Fresh Ideas for Retiring Rich
These seven bold strategies can help you supercharge your savings and realize your dreams.
By Mary Beth Franklin, Senior Editor
From Kiplinger's Personal Finance magazine, October 2005
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America is on the verge of a retirement revolution. The oldest of the baby-boomers -- the 76 million Americans born between 1946 and 1964 -- are turning 59½, the magic milestone when they can start tapping their retirement accounts penalty-free. In just three more years, the same advance team will be eligible to take early benefits from social security.
But just because they can pack it in doesn't mean that they should. In case you've missed the great national debate, social security alone can't guarantee you a smooth transition to living without a salary.
The stark reality is that to live comfortably in retirement -- whatever that means to you -- you must have your own resources. And given longer life expectancies, your savings may have to last 20 years or more. If you're years away from your retirement party, start planning now. But even if you're nearly ready to give up your parking space, it's not too late to catch up. To get you going, we offer seven approaches to amassing a big bundle, several of which should be new to you. Now that you know what they are, use them to secure your own future.
Save tax-free
1. Beginning in January, employers may offer a new retirement-savings account, the Roth 401(k). Like the more-familiar Roth IRA, it provides no up-front tax deduction, so your contributions won't reduce your current taxable income. But all the money you withdraw in retirement -- both contributions and earnings -- is tax-free as long as the funds have been in the account for at least five years and the account owner is at least 59½ years old. That means every dime will be yours to spend at a time when you may need the money most, unhampered by taxes that whittle away at most other retirement savings.
The Roth 401(k) offers two big pluses over the Roth IRA: higher contribution ceilings and no income limits. "The Roth IRA is the holy grail of retirement accounts, but we never started one because our income was right on the edge," says Trip Leonard, 34, a stay-at-home dad and self-described personal-finance geek who hosts his own Internet blog on the subject (visit www.musingmoney.com). "I don't mind paying taxes now if it means tax-free income in retirement."
Workers are barred from contributing to a Roth IRA once their income tops $110,000 for individuals and $160,000 for married couples. But, for the first time, high earners will be able to take advantage of tax-free retirement savings because the Roth 401(k) has no income limits -- although anti-discrimination rules that sometimes limit contributions to 401(k) accounts by highly compensated employees (those who earn $95,000 a year or more) will apply.
Trip's wife, Stacy Chagnon, 34, is the family breadwinner. "We're a good team," says Stacy. "I earn the money and Trip decides where to invest it." Stacy, an advertising executive, already contributes the annual maximum of $14,000 to her company's 401(k). She asked her employer to consider offering a Roth 401(k) next year, when the maximum increases to $15,000; employees 50 and older can put away an additional $5,000 in 2006. By contrast, the maximum contribution to a Roth IRA will be $4,000 in 2006 and $5,000 for those 50 and older who qualify for "catch-up" contributions.
Although companies are not required to offer Roth 401(k) programs, a recent study by human resources firm Hewitt Associates found that more than one-third of employers are likely to add them. Your employer may offer matching contributions to your Roth 401(k), but they must be held in a separate account because the boss's money and earnings on it will be taxed in retirement.
A Roth 401(k) can also be a great deal for young, lower-paid workers, who reap only small benefits from current tax breaks and are likely to face higher tax rates later. "Younger workers will have more years in the workforce and more years to accumulate tax-free dollars," says Lynn Foust, an employee-benefits specialist with Baker Boyer National Bank, in Walla Walla, Wash. Her advice: "Save as much as you can, as early as you can, and let compounding work its magic."
For example, a 30-year-old who contributes $10,000 a year to a Roth 401(k), with annualized earnings of 7% per year, would accumulate more than $1.5 million by age 67 -- all tax-free. With a traditional 401(k), he or she would owe more than $375,000 in federal taxes on withdrawals, assuming a 25% income-tax rate in retirement.
The Roth 401(k) offers some excellent estate-planning benefits, too. Although account holders must start taking distributions beginning at age 70½, you can circumvent that restriction by rolling over the money to a Roth IRA. You won't have to take mandatory distributions, and your heirs will inherit the money tax-free.
You can also split your 401(k) contributions between a traditional plan, to reduce your current tax bill, and a Roth, to build up tax-free savings, as long as your total contributions don't exceed the maximum limit.