Investing for Retirement

Thanks so much to those of you who have written in with questions. I’m looking forward to answering as many of them as I can in future episodes.

Today’s topic is investing for retirement, a topic some of you have asked about.

Why to Invest for Retirement

One big financial goal shared by almost everyone is accumulating enough money to retire comfortably. But figuring out a game plan can seem overwhelming! There are 401(k)s, traditional IRAs, Roth IRAs, as well as other types of retirement savings plans. The biggest risk is inaction. With all the investment choices, it’s all too easy to succumb to analysis paralysis and do nothing.

Strategic Retirement Investing

Now retirement investing is a really big topic. In this episode, I’m going to talk about just one aspect of it: how to be a little strategic when investing in an employer-sponsored retirement plan.

If your employer offers a retirement plan, such as a 401(k), it’s usually a good place to invest, especially if your employer matches your contributions and you have a broad array of investment choices within the 401(k). An employer match is free money so, if you do nothing else, invest enough in your 401(k) to take full advantage of the employer match.

Roth IRAs

And now here’s a little strategy: If you’re younger or think you’ll be in the same or a higher tax bracket in retirement than you are now, you’ll typically come out ahead if you contribute to your 401(k) up to the point of getting the full match and then contribute to a Roth IRA, if you’re eligible.

With a Roth IRA, you contribute after-tax money and your earnings get to grow tax free, which is pretty amazing! With a 401(k), on the other hand, you contribute before-tax money and your earnings grow tax deferred, which means you’ll have to pay taxes on them when you tap the money during retirement.

Not everyone is eligible for a Roth IRA: For 2007, if you’re single, eligibility phases out for incomes between $99,000 and $114,000. If you’re married and file jointly, eligibility phases out between $156,000 and $166,000.

At the very least, contribute enough to your 401(k) to get the full employer match. Then, contribute to a Roth IRA if it makes sense for you and you’re eligible. For 2006 and 2007, the contribution limit for a Roth is $4,000 (or $5,000 if you’re age 50 or older). And, if you can afford to invest more for retirement after contributing to a Roth, contribute more to your 401(k). The limit on 401(k) contributions for 2007 is $15,500 (and, if you’re over 50, you can contribute an additional $5,000).

If switching from your 401(k) to a Roth and then back to your 401(k) sounds way to complicated, remember that the most important thing is to contribute enough to your 401(k) to get the full employer match. Beyond that, you can simply keep on contributing to your 401(k) as your circumstances allow.

Lastly, I wanted to mention that there’s still time to contribute to a Roth IRA for 2006. The deadline for making a 2006 contribution is the same as the one for filing tax returns, April 16, 2007. That means you can invest $4,000 for 2006 and another $4,000 for 2007.

The Roth 401(k)

We don’t have time to talk about it in detail in this episode, but, last year, a Roth 401(k) was introduced. It combines features of a 401(k) and a Roth IRA: it has the same $15,500 contribution limit as a 401(k), but without the income restrictions of the Roth IRA. It’s a nice solution for those of you who are high income earners and have wanted to contribute to a Roth, but haven’t been eligible. If you fall into this category and your employer doesn’t have a Roth 401(k), ask them to consider offering it. It never hurts to ask!

Now, everyone’s situation is different so it’s a good idea to consult your accountant or tax advisor.

Cha-ching! That’s all for now, courtesy of Money Girl, your guide to a richer life.

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