Investing For Your Future
Monthly IFYF Investment Message
April 2006
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April is tax filing month and a good time to discuss investments that provide both tax advantages and a retirement nest egg. The intent of this article is to provide accurate and authoritative information on voluntary retirement savings plans, including those available through many employers. These are savings options above and beyond any mandatory savings provided by a pension plan. In no way does this article render individual financial advice. Readers should consult a competent financial professional if expert assistance is required. Retirement savings decisions must, necessarily, be based on individual factors such as financial goals, marital status, retirement lifestyle decisions, and available income to invest.
Having said that, many people wonder where they should place their limited retirement savings dollars. Below is a suggested order of preference in funding retirement savings plans recommended by many experts:
- A worker and/or spouse's 401(k) plan (if he/she works for a for-profit corporation) up to the maximum amount of employer match (e.g. 6% of a spouse's pay), assuming a stable marital relationship.
- Why? An employer match is "free money" and you should never walk away from an opportunity to receive free money, if possible. A 50 cents on the dollar match is an instant 50% return! In addition, you will be able to write off the contribution amount on your single or joint federal income tax return.
- A Roth IRA (if income-eligible...there is a $110,000 income cap ($95,000 phase out) for single taxpayers and a $160,000 income cap ($150,000 phase out) for couples filing jointly) up to the maximum limit of $4,000/$4,500 (age 50 + catch-up) in 2005. The maximum IRA contributions in 2006 are $4,000/$5,000 (age 50+ catch up). You have until April 15 to contribute to an IRA for the previous tax year.
- Why? Earnings on Roth IRAs can be withdrawn tax-free and there are no required minimum distributions at age 70 ½ as with other tax-deferred plans. This provides excellent estate planning opportunities. You must be age 59 ½ and have a Roth IRA account open at least 5 years to make tax-free withdrawals. Compound interest makes Roth IRAs especially beneficial for young workers.
- A 401 (k), 403 (b), and/or Section 457 (deferred compensation) plan (depending on what plan(s) are available through your employer) up to the maximum amount allowed by law, which is $15,000 in 2006, plus an additional $5,000 catch up contribution for those age 50+ ($20,000 total). Maximum contribution limits may be less for certain employers. Choose investments (e.g., mutual fund or annuity) from providers that charge low expense ratios (e.g., TIAA-CREF, Vanguard, and T.Rowe Price).
- Why? All voluntary salary-reduction retirement savings plans provide three advantages: a federal income tax write-off of the amount contributed, tax-deferred growth on both contributions and earnings, and automatic savings via payroll deduction. As noted above, some employers (primarily 401(k) plans and some 403(b) plans) also match the contributions made by their workers, up to a certain level.
- If you still have money to invest for retirement, select non-deductible traditional IRAs (there is no income cap like there is for Roth IRAs), assuming you have not fully funded a Roth IRA, and/or low-cost annuities, purchased with after-tax dollars, outside of your employer. Again, select low-cost annuity providers with below-average expenses, such as companies listed above, to increase your return.
- Why? Both non-deductible traditional IRAs provide tax-deferred investment growth, although there is no immediate tax write-off. Tax-deferred investments grow faster than those placed in taxable accounts.
- Another good choice for retirement investing, after you have "maxed out" an IRA and all available tax-deferred options through an employer, is low-expense stock index funds that are placed in taxable accounts. Two examples are S&P 500 index funds that track the Standard & Poor's 500 index of large U.S. company stocks and "total stock market" stock funds that track U.S. companies of all sizes.