How You Should Really Save For Retirement

As Congress and the Bush Administration duke it out over Social Security's future, don't sit idly by and wait to control your retirement destiny. There are proactive alternatives to just collecting government checks in your golden years.

A personal Individual Retirement Account (IRA) lets you contribute up to $4,000 for the years 2005-2007 and $5000 a year starting in 2008. If you are 50 or above, this year it's $4,500, $5000 for 2006 and 2007, and $6000 in 2008. You direct how and where to invest your money.

The traditional IRA lets you deduct your contribution amount from your income each year therefore reducing the taxes you may owe. Money deposited into the account also grows tax-deferred, and compound growth can be substantial. Instead, you pay taxes when you withdraw the funds at retirement, including taxes due on the account's investment growth. This tax-advantaged account is based on the principle that your tax bracket may be lower in the future.
 
Conversely, the Roth IRA doesn't let you take the contribution amount off your taxes today. Rather, the Roth gives you tax-free withdrawals. Roth IRAs are very attractive for younger investors. Your investment account could grow considerably and your withdrawals, including the account's investment growth, would be tax-free. People who already have funds in a traditional IRA need to investigate what conversion costs would be -- having to pay taxes today on previously tax-sheltered contributions.

A personal IRA should be part of everyone's retirement planning. In addition, self-employed musicians, and those with incorporated companies should investigate three additional retirement options: SEP, SIMPLE, and Keogh plans.

SIMPLE SEP Steps
Simplified Employee Pension (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) are the most common retirement plans for businesses. A SEP is a good choice for sole-proprietors; SIMPLE plans are more suited to incorporated companies.

Both plans are easy to set up and administer and allow contributions of up to 25% of income with a 2005 total cap of $42,000 based on a $210,000 income maximum. I know, that math doesn't add up (see below). Like traditional personal IRAs, contributions are tax deductible with tax-deferred growth. The assets in either plan must be managed by a financial institution (bank, investment firm, etc.), but plan members have control over their account's specific investments.

A company must offer its SEP/SIMPLE plan to all employees and let them deduct the same percentage as the owner. The SIMPLE plan also lets the company match employee contributions. Since both plans are based on income, the deductible amount can vary from year to year. When you have an especially strong earnings year, contribute more. If times are tough, scale back.

You, too, can learn math the exciting IRS way

For SEP, SIMPLE, and Keogh plans the maximum allowable contribution is 25% of income, however the math is a somewhat convoluted. Essentially, you can contribute the percentage of your income only after you reduce your income by that same percentage amount. Huh? First, determine your business profits (net after paying self-employment taxes). Second, divide that number by 1 plus the percentage you want to contribute (e.g. 1.25). Finally, multiple the answer to the second step by the percentage you want to take. The final figure is your contribution amount. For example: 100,000 / 1.25 = 80,000 x .25 = $20,000.

Keogh dough

Another retirement option for sole-proprietors and partnerships (but not incorporated businesses) is the Keogh plan. Again, this plan is tax-advantaged (deduct now, defer growth, and pay taxes later), but may be set up in several ways. A defined-benefit plan pays a fixed benefit amount to retirees. The profit-sharing model is similar to the SIMPLE plan with employer-matched contributions. The money purchase Keogh plan requires establishing a contribution percentage and sticking to it every year with strong penalties for non-compliance. Keogh plans require more work to set-up and run and therefore require the help of a professional pension manager.

Quick and easy retirement planning

If you'd invested $10,000 at 8% growth when you turned 21, by 65 you'd have a whopping $295,559 without having contributed another penny to the account. Of course, if you contribute more throughout your working life, the amount you save could be significant. If new parents placed a single investment of $10,000 at 8% annual growth at birth, their son or daughter would be a millionaire at retirement without ever contributing to the account again. You kind of wish the US government would encourage such a practice, wouldn't you?

Get started right now!

Whether you choose a SEP, SIMPLE, or Keogh retirement plan, you can save a substantial amount of your earnings (at far higher levels than personal IRAs and light-years beyond what's proposed for Social Security personal investment accounts), direct the growth options to maximize your investment, and then retire on your own tidy little nest egg. What are you waiting for, eh?