible.
Within 401(k) and IRA accounts you have different investment choices to make. Typically available options include stocks, mutual funds and bonds. How you allocate your funds among the available investment options depends on your age and your risk comfort level. Generally, older investors should invest more conservatively, while younger investors should choose more high-risk options since they have more time to ride out any market volatility.

Roth IRA investments are the best choice to avoid taxes in retirement, since any distributions of income, whether from your contributions or earnings on those amounts, are tax-free. With an annuity, only the amounts earned in excess of your contribution are taxed as ordinary income. Traditional IRAs and 401(k) plans will be treated as ordinary income and taxed when the funds are withdrawn.

There are several reasons why you might consider investing in an IRA to supplement your 401(k) plan, including the following:
  • You can maximize your annual contributions to retirement accounts.
  • IRAs offer more investment choices, which might better align with your financial goals.
  • Roth IRA funds can be used for purposes other than retirement. Your contributions can be withdrawn without penalty at any time, and your earnings can be withdrawn without penalty if for certain qualified purposes, including higher education, buying your first house or paying health insurance premiums while unemployed.
  • Unlike 401(k) plans that require a minimum distribution from your account beginning at age 70 1/2, Roth IRAs have no required minimum distribution.
  • Roth IRAs have no upper age limit for contributions.
  • You can use your Roth IRA to provide flexibility when it comes to taxable or tax-free income. If you want to minimize your taxable income in a year, then you could withdraw more from your Roth IRA, for example.