Financial Planning 101: Part 7
Retirement Funding Strategies

by Gerald Townsend, Financial Editor
July 2009

This month "Financial Planning 101" focuses on the best ways to accumulate funds for your retirement years.

How Much?
First, let’s recognize that everyone needs to save for their own retirement because employer pension plans are disappearing and social security alone is a woefully insufficient retirement income source. How much do you need to save? The short answer is a lot more than you think, and the best time to start was a long time ago. For a ballpark estimate of how much you need to save each year, go to choosetosave.org.

Once you set a goal for annual saving, what is the best way to save? An important lesson to learn is an automatic savings plan is the key to success. Whether it is an employer retirement plan, an Individual Retirement Account, or just a personal savings account, you should arrange for a pre-determined amount to be regularly and automatically deducted from your paycheck or drafted from your bank account.

Taxable or Tax-Deferred?
Should you save in a way that allows you to reduce your current income taxes (e.g. traditional 401k plans or deductible Individual Retirement Accounts)— or should you go ahead and pay your taxes now and just shelter your future investment earnings from taxation (e.g. Roth 401k or Roth IRAs)?

The conventional wisdom is that you should normally take advantage of a current income tax deduction (traditional 401k or deductible IRA) because you are in a higher income tax bracket during your working years and will be in a lower income tax bracket during your retirement years. In most cases, I agree with the conventional wisdom, but not always. For example, an inheritance might result in your retirement taxable income being higher than your current income, or changes in federal tax rates might result in future rates being much higher than current rates. Therefore, in some cases it might make more sense to not take a current tax deduction for your savings and instead simply invest in such a way that your future investment earnings will be totally tax-free (Roth 401k or Roth IRA).

If your employer provides a retirement plan (such as a 401k plan) that not only allows you to contribute but where the employer also matches your contribution to some degree, this should be your first choice. Note that you still have to choose between traditional 401k and Roth 401k. For example: Assume an employer matches your contribution 50 cents on the dollar, up to 6% of your salary. Therefore, if you contribute 6% of your salary to the retirement plan, the employer will contribute 3%, effectively giving you a riskless 50% first-year profit on your contribution! Because of this, I always recommend at least contributing up to the maximum level of the employer match.

Should you contribute beyond the limit of the employer match? In most cases you probably should, as long as you are satisfied with the investment options the plan offers. For 2009, the maximum contribution to a 401k is $16,500. If you are 50 or older, you can contribute $22,000.

After maximizing your contribution to an employer retirement plan it is time to consider Individual Retirement Accounts, either traditional IRAs or Roth IRAs. For 2009, the maximum contribution to an IRA is $5,000; or $6,000 if you are 50 or older. Note that this is the overall maximum for IRAs of any type, so if you contribute to both a traditional IRA and a Roth IRA you are still limited to a total contribution of $5,000 (or $6,000 if 50 or older).

If your income exceeds certain thresholds, you may not be eligible to make a contribution to an IRA. Check with your tax or financial advisor about these limits.

If you still have available funds to invest after maximizing your 401k and IRAs, then you can contribute to a personal savings account. In fact, building your personal savings is important, because the tax advantages of retirement plans come with many strings attached and are tapping into retirement plans prior to age 59 ½ can not only trigger income taxes, but also penalties. A personal savings account provides a much needed financial cushion.

Start early — save regularly — consider the impact of taxes and control your expenses. That’s the recipe.

Gerald A. Townsend, CPA/PFS, CFP^®, CFA^® is president of Townsend Asset Managment Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com

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