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RETIREMENT | Unraveling the mystery of The Golden Parachute (401K's, IRA's, Roth, Etc.)

Man In Parachute: FPS Insurance Retirement Definition "Retirement is a point where a person stops employment completely."
FPS Insurance Retirement Definition Retirement is a point where a person stops employment completely.

Planning for the future with Retirement Accounts.


If you Fail to Plan… you are Planning to Fail.  Benjamin Franklin

There are few things that are more overlooked in financial planning than retirement.

I've regularly talked to people in their 50’s and 60’s who have saved nothing for retirement. When asked when they will retire they all say they would like to retire between 65-70 years old. 

But what will they retire with? 

Social Security doesn’t pay enough to fund any real lifestyle. Given the state of Social Security it may not even be available much longer. Despite what you politician (from either party) has told you, Social Security is unsustainable. Simple math would tell you to bet that it won't be there for you tomorrow, and to plan for yourself.

I want to share some stories with you to get you thinking about your latter years.

~Planning Case Studies~


Let’s take a look at some retirement case studies.


Case Study: Martha


Martha worked for a bank when they came out with a new product called an I.R.A (Individual Retirement Arrangement) (See IRS Publication 590)[1]. The name actually came from one of the men working on the project at Federal level, Ira Cohen. So she, like our earlier case study Robert, put $2k aside in an IRA. They guaranteed her 10% on her money until she turned 60. This was her 60th birthday. She now had over $65,000 in just that one account.
           
In the same city a few miles away lives an older woman named Rita. She was working at a local department store as a greeter until she broke her ankle at 71 years old. She lives alone. She lives on a “fixed income” which means that she doesn’t work and receives only from her Social Security money. She only gets a fixed $1,200 a month from SSI.
            
Martha lives in her home paid off and drives her debt free car. Rita lives in a small studio apartment in a rough neighborhood. So how did they end up like this? If you fail to plan you are planning to fail. Each woman made choices that lead her to her current state.

Case Study: The Business Man - Precaution


It’s not always a failure of planning and working, sometimes it’s a failure of taking precautions.

I once worked with a couple. They are in their 80's at the time. He says to me,

“You know, I was once a great business man…we had so much money we could go anywhere, buy anything, drive any car. I had more money than you shake a stick at.”
            
I asked him

“what happened?” 

As he stands here telling me his story with an un-ending grin he and his wife are handing out samples at a grocery store.

“Well”, he says “I made a bad business deal…actually the business deal was great, but the guy I was partners with used it to take everything and leave me to fall for it. We lost everything in the after-math, even the house. 
If I’d just taken a couple of extra steps I could have put safe guards in place and prevented either the whole thing from happening or  the effects of it from hitting so hard. 
But I like people and I trusted him and I was blinded by how much money I was going to make on it."

~Planning Ahead~

            
These days you cannot count on social security even being available for you when you retire. Many times people don’t stay with one company for 30 years in order to get a pension plan, which are not commonly offered anymore anyway.

So how do you plan for the latter years? You can be sure of 2 things:
1). God will have to be your source. Money is a resource, jobs are a resource, investments can be a resource, but only God can be your source. Allow his ways and His wisdom and His Word to be your light! 
2). You must plan. If you fail to plan; you plan to fail. Allow the leadership of the Holy Spirit through prayer to give you divine instructions and plans. God was speaking to everyone in 2007 to get out of the stock market before it crashed. Those who listened to him got out; those who didn’t got stuck right in the middle of it. You don’t just plan, you pray through His plan for your life. So what kinds of things do financial institutions offer that you can participate in?

~401K~


Most companies offer a retirement account, plan or service. When you meet whatever guidelines and requirements the company offers you can start to have money taken out of your paycheck and put into one of these retirement vehicles. You can have what you put in matched by your employer.
            
For example:

You put in $50, your company puts in $50.This means that by adding $50 to your 401k you actually added $100. What makes this even better is the $50 is before taxes. So if you made $2,000 gross income (before taxes) then you actually only get taxed on $1,950.00. This can mean less going to taxes and in some cases can mean you pay so much less toward taxes that your actual Net (money after tax) paycheck is the same, or slightly less.

Really if your employer matches your contribution (which means that if you put in $50 they put in another $50 so now you have $100) some people would tell you that you are literally throwing away money by not putting at least as much as they will match in the plan. The beauty of these types of plans is that they are automatic. There is no thinking or discipline, it just goes away and you forget it’s there.

Many people don’t build enough savings.

They focus on more immediate needs.

Another benefit to the 401K is that you build a forced savings from which you can pull from in an emergency. If you need the money you can borrow from your 401K. It acts as a loan with interest but the money you pay back through payroll deductions all goes into your 401K, including the interest. You borrow from yourself and pay yourself back plus some. Sometimes you can withdraw the money without borrowing it. 

