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Retirement Finances (the Basics)

Retirement should be a time when you can relax and enjoy yourself after years of work. But in today's uncertain world, and with escalating health and energy expenses, you might spend your retirement worrying about money.

You wouldn't be alone. According to an updated Congressional Research Service report, an astonishing 42 percent of all workers ages 25 through 64 do not even have a retirement savings account. While that may be a discouraging statistic, it really doesn't have any bearing on your retirement plan. A financially comfortable future is largely in your own hands. Here are some basic plans to help you plan, save and live your retirement.

1. Set Goals and Figure Out How to Achieve Them

A study released by the American Savings Education Council found that 58 percent of American workers in 2007 didn't know how much they need to save for retirement. In fact, the study concluded that the lack of a financial plan would probably make two out of three households unable to achieve one or more major life goals. To avoid being part of the statistic, think about the following:

  • When would I like to retire?
  • How many years do I expect to live in retirement?
  • What lifestyle do I want when I retire?
  • What monthly income will I need during retirement to maintain that lifestyle?
  • What will provide that income (pensions, Social Security, investment earnings, etc.)?
  • How many years do I have left to save?

Use the numbers you've come up with to calculate what you'll need in retirement and how much you have to save between now and then. An online calculator is the way to go - it allows you to play with the variables and does the really hard math (like adjusting the numbers for inflation and computing compound interest) for you in a flash.

Thinking about what you'll need should put you in a retirement frame of mind and encourage you to keep working on your plan.

2. Use Accounts That Help Your Money Grow

Saving for retirement is so important that even the government is willing to help out by letting you pay the taxes on the earnings in your retirement accounts - such as IRAs, 401(k), 403(b) and 457 plans - later.

Some retirement plans even provide a break on the front end by letting savers invest pre-tax dollars or deduct their contributions.

While all retirement accounts offer tax benefits, no two are exactly alike. That's why you need to take the time to learn about your options. You'll want to pick the one that provides someone in your particular situation the best opportunity to save the most.

401(k), 403(b) and 457 Plans: As a general rule, anyone with access to an employer-sponsored retirement plan should participate. The fact that contributions are deducted from your paycheck pre-tax means that whatever amount you contribute will show up as a smaller reduction in your net pay. For example, if you're in the 25 percent tax bracket, a $100 contribution might reduce your paycheck by only $75.

Plus, many employers make contributions to your account based on a percentage of your salary or they provide matching funds based on how much you contribute to the plan. That's like getting a bonus every pay period!

If you're not already participating in your company's retirement plan, ask your HR/Benefits representative:

  • If the company offers an employee retirement plan
  • If the company matches employee contributions (if so, at what rate and how much do you have to contribute each month to get the maximum match every year)
  • What investment options are available
  • When you can sign up

IRAs: If your employer does not offer a 401(k) or similar retirement plan, you may be eligible to fund a deductible traditional Individual Retirement Account (IRA). Whether or not your employer offers a retirement plan, depending on your income, you may be eligible to fund a tax-deferred traditional IRA or a tax-free Roth IRA.

3. Choose Investments That Grow But Don't Keep You Up at Night

You're not going to get much further if you put your money into a savings account, money market fund or other "safe" place than you would if you stashed your cash under the mattress. In fact, these supposedly safe options are actually quite risky. The return they offer is so low; your money won't be able to keep pace with inflation. In other words, after taxes are paid on your earnings, you'll be able to buy less with your money when you retire than you can today.

Just think about where you'd be today if you had your retirement money invested in 30-day Treasury bills (which are taxable at the federal level).

There's no one investment model that works for everyone -- some savers are more risk tolerant than others (they don't lose sleep over temporary dips in the stock market), some have a longer time horizon, and all have different goals. But, without exception, everyone needs to invest with the objective of at least achieving after-tax returns that beat inflation. Beyond that, each individual will have to do some self-assessment to determine what asset allocation works best for their particular situation.

4. Make It Easier by Sticking to a Plan

Saving for retirement is a lifelong activity. Like the story of the tortoise and the hare, slow and steady usually wins the race. Consistent contributions to tax-advantaged savings accounts should be a part of everyone's plan. Regular savings outside of designated retirement plans might also be wise (they don't carry many of the same age-related withdrawal limitations, making it possible to use the money for an early retirement).

Wherever you stash your savings, dollar-cost averaging should be part of your strategy. In a nutshell, dollar-cost averaging means investing a fixed amount on a regular basis in a particular investment. One of the benefits of investing consistently is that you avoid the temptation to try to time the market. Not even experienced traders are consistently able to time the market successfully. And making even a few mistakes in your timing can be disastrous to your long-term investment returns.

Another benefit of dollar-cost averaging is that you even out some of the fluctuation in share price. For example, if you invest $100 on the first of every month, and this month shares are at $10, you buy 10 shares. Next month, when shares are at $5, you get twenty. That means you've got 30 shares at an average price of $6.66 -- neither the highest nor the lowest price of the two-month period, but lower than the actual average price of $7.50. Over time, dollar-cost averaging can improve your investment returns.

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