Retirement Income Planning: A Look At The Various Retirement Savings Plans

By MySpendingPlan.com Editorial Staff

Saving for the future is something that everyone has to do – and people are living longer lives than ever.  But the only way you’ll be able to lead a financially independent life when you retire is to have a decent retirement income.  Many people rely on Social Security benefits to get them through their old age.  However, Social Security will definitely not be enough because it is a pay-as-you-go system, and many economists are worried that there will not be enough in the kitty to take care of the large spike in the aging population, as the Baby Boomers retire.

What this means is that whatever you pay towards Social Security today goes as benefits to the retirees of today.  What you will get as benefits after retirement will depend on what the government has been able to collect at that time, which may be significantly lower as the years pass.  So you have to consider other retirement savings plans to help you save for your golden years.

Retirement Savings Plans

1. Individual Retirement Account (IRA):

An IRA is a type of savings account where you can save money for retirement.  It can be invested in stocks, bonds, mutual funds, among other investment options.  The money deposited into an IRA is income tax deductible, thus lowering your immediate tax liability.  However, upon withdrawal of the money, you will have to consider any investment gains as income and pay tax accordingly.  A regular IRA also stipulates that you start making some withdrawals after the age of 70 ½.

2. The Roth IRA:

A Roth IRA is a kind of reverse IRA, wherein the contributions that you make to the account are not tax deductible from your current income.  However, your money grows tax free and you do not have to pay any tax upon withdrawal!  What’s more, you are not required to start making compulsory withdrawals at any age but can let the money accumulate for as long as you like.  However, Roth IRA rules are such that it is not available to everyone but only people who have incomes under certain levels.  The current Roth IRA rules for income are:

• For individuals filing singly, your Adjusted Gross Income (AGI) should be less than $95,000 to take advantage of the full contribution of $4,000 a year.  If your income is between $95,000 and $110,000, partial contribution is allowed, whereas those with incomes above $110,000 are not allowed to save under Roth IRA.
• If you are filing as Married Filing Jointly (MFJ), then you are allowed full Roth IRA contributions if your AGI is under $150,000.   If this income is between $150,000 and $160,000, full contribution is allowed, whereas for those having incomes above $160,000, no contribution is allowed.
• For persons filing as Married Filing Separately (MFS), you are allowed to save under Roth IRA only if AGI is under $100,000.

For people over 50 years of age, the maximum Roth IRA contribution allowed every year increases to $5,000.  This information is to help you understand Roth IRAs, but always check with the IRS on what the latest rules and limits are – tax laws change.

3. 401K:

This is a type of retirement savings plan and is sponsored by your employer.  If you choose to save for retirement with a 401K account, some portion of your salary will automatically be deposited into this account before calculating taxes, while the remainder will be paid to you.  The maximum amount that you can contribute towards your 401K plan varies from plan to plan.  In some cases, an employer may match your contributions to the 401K, either a part of it, or dollar for dollar.  You generally a say in where your money gets invested and at what interest rates, but the options your employer offers may be limited.  Withdrawals from 401K accounts are taxable, but contributions can be tax deductible.

You do have other options for retirement savings such as Simplified Employee Pension (SEP IRA), the Salary Reduction Simplified Employee Pension Plan (SARSEP), etc.  However, the more important ones are those explained above.

Which Retirement Saving Plan Is Best For You

If you do have the option of saving with a 401K, experts say that you should contribute towards it to the maximum and then look elsewhere for other retirement savings plans you can also contribute to, such as the traditional IRA or the Roth IRA.

The Roth IRA does have more benefits that a traditional IRA since your money grows tax free and you do not have to make any mandatory withdrawals.  In addition to helping you create a great nest egg, a Roth IRA can be a very useful estate planning tool too.  However, as we have discussed, there are restrictions to who can save under the Roth IRA, so find out if you are eligible.

If you are already saving for retirement with a traditional IRA, you could choose to rollover your traditional IRA into a Roth IRA.  Even though you may have to pay taxes on the part that is considered your income at the time of rollover, you still stand to gain considerably if you keep the Roth IRA for a long period in high return investments.

A retirement calculator can help you to figure out how much money you need to put into a Roth IRA or other retirement savings plans in order to enjoy the same lifestyle after retirement.  Such software can also help to calculate how much money you will save by rolling over a traditional IRA into a Roth IRA.

Whatever retirement saving plan you decide to go for, whether it be a traditional IRA, a Roth IRA, or a 401K account, do make sure you start saving early and do so after consulting a financial advisor.  And make no mistake, Social Security is never going to be enough if you want to have a very comfortable financial life after retirement.  Retirement savings plans are an absolute must for everybody.