Funding Your Retirement

The Best Time to Start Retirement Planning is When You Get Your First Paycheck

Retirement planning and, for that matter, all your financial planning should start when you are young - ideally on the day you receive your first paycheck.

At that point you have time and the power of compound interest on your side. Read Get Rich Slowly to see how a twenty-two year old could become a millionaire by just contributing $4000 a year to his or her IRA from that age on.

The purpose of retirement planning is to allow you to maintain your lifestyle after you stop working. Or it could be to enable yourself to fulfill a lifelong dream; a beach house in Hawaii, around the world travel, opening a restaurant - the list is endless.

Since you can expect to live longer than prior generations, you also have to consider how you will pay just to live until your late 70's or early eighties.

Of course you can plan on continuing to work, an option more and more people seem to be leaning to - and not entirely for financial reasons. See Working in Retirement for more.

For most of us, retirement planning revolves around pensions - now more commonly 401 K plans, IRA and other individual savings and, finally, Social Security.

It is probably a bad idea to rely on Social Security. I don't think the program will ever die, but I do think, unless our leaders get serious about the subject, it will be whittled down by means-testing and higher taxes on recipients. It might very well wind up as a welfare program for the elderly.

It is rare for workers to be eligible for a "defined benefit plan" pension, the type that promises to pay so much for life based on your working salary and years with the company. Most major corporations have found this type of pension plan too expensive to be sustainable. Many have tried to pass their obligations on the the government.

In place of the defined plan, employers now commonly offer a 401 K plan, often with a matching contribution. This shifts all of the risk of a lifetime pension from the employer to the employee. If you make the wrong investment choices, tough luck.

401 K plans now come in two flavors, the original tax sheltered version and a new "Roth" version. In the first, your money is invested before taxes, grows tax free, but is taxed on withdrawal.

In the Roth version, you pay taxes on the contribution to the plan, again it grows tax free, but you pay no taxes on withdrawal. This complicates what used to be a simple decision. There are pluses and minuses to both plans. You will need to talk to a qualified financial planner or accountant to see which is best for you.

If you only are offered one of the options, use it. This is too valuable a "perk" to pass up. As a matter of fact, fully funding your 401 K plan should be your first step in retirement planning. (There are other options for the self-employed, like Keogh Plans and SEP's. No matter what they are called, these goverment approved tax shelters should not be ignored.)

Next is the IRA. Again there is the traditional plan and the Roth version and they both work the same way as the 401 K version. However, it is difficult to qualify for the tax deductibility of a traditional IRA, so the Roth plan is the only real alternative. Right now you can contribute $4000 a year, going up to $5000 in 2008. Again, you should take full advantage of this tax shelter.

Finally, if you have any money left, you should invest it for long term growth. This money can be used for any purpose. You and your financial advisor can determine how much should be ear-marked for retirement.

It's never too late to start your retirement planning, but it will become more difficult to reach your goals the older you get. If you're in the boomer generation and have no savings, you choice has already been made - you will need to continue to work.

Start saving for retirement as soon as you can and maximize your use of tax shelters. While you might have to make some sacrifices along the way, it will beat having to decide what you can afford in retirement, food or your medications.

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