Are you ready for your retirement? Your one-stop prepare-to-retire plan

There are many options available on how to be financially secure during retirement. It can be quite a challenge to narrow down these options and select the best one suited for an individual. Present situations and future plans differ from one individual to another.

One way to start off the planning process is by asking the following set of questions:

  • How long can I expect my retirement period to be? The estimated length of time will impact your plan for the period.
  • What will my lifestyle be during my retirement? If you plan to travel, do volunteer work, or have a part-time job you need to consider these as well.
  • How much do I need to prepare? Do you need an 80 percent equivalent of what you earn today or do you need 100 percent? Consider where your expenses will be going.
  • Where will I draw my retirement income? To meet your future needs you need to know what your future sources of income will be.

The foregoing questions share a common concern for would-be retirees or those simply planning ahead - that is, income in the future. Let us take a look at the available options and see how they can fit your situation.

Social security

A report from the U.S. Social Security Administration indicates that for most Americans aged 65 and above, the largest source of income is their SS retirement benefits. A survey conducted by Gallup also shows that among current workers, 34 percent expect to fund their retirement largely with their Social Security benefits.

Now, would social security alone be enough for you? Based on 2010 figures, the average payout per month was $1,176.

Social Security Retirement Benefits
Pros Cons
  • SS retirement benefits are more advantageous to who belong to the lower earning brackets, as their benefits are relatively higher.
  • To some people (those who have worked in a job covered by Social Security for about ten years), they can receive benefits as early as the age of sixty-two.
  • If an individual retires at a later age, his benefits will be higher.
  • Family members may also get benefits based on the individual's earnings record.
  • The amount that one will get will be based upon earnings made over their working career. If an individual did not earn anything or had low earnings over certain years, the benefit amount could be lower.
  • If an individual retires early, he will receive less. Those who have paid into the SS system for a minimum of ten years can start getting their benefits by the first full month after the age of sixty-two. However, getting these benefits at this early age will mean lesser amounts - between twenty to thirty percent less.
  • In certain situations, an individual may have to pay taxes on his SS earnings. A retiree who also earns from interest, dividends, salary from a part-time job could be required to pay taxes on his benefits. This is dependent on his "provisional income" which covers tax-exempt interest plus adjusted gross income, plus fifty percent of his SS benefits. Individuals who are single, who declare their provisional income to be over $25,000 may have to pay taxes on their SS benefits. The same is true for married couples filing jointly who are over the $32,000 provisional income threshold for married couples.

How to maximize SS retirement benefits:

  • Work for a minimum of thirty five years. SS retirement benefits are arrived at using a 35 year time period where the individual earns the most.
  • Increase your income. In doing so, one also increases SS retirement benefits.
  • Claim SS benefits during full retirement age. If benefits are claimed earlier, the amount received will be less.
  • Delay making claims until seventy years old. Each year delayed adds an additional eight percent to the benefits to be received.
  • Claim spousal benefits. Couples who are married can claim higher benefits by taking advantage of one spouse's work record or the benefit of the one who earns higher of the two.
  • Claim twice. Couples who are dual-earners and have attained full retirement age may benefit more by claiming spousal benefits and then later change to benefits that are paid based upon their work record.
  • Include the family. Those with children who are dependents can claim SS benefits for each. To qualify, children would have to 19 or under, single, or have a disability. Each qualified child may get up to half your retirement benefit.
  • Make a claim on a former spouse's work record. Those who were married for a minimum of ten years and later divorced, they can claim SS benefits on the basis of the former spouse's work record.
  • Avoid earning too much when you are retired. Working while claiming SS retirement benefits can have its downsides - some of the benefits will be withheld if the earnings are too much. For those who are under the full retirement age and are earning over $14,640, the U.S. Social Security Administration will deduct a dollar from the benefits for every two dollars earned above $14,640. Upon reaching full retirement age, the limit increases to $38,880 while the goes down to a dollar withheld for every three dollars earned over the limit.

