Financial Fundamentals: Understanding retirement planning
Monday, 30 December 2019
Most financial experts agree that retirement planning is the most important financial planning you can do.
Even so, there are still many Americans who have no retirement savings and many others who don't have enough.
Understanding the different types of retirement savings accounts can be extremely helpful as you start to plan for the future. Here are some of the most common types of accounts:
Employer-Sponsored Retirement Plans
There are many different kinds of employer-sponsored plans; however, the most common today is the 401(k). With these plans, employees deposit pre-tax money into an account and, in many cases, funds are matched or partially matched by the employer. Many of these plans also allow employees to determine how their money is invested by selecting from a menu of investment options. The benefits of these accounts are many: automatic saving, potential tax benefits, access to professionally managed investment funds and, of course, the matching money from the employer.
If you are unsure if your employer offers such a plan, check with your Human Resources Department. They can also help you enroll in the plan if one is available. Also, once you enroll, it's wise to learn how the plan works so you can take full advantage of the benefits it offers. For example, determine how to maximize the matching amount and, if available, enroll in automatic deposit increases, which will help you save more without even trying.
Individual Retirement Accounts (IRAs)
An IRA is a personal retirement account and a good alternative if your employer doesn't offer a retirement plan. There are several different kinds of IRAs. One of the main differences between these accounts is whether you invest pre-tax or after-tax money.
With a traditional IRA you invest money that has not been subject to income taxes. You can deposit up to $6,000 annually into a traditional IRA before the age of 50 and up to $7,000 after age 50. If you make withdrawals before age 59 1⁄2, you will pay a penalty. At age 70 1⁄2 you must start taking required minimum distributions (RMDs) which are taxed as income.
With a Roth IRA you deposit money that has been taxed. You can deposit up to $6,000 annually before the age of 50 and up to $7,000 after age 50. There is a penalty for taking money out before age 59 1⁄2. After you reach age 70 1/2, there are no minimum distribution requirements and you do not pay income taxes on withdrawals. Roth IRAs do have income limits, meaning you could make too much money to qualify for one.
SIMPLE stands for “savings incentive match plan for employees." These accounts are for small-business owners and the self-employed. Employees invest pre-tax money and employers can choose whether to provide matching funds. The annual employee contribution limit is $13,000, but employees over 50 can make $3,000 annual catch-up contributions. There is a penalty for taking money out before age 59 1⁄2. At age 70 1⁄2, employees must start taking RMDs, which are taxed as income.
Designed for small businesses, with SIMPLE 401(k)s employees put some of their earnings into an account, and the employer then provides some matching funds. Employees can set aside up to $13,000 each year. If the employee is age 50 and over, they can make an additional annual “catch-up" contribution of $3,000. Like most retirement plans, there is a penalty for taking money out before age 59 1⁄2. Required minimum distributions (RMDs) start at age 70 1/2 and are taxed as income.
Annuities and Other Retirement Income Solutions
Fixed annuities are life insurance products you buy with a lump-sum payment. The annuity grows at a fixed rate. If you purchase a fixed annuity with pre-tax money, you will pay income taxes when you take money out. If you purchase one with after-tax money, you will only pay taxes on the earnings. There is a penalty for taking money out before age 59 1⁄2. Fixed annuities are often used to provide income for life.
With variable annuities you choose how your money is invested, and your earnings depend on how well those investments perform. You are not guaranteed a fixed rate of return, and you can lose some of your original investment. There is a penalty if you take money out before age 59 1⁄2. Variable annuities can provide income for life and even include a death benefit.
Lifetime Income Solutions
Most working Americans are eligible for social security when they retire, but it's not always enough to make ends meet. However, there are other ways to create a steady stream of income for life.
One of the most commonly used lifetime income solution is a Lifetime Annuity. You purchase this annuity with a lump sum, and you're paid a set amount for the rest of your life. Other lifetime income solutions include:
Laddered Bond Strategy – With this strategy, you invest in a number of bonds that mature at regular intervals, for example one year, two years and three years, giving you income as each bond matures.
Managed Payout Fund — These are mutual funds that provide a fixed level of income for a period of time, for example, 30 years. However, the income payments can change based on how the fund's investments perform.
Target Date Fund — These mutual funds earn interest and become more conservative as you get closer to retirement. Once you retire, you will receive regular income payments from the fund.
There are other retirement planning solutions that may suit your retirement needs. To learn more about important personal financial topics contact a BBVA Investments Financial Consultant or:
Learn more about personal financial topics by checking out the other stories in this series including:
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial consultant about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates.
Links to third party sites are provided for your convenience and do not constitute an endorsement. BBVA USA does not provide, is not responsible for, and does not guarantee the products, services or overall content available at third party sites. These sites may not have the same privacy, security or accessibility standards.
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