There's more to planning for your retirement than just settling for whatever your employer has to offer. After all, your company's plan may not be robust enough to support you as you'd like in retirement. Or maybe your employer doesn't offer a plan at all.
No matter what, your retirement is your responsibility, and if your company plan is insufficient or nonexistent, you've got to find a way to make up for it. Happily, you can solve the problem by turning to the other tax-advantaged investment options: individual retirement accounts (IRAs), SEP-IRAs or Keoghs (for the self-employed) or, in some situations, variable annuities. Here's a breakdown of how each option works.
The 401(k) vs. IRA
Let's face it: It's certainly hard to beat a well-managed 401(k) or 403(b). After all, most 401(k)s offer some sort of employer match. And, unfortunately, you may not qualify for the most generous types of IRAs, namely a Roth IRA or a tax-deductible IRA. That said, all IRAs come with a distinct advantage: You can choose among a variety of investment options.
Our advice is to follow this basic, tiered strategy: First, max out your company plan, even if it is lacking, to take advantage of the company match. Then turn to an IRA, which gives you lots of investment freedom, but is limited to contributions of $4,000 for 2005 ($4,500 if you are 50 or older). After that, most folks will do best investing in a taxable account, although in some rare situations, a variable annuity could also be considered.
For most people, a Roth IRA is the best type of IRA, especially if retirement is still a long way off. Although you invest with "after-tax dollars," you should come out ahead, provided you don't expect to be in a much lower tax bracket when you start to tap the account. Contributions aren't deductible, but withdrawals are tax-free if you've held the account for at least five years and are at least age 59 1/2 when you start taking withdrawals. (Some exceptions apply, including if you become disabled or are using up to $10,000 of the account for first-time home-purchase costs.)
For 2005, individuals earning less than $95,000 and married couples earning less than $150,000 can each contribute $4,000 to a Roth IRA ($4,500 if you are 50 or older). Eligibility phases out between $150,000 and $160,000 for couples ($95,000 and $110,000 for individuals). If you have an adjusted gross income under $100,000 (married or single), you can transfer some or all of your traditional IRA into a Roth. This is called a Roth conversion. Just keep in mind, you'll owe tax on the conversion.
The Traditional IRA
If you (and your spouse) aren't eligible for a retirement plan at work, you can open a tax-deductible IRA and fully deduct your IRA contributions of $4,000 ($4,500 if you are 50 or older). If you do have a plan at work, the 2005 deduction tapers off between $50,000 and $60,000 for retirement-plan participants who are unmarried; $70,000 and $80,000 for married people filing jointly. If only one spouse participates in an employer-sponsored plan, deductible IRA eligibility phases out between $150,000 and $160,000 for the uncovered spouse, and between $70,000 and $80,000 for the covered spouse.
What to do if you don't qualify for either a Roth or a deductible IRA? Well, anyone can contribute to a nondeductible IRA, although these wouldn't be our first choice for retirement savings.
If You're Self-Employed
If you or your spouse is self-employed, not only do you get to contribute much more to your own retirement account, but you can also claim tax deductions for your contributions. Your options include SEP-IRAs, Solo 401(k)s and Keogh retirement plans. For more on these plans, see our story.
So where do you start? When it comes to investing your IRA, the only limitations are those imposed by the company that holds the account. Banks offer IRAs, for instance, but they often limit you to their own CDs or money-market accounts. That's a problem if you want to invest in equities (which we strongly recommend). The big, full-service brokerage firms also offer IRAs, but they often come with a broker (and a broker's fee). And that can be expensive.
A better bet is to open an account with low fees and a broad menu of investment options, which is what you'll find at mutual-fund companies and discount brokerages. Of course, if you aren't happy with the firm that currently handles your account, you can always rollover your IRA to another brokerage firm or fund family.
Rolling Over a Retirement Account
If you lose your job or change companies, you have the freedom to roll your retirement savings tax-free into an IRA. And that can be a smart move since it will increase your investment options. Suppose you lost your job and rolled over $100,000 to an IRA at, say, Charles Schwab. You could then divvy up that $100,000 among various mutual funds, plus put a portion in a stock portfolio you run yourself. Not that ambitious? Then just pick a mix of funds that best suit your needs.
These products, which are essentially mutual funds that incorporate an insurance policy, have largely deserved their bad rap. Many insurance companies that sell them typically charge high fees while offering poor investment choices. You'll find better deals at mutual fund companies like Vanguard, T. Rowe Price and TIAA-CREF, which offer variable annuities that feature a broad range of investment options with competitive fees. Nevertheless, you should only consider a variable annuity after you've maxed out on your employer-sponsored plans and fully funded your IRA.
Good annuities allow you to allocate your money among various "subaccounts," which are often clones of well-regarded mutual funds. The variable-annuity plan offered by T. Rowe Price, for example, lets investors choose among 10 subaccounts. They range from one based on the firm's New America Growth fund -- which invests in sectors the manager believes to be the fastest growing -- to its Limited-Term Bond offering, which invests in investment-grade bonds with maturities ranging from one to five years.
Unlike IRAs and other tax-advantaged retirement accounts, with variable annuities there is no limit on how much you can sock away each year. But on top of money management expenses, annuities also have annual fees to cover the insurance part of the product. With the additional costs, you'll often need to hold the annuity roughly 15 to 20 years before the advantage of tax-deferral tops a standard mutual fund.
So what does the insurance offer you? It basically guarantees that your estate will be made whole if you die at a time when the market value of your investments is lower than the sum of your contributions. For an added fee, some policies will "step up" your guaranteed death benefits every few years so you can lock in gains. Insurance also comes into play when you enter the payout period. Some insurance choices include:
· Single life: Guaranteed payments each month for as long as you live, no matter how much principal you have. (Of course, if you die early, your principal vanishes.)
· Period certain: Coverage for a set number of years or your lifetime, whichever is longer, and your heirs get the remainder if you die before the term is up.
· Joint and survivor: Payments for your life and the life of your beneficiary.