For further information about Social Security retirement benefits, check out http://www.ssa.gov/retirement/. The site provides, among others, a retirement estimator, information on when and how to apply, and other things to consider.

Retirement Accounts

Another very popular source of retirement funds are known collectively as "retirement accounts." In this group include individual retirement accounts or IRAs, simple IRAs, 401(k)s, as well as multiple retirement accounts. Let us have a look at each one of these. The following tables highlight the pros and cons of each type.

IRA

Traditional Individual Retirement Accounts (IRAs)
Pros Cons
  • Allows an individual to make contributions to the account without the effect of having any taxes taken out. Because of this, an individual's pretax income gets lowered, and, under certain conditions, may place them in a lower tax bracket. What is earned from the investments is also not subject to tax until the time the money is taken out during retirement.
  • Another advantage is the multiple investment choices. Among these include commodities, real estate, precious metals and foreign currencies. In contrast, money placed in a 401(k) has only a few number of mutual funds along with basic bonds and stocks to invest in.
  • One downside of this type of retirement account is the low limits on contribution. As of 2012, the maximum one can contribute each year is $5,000. Those who are fifty years old and above, are allowed $6,000. In contrast, 401(k) accounts have a maximum of $16,500 per annum.
  • Another downside has to do with withdrawals. This account may not have its contributions subject to tax. However, money taken out will always be subject to taxation.

How to maximize traditional IRA:

  • Start early. Young individuals are allowed to contribute to a traditional IRA. The sooner one starts the more time the money is allowed to compound.
  • Plan out your investments. By planning, one has better chances of maximizing his potential returns and tax benefits.
  • Convert a portion or all of the account into a Roth IRA which offers the advantage of not having to follow the required minimum distributions at any age.
  • Choose the right option when it comes to beneficiaries. This can stretch out the value of the IRA. For example, when a spouse is the named beneficiary and the individual with the traditional IRA dies, his IRA may be rolled into the IRA of his surviving spouse. If a spouse cannot be named, a child or grandchild can be the designated beneficiary.

Roth IRA

ROTH IRA
Pros Cons
  • More options where to invest unlike 401(k)s
  • Allows individuals to make contributions up until the tax date of the next year.
  • Withdrawals can be made at any time with no consequence of penalty or tax.
  • Cheap to open one. Some companies allow an individual to start one for as cheap as $50.
  • No limit on age, even children are allowed to have one as long as they have income and their parents are under certain income levels.
  • Many companies offer them.
  • An individual may have his tax bracket changed. Those who occupy a higher bracket now than when he be during retirement may find the traditional IRA to be more advantageous. Those who occupy the lower bracket at present, the Roth IRA would be more beneficial.
  • There are income limitations.
  • An individual may miss out on certain tax benefits.
  • Certain limits apply to yearly contributions as well as to income for those who wish to participate.

How to maximize Roth IRA:

  • Be in control. Do not put control over your investment in the hands of a money manager especially one you do not know. If you do, you may give someone who has an appetite for excessive risk to gamble your money away. Ultimately, if you decide to manage your investments, you will need to conduct extensive research and have a good understanding of the risks involved.
  • Bring down your investment costs. Because there is a yearly limit to how much you can put into your Roth IRA, you need to keep your investment costs down to a minimal. For instance, for many individuals the contribution is limited to $5,000. If an individual pays $50 a year for investment costs, this is equal to 1 percent of the yearly contribution. Over time, this can be a significant expense.
  • Bring down investment cost by bringing down operating and transaction expenses. These are the two ways you can lower your expenses.

