Although your retirement date may still be many years off, it is never too early to start your preparation. Yet, many people may spend more time planning their annual vacations than they do planning for their retirement future. A retirement plan that includes a variety of financial instruments, such as tax-favored retirement savings vehicles, annuities, mutual funds, and life insurance, may help you maintain your quality of life today and in the future.
As you begin contemplating your investment strategy, consider a tax-deferred savings plan, such as your employer’s 401(k) plan. The earlier in your career you begin participating in an employer-sponsored plan, the longer its advantages have to work for you. You can elect to contribute part of your wages to the plan (with restrictions) and, in some instances, your employer may match your contributions up to a predetermined percentage and subject to a maximum. While no one can guarantee the performance of your savings vehicles, if you take advantage of matching contributions, you automatically increase your principal, sometimes by as much as 50%. Furthermore, contributions to a 401(k) plan may reduce your taxable income if you meet certain requirements as defined by the Internal Revenue Service (IRS).
Another alternative for tax-deferred savings is an Individual Retirement Account (IRA). By opening an IRA account as soon as possible, you will enable time and compound interest growth to work on your behalf. Depending on your income, your participation in an employer-sponsored plan, and the type(s) of IRA you choose, you may be eligible for an income tax deduction. The maximum contribution in 2015 is $5,500 ($6,500 for those age 50 and older).
Annuities, contracts with life insurance companies, offer you another tax-deferred retirement planning opportunity. The earnings on an annuity have the potential to grow tax deferred, just as with a traditional IRA or 401(k) plan. While all three long-term savings instruments have benefits in common, they also share a restriction—early withdrawals, prior to age 59½, may result in a 10% federal income tax penalty, as well as being subject to income taxation.
Two popular types of annuities are variable annuities and fixed annuities. When a fixed or variable annuity is used to fund a qualified retirement plan, tax deferral is provided by the qualified retirement plan. An annuity provides no additional tax deferral. One should consider using a fixed or variable annuity contract to fund a qualified retirement plan in order to benefit from annuity features other than tax deferral, including the lifetime payout option, death benefit protection, and the ability to transfer among investment options without incurring sales charges or withdrawal charges.
With a variable annuity, payments are invested, and future payments to the purchaser are based on the performance of the investment portfolio. Variable annuities may be redeemed for more or less than their original cost. If you die before receiving income from your variable annuity, your beneficiaries are entitled to the amount invested in the annuity, regardless of the portfolio’s performance. In contrast to a variable annuity, a fixed annuity guarantees regular, fixed payments for a specified period of time, or for life. You generally pay a premium either in a lump sum or in installments. Guarantees are based on the claims-paying ability of the issuer. Early termination of an annuity contract may result in certain surrender charges.
Mutual funds may be another excellent way to take advantage of the knowledge and experience of professional portfolio managers. With stock mutual funds, you are spreading investment risk among a variety of company stocks. In addition to common stock funds, mutual fund investments can be made to money market accounts and bond funds. Money market funds are neither insured nor guaranteed by the U.S. government. Remember, the investment return and principal value of all mutual funds will fluctuate due to market conditions. When shares are redeemed, they may be worth more or less than their original cost.
It is often convenient with mutual funds to implement dollar-cost averaging (investing a specific amount regularly over a period of time). While it cannot guarantee you a profit or protect you from a loss, this method may create a lower cost per share over a long period of time. For the strategy to work, you (as an investor) need to be able to invest through periods of low price levels. In addition to reinforcing the discipline of regular investing, dollar-cost averaging takes the guesswork out of trying to “time the market.” There is no guarantee that dollar-cost averaging will result in a lower cost per share.
Life insurance, depending on the type purchased, may serve multiple functions as you plan for retirement. By using cash value life insurance, such as whole life insurance or variable life insurance, you have the advantage of a supplemental source of savings during your retirement years that accumulate cash value on a tax-deferred basis. Furthermore, in the event of your death, it provides benefits for your spouse and dependent family members.
In addition to qualified plans such as 401(k)s and IRAs, annuities, mutual funds, and life insurance may each have a place in your personal retirement plan. Even if you can only save a small amount at the outset, the key is to start early and continue on a regular basis. The more you know about investing for your retirement years, the more comfortable and secure your future may be.