written by Ellen Freudenheim, MPH
If at age 45 or 55, you’re still not sure what to do with that cash under your mattress—or your bonus, or Aunt Zoe’s inheritance—here are two basic, mandatory lessons. First, put as much money away as you can in a retirement account if you are still employed. Second, diversify your holdings.
Of course it’s hard to save money—for some people, nearly impossible. But for Boomers, saving for the future is imperative. Putting money away for retirement is a now-or-never proposition (unless you are rolling in dough) so resist the temptation to over-consume. If you are still fully or part-time employed, sock some savings away.
(NOTE! If you’re a person who needs a reason not to spend every last penny—or needs to be tied up in telephone cords to keep yourself away from the mall sales—then perhaps it’s time to reconsider your addiction to spending. You could take the path of reason and calculate how much you can save in taxes by squirreling away money now in retirement plans, especially if you invest up to the legal limits. Or, you could take the path of least resistance, and just set up an automatic transfer from your checking account into a mutual fund, for instance. If you don’t see it, maybe you won’t spend it.)
Places to Stash Cash for the Future
You can put money away for retirement in three different investment vehicles:
401(k)s: Most 401(k) plans (if you work for a not-for-profit, your plan might be called a 403(b), but they’re essentially the same) let you put away pre-tax dollars in an account that grows tax free until you start making withdrawals in retirement. Many such plans also offer a company match, an especially sweet deal for you.
IRAs : Though an IRA is an important part of your investment plan, you should always contribute to a 401(k) plan first. Why? Because the contribution amounts are higher for most 401(k)s. Still, an IRA is worth having. Traditional IRAs let you contribute up to $4,000 a year for tax year 2007 if you make the contribution by April 15, 2008. Those who are at least 50 years old may make “catch-up” contributions of up to $1,000 to accelerate the accumulation of assets in their IRAs. Depending on your income and whether you participate in an employer’s retirement plan, your contribution may be tax-deductible in part or in full. Contributions can be made to traditional IRAs up to the year you turn 70½, at which time you must start to withdraw a required minimum distribution from the account.
A Roth IRA is best for most people because while you put in after-tax dollars, your investment grows tax-free and withdrawals in retirement are also tax-free. (Check out the income limits for contributors to Roth IRAs. If your income is above these fairly high limits, then a regular IRA is your best option.)
SEPs and Keoghs: If you’re self-employed—whether or not you have employees—you’ll likely set up a Simplified Employee Plan IRAs (SEP IRAs) or Keoghs plan that let you squirrel away retirement assets in pre-tax dollars. Like a 401(k), these investments grow tax-free until withdrawal, but contribution limits are much higher than 401(k) plans.
Can You Afford to Follow Your Dream?
How much do you need before you’re sufficiently secure financially to launch that new business venture, move to Argentina to learn Spanish, or start a non-profit organization that deals with an issue close to your heart?
One rule of thumb says that you should have a sufficiently large nest egg so that you can withdraw four percent of it annually and provide for all of your needs. Adjust this figure for inflation each year (check the current Consumer Price Index for that number), stay within that four percent guideline, and you have almost a good chance of not running out of money– if your expenses (including health care) stay stable.
To get a sense of whether you have sufficient income to maintain your current lifestyle, use any of the online financial planning calculators. (Most of the large financial service firms offer them.) For instance, T Rowe Price has an online calculator that takes into consideration factors such as your age, how long you plan to be out of the workforce, your marital status, your assets, how you are currently invested in terms of cash, bonds, and stocks, how much money you need to live on monthly, and so on. In fact, you can plug in your numbers to a few different calculators to see a range of scenarios, because each company has a slightly unique formula, based on economic assumptions, for assessing an individual situation.
Of course if you want to start a business or non profit organization that requires you to stake your own money, factor that in just as you would if you planned to take up pricey hobbies like travel or golf that aren’t currently in your budget.
Investing Still Key
Of course you have to manage expenses, but experts stress that it’s important to have a mix of different investments—in stocks, bonds, cash, and real estate.
In terms of what to invest in, you have to know yourself—and how much risk you can tolerate. Recent rumblings in the sub-prime lending business and the ripple effect that’s brought real estate prices down prove the point that all investments carry some risk. Conservative investors won’t make as much as the market when stocks start to zoom, but they can sleep at night when the Dow Jones drops. If you’re a moderate risk taker where your money is concerned, then you’ll want a plan that has some risk but not enough to give you ulcers. If you’re a high stakes gambler, know thyself (and thy spouse, too, if you want to stay married); just how much can you afford to lose? A good bet is to take the long view: invest wisely, don’t drive yourself to distraction by checking how you are doing every day (or twice a day) and stay the course.