401(k)

401(k)
Pros Cons
  • Taxes are deferred; contribution can be taken out without having to pay taxes.
  • The individual has the choice as to how much he wants to contribute. His employer may match this with its own amount eventually helping the account to grow.
  • Benefit of payroll deductions. Majority of the companies allow contributions via payroll deductions.
  • Has no bearing on Social Security. This allows a 401k account to supplement SS benefits.
  • Protection from bankruptcy. In case the employer files for bankruptcy, the individual's money is protected as it is held in trust by a third party.
  • Possibility of getting a loan against the account. This is very handy in the event of an emergency.
  • While the ability to borrow against the account may be an advantage, it may prove to be risky too as failure to repay will result to a hefty penalty and the possibility of forfeiting the remainder of the account.
  • The possibility of losing money is there. Since the account is market driven, there is a chance of losing money.
  • Payout may be limited. To minimize possibility of a loss, many people spread out their investment. This, however, also puts a limit on the return on investments.
  • Limitations by employers. There are employers who limit the amount of contributions or may not want to match an individual's contributions.

How to get the most out of your 401(k):

  • Target your maximum allowable contribution in a year. See how much it would take you to set aside money each month by dividing the maximum amount into twelve. This may require you to budget your finances well or aim to supplement your income so you can meet the needed amount.
  • Make the most out of an employer's match. Under certain conditions an employer will match dollar for dollar what an individual contributes. By not taking advantage of this, an individual is not optimizing his account.
  • Keep an eye on investment costs. A high ratio between expenses and amount of assets managed is not good.
  • Move your 401(k) with you. If you are under a new employer, you should roll the old 401(k) into the one offered by the new company.
  • Do not cash out earlier than you need to. There are temptations to do this especially if your finances are tight. However, if a withdrawal is made before an individual reaches 59½ years old, there is a likely penalty of ten percent plus taxes.

Simple IRA

SIMPLE IRA
Pros Cons
  • A Simple IRA allows for a larger contribution compared to a Traditional IRA. Up to $11,500 a year may be allowed compared to the $5,000 on a Traditional IRA.
  • Maintenance is easy.
  • Year-end tax statements are complete as well as easy to understand.
  • No large fees involved.
  • Employer also benefits because of a tax deduction.
  • Only limited to small companies. SIMPLE IRAs are only available to employers with less than a hundred employees.
  • Hefty penalty. For those who take out their money, there is a penalty of up to twenty five percent.

How to get the most out of a SIMPLE IRA:

  • An individual has to maintain tax deductibility on a SIMPLE IRA. Taking money out of an account means you get subject to tax deductions.
  • As income on the job grows, an individual has to increase his contributions to be able to get the most out of a SIMPLE IRA.

Roth 401(k)

ROTH 401(k)
Pros Cons
  • No taxes to be paid on withdrawals. This would make sense to those who think taxes will be higher when they retire.
  • Withdrawals made against a Roth 401(k) are not counted towards Social Security benefits.
  • No mandatory withdrawals for those who have reached the seventy years old and a half.
  • Employers have no financial incentive to offer this retirement account. Because of this, a comparatively smaller number of employers offer a Roth 401(k).
  • No tax deductions for the current year, which means the any tax-related benefits, will have to wait.
  • For those who are first-time homebuyers, they are not allowed to use this as a reason to use their Roth 401k.

How to maximize a Roth 401(k):

To get the most out of this type of retirement account, an individual should ask the following questions:

  • What will be the marginal rate on taxes during his retirement? If he thinks the rate will be higher during that time then a Roth 401k could be a good option.
  • Is the individual's current income greater than the limit on a Roth IRA? There are restrictions on income on a Roth IRA which are not found on a Roth 401(k).
  • Where will he spend his retirement? Will it be in a state with a high rate of income tax? Check out how state taxes will have an impact on both a Roth IRA and a Roth IRA 401(k). In a state with a high tax rate, an individual might forgo the benefits of tax-exempt contributions.

Certificates of Deposits and Savings Accounts

According to the Gallup poll results, thirteen percent of current retirees use these as source of their retirement fund. It also reports that twenty two percent of current workers look forward to using these options as their retirement fund.