If you did it would get a penalty tax taken from the amount you withdrew, usually about 20% goes to penalty tax if you withdraw the funds before you turn 59 ½ years old. You may say why have a 401K if you can’t take money out without penalties? Most people don’t save so they would have zero to borrow from without this.

Another factor to consider is that many times half of that money was put in by your employer if they do matching, so really the employer is paying your 20% tax. 80% of $2,000.00 which you saved is better than 100% of $0.00 that you didn’t save.

Another great thing about 401K plans is that if you move companies before you retire (which my statistics show you are more likely to do these days) then you can take it with you. This was not true as much with many pensions.

The down side of these plans is that you are limited to the small group of investments that the 401K plan administrator offers.

They may not give you any FDIC insured products or any access to annuities.

If you want better or broader choices, and you are willing to put some away each month without them making you through payroll deductions, you could be better off with other products.

So what if you decided to open your own business or work for a smaller business that has no retirement plan? What if you want other options not included in a 401K? Or what if you wanted better access to the money should you need it?


An IRA is an Individual Retirement Arrangement. 


These accounts are self-directed, which means that you are in charge of getting money in and you are in charge of making sure you keep on top of that money so it grows as you wanted it to.

If your company does not offer matching to your 401K this could be a better place to put your retirement. 

The draw backs are that it is not payroll deducted so you have to remember to put it in and report it on the taxes, and that you can make higher dollar contributions to the 401K.

The benefits are that the money is more accessible, should you need it, and that you have greater control over what it is invested in, even an FDIC insured Savings or CD if you like, which many if not most 401K’s do not have.
            
IRA’s can be in nearly any vehicle. Which means you can put your money into CD’s and savings accounts or you can invest your money in the market with investments. You can even have gold and silver purchasing plans through an IRA.

As long as that company slaps the IRA label on it, nearly any product type offered by a bank could be an IRA.

Check with your bank or financial institution about what IRA products they offer. Look also for alternative programs, but make sure to check any company through the better business bureau at www.bbb.org.
            

In order to understand IRA’s you must see them as having two parts. 


There is an IRS side and a Bank side. 

Understanding The IRS side of IRA and the Bank side of IRA can be confusing.

But let's make it simple.


  • Think of the IRS term “IRA” as the umbrella, or the label. 
  • Think of the Bank side as the container. 
  • You can place the “IRA” label on many containers and they will all conform to the IRS rules AND the rules of that container. 

There are several types of IRA’s but they are all just labels.




IRA - Traditional, Roth, SEP, ESA --- Bank - Savings, CD/TimeAccount, Investment Account


            
You can have an IRA savings or an IRA brokerage. If you have an IRA savings it will still function as a savings would, earning interest. The IRA savings will simply have the additional functions of an IRA which means that the interest you earn will not be included on your taxes until you take it out, or possibly never.   
         

~IRA Types~


IRA’s come in several forms. The two that you are most likely to use and see are the Traditional and ROTH.

First a word on the other types:
In short, the SIMPLE and SEP IRA’s are for small employers and self-employed people. If you are in that situation these may be something you want to do research on. Often self-employed individuals and business owners can make contributions (deposits) into a SIMPLE IRA on behalf of themselves and on behalf of the company they own. This gives the individual tax benefits and the company also gets tax benefits. You can also place money into a SEP IRA for your employees, also getting a business tax write off.

An ESA is an Education Savings Account. This is an IRA designed to build a savings for education expenses of a child. You can get a tax deduction for putting money into a savings for your child and the child can then take out the money tax free and use it for school later in life.
The two IRA types we will focus on here are the Traditional and ROTH.

~Traditional IRA~


The traditional IRA is the most basic form and it is the most used. It is similar to a 401k in that you put money into the retirement account in order to reduce your taxable income. But your employer does not add to this plan. And you can put in less per year then a 401k. Typically the IRA has a limit of $5000 per year in contributions versus contributions as high as 25% of your income in a 401K. The limits are higher for those over 50 and change from year to year. 

However unlike the 401k where they handle the money for you, in an IRA you are in charge of your money. This is bad if you neglect it because no one is watching it to help it grow for you but great if you’re on top of the account because who’s more motivated than you to do right by your money.

To give you an idea of how this works let’s look at an example. If you make $40,000 gross (pretax) income, and you place $5,000 into a Traditional IRA, you will be taxed on $35,000 gross income. The amount of money you pay in taxes will be less. Let’s say that you are using a tax service, such as TaxAct.com or TurboTax.com, and the calculator came out with a result of owing the government $500 in taxes. If you go back and tell the system that you contributed $2000 into a Traditional IRA you may be surprised to see that you are now getting a $1500 refund.

