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An Introduction to Retirement Planning
By Jay Falk

In order to maintain your standard of living throughout your retirement, you will need to plan ahead. With an increase in average longevity, retirement periods of 20 or 25 years will be common, so planning ahead is essential.

In addition to personal assets that you may have, there are essentially three sources of retirement income: 1.) personal retirement accounts - such as Traditional IRA and Roth IRA accounts, 2.) employer sponsored plans - such as 401k and 403b plans, and 3.) Social Security. Typically, no single source of income can maintain your current standard of living throughout your retirement. It is, therefore, important to understand your options for maximizing your retirement nest egg and income.

Over the last two decades there has been a gradual trend away from large defined benefit retirement plans to defined contribution plans(e.g. 401k) and a variety of IRA accounts. The result, in part, has been a transfer of investment responsibility from the plan sponsor to the individual. Consequently, it is now more important than ever for individuals to take charge of their retirement planning and investment decisions.

Strategies for Retirement Planning

1.) Start saving for retirement as early as possible.

The sooner you start saving for your retirement, the more compounding will work for you. Compounding is the result of your returns being reinvested year after year. The graph below shows the compounding of an initial $2000 investment at 9% taxable return (assuming a 28% federal tax rate).

This graph illustrates the power of compounding, with a $2,000 investment growing to over $13,000 in 30 years and to nearly $25,000 in 40 years.

2.) Contribute to your retirement regularly.

You can build a substantial nest egg by contributing to your retirement account each year. The graph below shows the growth of an annual contribution of $2000 at a 9% taxable return (assuming a 28% federal tax rate).

Making annual contributions can have a profound affect on the ultimate value of your retirement account. Investors that start saving early for their retirement and contribute regularly are rewarded over time. For example, after 30 years, an account with an annual contribution of $2000 can grow to over $170,000 - and at 40 years, over $350,000.

3.) Take advantage of tax free retirement accounts.

To maximize your retirement, take advantage of tax deferred retirement accounts. These accounts offer substantial tax advantages. The graph below compares the growth of an annual contribution of $2000 using a taxable and tax deferred return of 9%.

The difference in growth between a taxable account (at 28%) and tax deferred retirement account is dramatic. After 20 years, an investor making annual deposits of $2,000 would have accumulated about $77,000 in a taxable account. During that same time, the tax deferred retirement account would have grown to $124,000 - or 60% more than the taxable account. After 30 or 40 years, the difference is even greater.

The bottom line for successful retirement planning: start saving early, make regular contributions, and take advantage of tax deferred retirement accounts.

Overview of IRA Options

Individuals may, depending on their particular circumstances, participate one or more of the following types of retirement accounts: Traditional Individual Retirement Account (IRA), Roth IRA, Simple IRA, and SEP-IRA. Although each type of retirement account has different requirements, in each case your investments can grow tax deferred. Below is a brief description of each of the different IRA accounts. Please note that this information is strictly educational and is not intended as investment or tax advice. Consult with the appropriate professionals before making any decisions.

Traditional IRA

Maximum contribution: Up to $2,000 annually.
Contribution Requirements: Annual contributions are not required. Contributions are fully tax deductible if 1.)your adjusted gross income is less than $30,000 if you are single or $50,000 if your are married and filing jointly or 2.) if you are not enrolled in an employer sponsored retirement plan. Non-deductible contributions may be made regardless of your income level.
Eligibility Requirements: You must be under the age of 70 and have employment income.
Contribution deadlines: April 15th
Filing requirements: IRS filings are not required.
Withdrawals and Distribution Distributions may begin as early as 59 and must begin by age 70 . Withdrawals before age 59 are subject to a 10% penalty , except for qualified higher education expenses or a qualified home purchase of up to $10,000.

Roth IRA

Maximum contribution: Up to $2,000 annually.
Contribution Requirements: Contributions are not tax deductible, however, all income and capital gains are not taxable for qualified withdrawals.
Eligibility Requirements: You must have an adjusted gross income of less than $110,000 if you are single or $160,000 if you are married , filing jointly. Eligibility phase outs begin at $95,000 and $150,000, respectively. There are no age limitations.
Contribution deadlines: April 15th
Filing requirements: IRS filings are not required
Distributions and Withdrawals Distributions are not required at anytime. Withdrawals of principal can be made at anytime free of taxes or penalties. Withdrawals of earnings can be made without taxes or penalties if 1.) the account has been open for a minimum of 5 years and 2.) you are at least 59 or 3.) upon death or disability or 4.) for a qualified home purchase.

Simple IRA (for employees or self-employed)

Maximum contribution: Employees may contribute up to $6000 each year of earned income. Employer may 1.) match employee contributions up to 3% of compensation or 2.) contribute up to 2% regardless if the employee contributes or 3.) may elect to contribute 1% in any 2 years in 5 consecutive years.
Contribution Requirements: Contributions are required. All contributions must be same percentage for all eligible employees.
Max. Employee Eligibility Requirements: Must earn a minimum of $5,000 during the year and have earned at least $5,000 during any previous 2 years.
Contribution deadlines: Contributions must be made during the calendar year.
Filing requirements: No annual IRS filings are required. An IRA application and Adoption Agreement must be completed. W-2 must also be issued annually.

SEP IRA (for employees or self-employed)

Maximum contribution: 15% of compensation or $24,000, which ever is less.
Contribution Requirements: Contributions are not required. All contributions must be same percentage for all eligible employees.
Max. Employee Eligibility Requirements: Must be 21 years old and have worked for the company for 3 of the last 5 years and earned at least $400(adjusted annually).
Contribution deadlines: Contributions must be made during the calendar year.
Filing requirements: No annual IRS filings are required. An IRA application and Form 5305-SEP must be completed. W-2 must also be issued annually

Social Security

No discussion of retirement planning would be complete without mentioning Social Security. The Social Security system was established in the 1930s as a supplemental source of retirement income. It has since become one of largest items in our federal budget.

There has been much press coverage of the Social Security system in recent years. Weve all heard about the current social security "surplus" - the result of more receipts than payments. At the same time, we have also heard about projected shortfalls in the Social Security system, beginning around 2016 or 2018.

Full Social Security benefits are currently available at age 65, while reduced benefits are available at age 62. However, if you were born in 1960 or later you will have to wait until age 67 to receive your full benefit and age 65 for reduced benefits. To ease the expected shortfall, there has been discussion of further increasing the age to as much as age 70. Congress will ultimately make this decision - so stay tuned.

Although future changes to Social Security are unclear at this time, one thing remains certain: Social Security is only a supplement to your retirement income - not a replacement. For retirement planning purposes, you can contact the Social Security Administration to obtain an estimate of the benefits that you may be entitled to receive. This can be easily done by ordering a Personal Earnings and Benefit Estimate Statement (PEBES) at the Social Security Administration web site. Your statement will be sent to you in 2-3 weeks via snail mail. For additional information regarding Social Security, visit the Social Security Administration home page at www.ssa.gov.

Jay Falk is the founder and President of SocialFunds.com, a personal finance site dedicated to socially responsible investing.

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