Certificates of Deposits
Pros Cons
  • Regarded as a safe retirement account especially if an individual does not need the money right away and does not want it to be exposed to too much risk.
  • Certificates of Deposits are insured by the Federal Deposit Insurance Corporation.
  • Available with fixed as well as variable interest rates.
  • They can be bought from banks or from brokers or brokerage companies.
  • Higher interest rate than with savings accounts.
  • Danger of inflation. Generally, interest rate on CDs get outpaced by the inflation rate. This is bad news for those who plan their retirement early.
  • Danger of being stuck on a low rate with a long term certificate of deposit. This is especially disadvantageous when interest rates on the market are on a hike.
  • CDs are deemed as wealth preservation account rather than a wealth-building account.

How to maximize the use of CDs as retirement accounts:

  • Use the laddering approach to take advantage of the best rates available. Laddering is when the maturity dates of a number of certificates are staggered. This allows some of the money available to be used for the current best rate.
  • Use the barbell approach. Here, half of the money is put into long-term certificates and the rest in short term certificates. This helps you deal with rate drops while also allowing you to benefit from increasing rates in the short term.
  • Close out a long-term certificate when the market interest rate is high. Confirm this first if the penalty is worth paying to get the benefit of a high rate.
  • Look for the best offer. Institutions compete to get clients so they usually try to outdo each other by offering the best rates.
Savings Accounts
Pros Cons
  • Anyone can open an account. No requirements related to income and employment.
  • Opening an SA is simple and easy.
  • With most banks, fees are low and these may be waived if the individual meets certain saving thresholds.
  • Money remains safe, accessible and secure.
  • Low return rate. USA Today reported in 2011 that the average SA return rate is under one percent.
  • Even though online banks have better rates than their brick-and-mortar counterparts, compared to a 401(k) the rate is still very low.

How to get the most out of a savings account for retirement purposes:

  • Keep a record of your monthly expenses. In this manner you get to find out areas where you can save money to put into your SA aside from revealing to you areas where you make needless expenses.
  • Set up automatic deposits to your savings account. This is what observers call an autopilot savings account. Once you get your salary, a portion is automatically saved or deposited in a saving account.

Stocks and Stock Mutual Funds

Figures provided by Gallup indicate that only twenty percent of workers look favorably toward stocks and stock mutual funds as a major part of their retirement fund. The same source says that an estimated fourteen percent of current retirees expect to use these as their source of funds for their retirement expenses.

Stocks
Pros Cons
  • Stocks have the potential to provide high returns in comparison with other long-term investment types.
  • Certain stocks pay investors dividends. This can offset a drop in the stock's share price and also provide an additional source of income to a retiree.
  • Prices of stocks are known for its dramatic rise and fall.
  • Does not provide a guarantee on the returns.

How to make the most out of stocks investment for retirement:

  • Put your money on stocks you know. This would require extensive research on your part about the stock and others which come from the same industry.
  • Track dividends. There are those who prefer the stability and comfort of stocks which pay out dividends. By knowing how to track a stock's dividends you get to know how you can get the most out of it come retirement time.
  • Develop your own investment rules. For a start, consider Warren Buffet's strategy of looking for investments that produce and deliver.
  • Diversify your investments. Putting all your eggs in one basket would be very risky.
  • Stay disciplined. The stock market is known for its wild swings. You need a lot of discipline to keep yourself from getting caught up in all the frenzy.
Stock Mutual Funds
Pros Cons
  • Allows for diversification with one purchase which spreads the amount of risk involved.
  • Highly liquid. Can be purchased or sold on any day in the market.
  • Easy and simple. Any investor can purchase with little money unlike stocks and bonds.
  • Available for purchase online or via advisers or brokers.
  • The costs involved can be a drag on returns.
  • Having a fund manager does not provide a guarantee against losses.

Home Equity

This used to be a more popular choice for those who plan for their retirement.

Back in 2007, 30 percent of Americans thought about using the equity they have built up in their homes as a source for a retirement fund. Today, only 20 percent are thinking about this option.