How did you go from owing $500 to getting a refund of $1500? You reduced your taxable income and less became owed. If you already have money set aside for something at tax time you may find placing that into a Traditional IRA for your later years will cause you to get money back from the IRS.
            
Not only can Traditional IRA’s reduce your taxable income in your working years, but for many people income is lower in retirement years. This means that when you take out the money in your retirement years the money will be taxed at a lower rate, because the IRS taxes you at different rates depending on income levels. If you are very wealthy in your older years it will be taxed at a higher rate, however being wealthy it doesn’t hurt as much as it would in your developing years. Either way the Traditional IRA has benefits for your income today as you are putting money in.
            
The IRS wants you to save for retirement, so there are penalties for taking money out before 59 ½ years old. The IRS will take 10% of any money you take out early, unless it is for one of the few exception reasons they list. These exceptions can be found in IRS Publication 590.


However because the IRS wants their taxes they also have rules that require you take it out eventually. At 70 ½ years old you must start to take out from your IRA so that the government can take their taxes. Because you must start taking money out at 70 ½ you must also stop putting money in at this age as well.

~ROTH IRA~


A ROTH IRA is slightly different, but in profound ways.

This is for after tax money you put in. If you will be making more money or living at higher tax brackets in your retirement years, you may want to consider a ROTH IRA.

The money you put in is AFTER TAX which means it will NOT reduce our taxable income up front. However all the money you earn on your money will typically grow tax free (consult a tax advisor).

If you recall Robert (HERE) who put in $2000 and it grew to $48,000.


  • If that was a Traditional IRA he would be taxed on all that growth. 
  • In a ROTH IRA that would tax free growth. Not just the $2,000 he put in, but the whole $48,000.
Therein is the benefit of the ROTH.

You don’t get a break for putting money in, but you get tax sheltered or tax free growth.

The IRS doesn’t care how long you keep the money in a ROTH IRA because it’s after tax money anyway. Since the IRS is not going to get paid from the money anyway you can continue putting money in to grow tax free well beyond the 70 ½ limit placed on traditional IRA’s.

~Annuities~


Annuities are products sold through insurance companies. These can be complicated but a very elementary understanding would be that you buy the policy from the company at one value and agree to let it mature with them for some time. At the maturity you can either redeem the policy for the increased value or take monthly payments. If you choose monthly payments they could go on and on for the rest of your life, even paying you more than the value of the annuity plan. The payments, if this was your arrangement could continue until the company goes out of business or you die. There are terms and conditions and some companies are stronger than others.

~Summary~

            
The 401K is an employer plan, managed by, primarily the employer. You can choose within the plan the investments you want, but only those that they offer. IRA's can give you the freedom to manage them on your own, or with advice.
            
If you leave your employer you will almost always want to take the 401K and role it into your new employers plan or into an IRA. If you do roll it into an IRA you can get to the money MUCH easier than you can when it is in the 401K.
            
As Robert’s case study taught us, enough right decisions over a long enough time can create a successful plan of action. Here are a few thoughts to ponder. The journey to a thousand lands begins with a single step. Whether you’re 15 and just starting to think about your money, or 50 and trying to catch up on a life passing you by, or 80 and on what you “think” is a “fixed” income. Small steps of wisdom can take you so much farther than you think. The seed you sow will take you where you want to go.
            
All investments are a personal decision, many could lose value. Therefore pray through any decision and seek the help of a trustworthy godly financial advisor. Make sure that they are an independent advisor and not one working for a major bank or insurance company. Advisors employed by financial institutions are given quotas of products to sell. 

They are more interested in their bottom line than your benefit regardless of what they tell you. They have to be, that is what they are employed to do. An independent advisor, one not working on behalf of a specific financial institution, would be more likely to lay all available alternatives with the full pro’s and con’s for you.



[1]     http://www.irs.gov/publications/p590/ar01.html#d0e295





The Insider

The Insider is a BIG fan of Dave Ramsey:

  • Go read/listen/watch Dave Ramsey and he'll teach you how to do it right!
  • Listen to The Dave Ramsey Show (HERE)

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Darrell's Reading List


Here are some books I've been reading lately:
  • Hacker: The Outlaw Chronicles (here) by Ted Dekker (Author). The story of a young Hacker girl, who went on a wild adventure into the supernatural realm beyond trying to save her mom, but saved her self too in the process.
  • Saint: A Paradise Novel (here) by Ted Dekker (Author). He's an assassin, or is he? He finds a secret to his past that unlocks supernatural abilities, at a cost.
  • For a full list of all my book suggestions, see my Amazon Store.

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