There are basically three ways of taking advantage of home equity for retirement purposes: by downsizing (selling the home and get a cheaper, smaller one), reverse mortgages, and home equity loans.

Home Equity
Pros Cons

For those who downsize, they may be able to generate sufficient cash. Downsizing can also result to some tax benefits as well as be able to eliminate a mortgage.

Those who opt to get a reverse mortgage may be able to enjoy the following advantages:

  • They may remain in the house and retain ownership over it.
  • May be able to generate substantial amount.
  • Interest rate may be lower compared to home equity mortgages.
  • May be able to enjoy tax benefits.
  • No payments made while still residing in the property.
  • Accumulated interest will not yet be paid until the home is vacated or is sold off.
  • The amount owed is not more than the home's value.

For those considering a home equity loan:

  • They can still use the home as residence.
  • They can still take advantage of the appreciation of the home's value.
  • Interest paid on the loan may be tax deductible.
  • Possible low closing costs.

Downsizing may have an emotional impact on the family.

Reverse mortgages:

  • Tend to be complicated loans.
  • Upfront expenses can be high.
  • Interest cost tend to be higher compared to home equity loans.
  • Homeowner will still be responsible for property taxes, insurance, home maintenance.

For home equity loans:

  • Not all individuals can qualify because of credit and income requirements.
  • Homeowner will still be responsible for property taxes, insurance, home maintenance.
  • Additional financial burden.
  • Danger of declining home value.

Should you consider homeowner's equity as a source of retirement fund:

  • Majority of financial experts tend to agree that tapping homeowner's equity should be the last option in retirement.
  • There is wisdom in this advice, that any individual would need a place to reside especially when they retire.
  • If you use the equity in your home to purchase a cheaper place to stay, the money left may not be enough for retirement expenses.
  • Also, getting a home equity loan may not make sense to retirees with limited income as they would be required to make loan repayments.

Part-Time Work

In Gallup's survey, 18 percent of the respondents said they would be taking up jobs when they retire. This is an increase from 2001 where only ten percent of the respondents looked forward to working in retirement.

Part-Time Work
Pros Cons
  • Keeps the individual mentally and physically active.
  • Provides extra income during retirement.
  • May allow Social Security, pension funds further growth
  • May allow access to company's retirement and health insurance benefits.
  • Opportunity to work on selected hours.
  • Working may be a strain to people of old age.
  • May encounter difficulty in finding a suitable job.
  • To qualify for company benefits may require more working hours.
  • Certain pension funds may be compromised.
  • SS benefits may be taxed.
  • May not allow full enjoyment of a retired life.

Should I consider working after retirement?

  • Many experts think the answer to this would eventually depend on the individual. They also agree that those who work because they want to get enjoyment at this stage unlike those who work because they have to.
  • Those who have to work because of their limited funds should look at ways of increasing their savings and also find ways to live within a tight budget.
  • Also, working in retirement may have an impact on SS benefits. Those who wish to defer these may enjoy higher benefits in the future.

Inheritance

Nine percent of Americans expect to inherit a significant amount of assets according to Gallup. Currently about three percent say they are using inherited wealth to pay for retirement expenses.

Inheritance
Pros Cons
  • "Free" money, properties or assets.
  • You need not work for it.
  • Can be used for anything.
  • If the inheritance is considerable, you may be expected to be responsible in using it.
  • Large ones are subject to tax.
  • The one who left it may have some conditions on its use.
  • May lead to stress.

How to make use of inheritance for retirement and other purposes:

  • While you can use it for retirement purposes, receiving a considerable amount of inherited assets will still require general planning of its use.
  • While you are still deciding on what to do with the assets, you have to place it in an account that is accessible and interest-bearing.
  • Get trusted, professional advice on how to deal with taxes.
  • Aside from your retirement needs, you may have some debts, e.g. home mortgage, credit card, personal loans, etc. which can be paid off.
  • Portion of the inheritance should be set aside for emergencies.
  • If the inheritance is a property, make sure you have the proper insurance to cover it. You should consider getting professional advice on building a long-term plan for the property.
  • For retirement needs, you may consider setting up an annuity on which you can get income on a monthly basis.
  • If you currently have retirement accounts, see how your inheritance will complement these.
  • You also need to plan out how you leave what you have inherited to your own children; this means planning about taxes, distribution, your expectations from them, etc.

Annuities or Insurance

Survey results indicate that around eight percent of current workers along with retirees say that annuities form a major part of their retirement plan.

To learn more about this option go to our comprehensive guide Annuities explained from A to Z, where we discuss all types of annuities with their pros and cons, how they are taxed, how to shop for one, some important riders and features and more.

Some experts advise to approach these products with caution. They suggest reviewing thoroughly on what the fine print provides.

Annuities or Insurance
Pros Cons
  • Income for up to a lifetime.
  • The older the retiree gets, the larger is his regular payments.
  • Protection against inflation. Annuities can be set up to be at pace with rising cost of living.
  • Protection of principal. The money received will be equal to or more than the amount used to purchase the annuity.
  • Tax efficient. Only income derived from the annuity is subject to tax.
  • Certain annuities are not favorably viewed by many consumers.
  • Returns on investment are low. This is in comparison with other products like stocks.
  • Inflexible. Does not afford the individual access to his money.

How to select an annuity for retirement:

  • Compute how much your payout will be. Compare your monthly annuity income with the total amount you will invest.
  • Check the company's financial strength. Look at how they are rated by Fitch Ratings or A.M. Best.
  • Check how the returns are arrived at. Especially look at the fees and related expenses.
  • When it comes to fees, go with annuities that have charges that do not go beyond 2 percent.
  • Consider one that offers a death benefit.
  • Compare surrender fees. You may be charged a fee for canceling an annuity and withdrawing your savings.
  • Include low-fee annuities in your shopping list. Many companies charge fees that costs only 2 percent.

Rent and Royalties

According to the Gallup results, six percent of those currently working look forward to using money earned from rental properties or from royalty payments as their retirement fund. Currently, about five percent of retirees get their retirement income from these sources.

Rent
Pros Cons
  • Monthly income.
  • Certain tax advantages (for example, depreciation).
  • Increasing income over time.
  • Can be used to cover mortgage expenses.
  • Regular expenses on property upkeep
  • Deadbeat renters
  • Risk of vacant units
  • Asset is illiquid, that is, not readily convertible to cash.

How to maximize rental income for retirement purposes

  • Reduce the times the property is vacant. One key step is to keep it always ready. Deal with repairs and cleaning requirements immediately.
  • Rent should follow the market conditions. Look at how much is the rent for similar properties in the community.
  • Security deposits should also follow market prices.
  • Screen your tenants. Look at their employment, credit, rental histories. This way you avoid deadbeat renters.
  • Advertise your property.
  • Take advantage of tax breaks on repairs and expenses.
  • Reinvest what you earn.
Royalties
Pros Cons
  • Passive income.
  • May bring in higher returns compared to other traditional investment vehicles like stocks.
  • If derived from natural resources such as oil and gas, royalties may be a finite prospect. When income from oil and gas dries up, the royalty payments will come to a stop.

How to invest in royalties:

  • Select a commodity that you expect to appreciate some time in the future. For example, you anticipate crude oil prices to rise consider then in investing in this commodity.
  • Get the help of a trusted commodities expert to help you identify firms that trade in the commodity you are interested in.
  • Study the different sites that each firm produce the commodities. Look at a site's record of production. This enables you to assess the level of risk involved per site.
  • Get in touch with the companies and ask them about royalties. Usually, rates are set at which the firm allows investors to participate. Not all will be willing to negotiate. However, if you search long enough you will come across willing firms.
  • Before you sign any contract to purchase royalties, consult a trusted lawyer who has experience in this field. Read the contract thoroughly before you sign it.
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