Sunday, July 17, 2016

Basics of Retirement Options

Here is some Basic information that I have been able to understand:To get/save money, there are 4 classes .... based on taxation
  1. Free: Inheritance
  2. Tax-Free: HSA, Roth IRA, Life Insurance, 529, Money Bonds.
  3. Tax-Deferred: IRA, 401k, 403b, 457b, Annuity
  4. Taxable: Income
Of course free is the best (inheritance). Tax-Free is better but Tax-deferred, which is the last option!

Most universities offer a combination of plans which may be Pension plans (like STRS), Contribution plans (401k, 403b) or other. Companies offer 401ks.You should also explore 529 and HSA options in your employment.

Here are some basics on different types of options:
  • 401(k): Pre-tax, tax-deferred (i.e., taxed at withdrawal), 59.5yr rule applies (10% penalty if withdrawn early, some qualified withdrawals are allowed though), 70.5ys required withdrawal, max $19000/year contribution (which is updated every year). 
  • IRA: Pre-tax, tax-deferred, 59.5yr rule applies (10% penalty), 70.5ys required withdrawal, max $6000/year contribution (updates every year), income limit $70k for singles (or $116k if you're married filing jointly).
  • Roth-IRA: Post-tax, tax-free (contributions grow tax free), 59.5yr rule applies (10% penalty) unless its qualified withdrawal, 5 year rule applies (taxed before that), max $6000/year contribution (updated every year), max income limit $114k for singles ($181k if married filing jointly). For withdrawal: Contributions can be withdrawn any time for any reason. Earnings can be withdrawn penalty free for qualified expenses (upto 10k, lifetime max limit) and Income tax free if first contribution was older than 5 years.
  • Roth-401(k): Post-tax 401k, tax-free, no income limit
  • 403(b): Its 401(k) version for government entities - those who don't offer 401k.
  • 457(b): Its 401(k) without the penalty
  • Broker Account can also be very useful as a substitute to quick-money. Tax is calculated when you sell stocks (not when you withdraw funds). Capital gains are taxed at individual income tax rate if short-term (held less than a year) or at 0%, 15%, 20% for long-term (if held long than a year). Qualified dividends (paid by companies) are taxed at the capital gains tax rate and Unqualified dividends (like REIT) are taxed at the income tax rate. 
Here are some other saving options:
  • HSA (Health Saving Accounts) are available with high-deductible plans. They have triple tax benefits. They are pre-tax (i.e., deductible from taxable income) saving accounts where money can be saved as cash or can be invested (if more than minimum, which is usually $100). Invested money grows tax free and can be used on qualified medical expenses without any tax (penalty applies for other usage).
  • 529 accounts are saving accounts (post-tax) for kids education which offer double tax benefits and some may offer tax advantages like state tax refunds. Money can be invested and grows tax free. Qualified withdrawals are also tax free. 
Some related information to keep in mind:
  • Company usually offers either 401k or 403b. Difference may be the type of company or the fee charged!
  • 401k/403b may be invested into stocks, bonds, etc.
  • 403(b) is protected from bankruptcy but IRA is not.
  • Roth-IRA has income limit and Roth-401k doesn't, both have contribution limits.
  • Roth-IRA can be passed to dependents and has more investment options
  • 401k is not guaranteed while Pension plans are guaranteed.
Some Useful Information, Tips and Terminology:
  • Company usually offers either 401k or 403b. Difference may be the type of company or the fee charged! 401k/403b may be invested into stocks, bonds, etc. 403(b) is protected from bankruptcy but IRA is not.
  • Roth-IRA has income limit and Roth-401k doesn't, both have contribution limits. Roth-IRA can be passed to dependents and has more investment options
  • 401k is not guaranteed while Pension plans are guaranteed.
  • If your employer offers to contribute to your retirement accounts, you should make every effort to get that free money. For that, pick the minimum possible pension/contribution amount that is required to get employer's contribution (sometimes its a simple salary match). After that get additional individual retirement plan s (IRA/Roth-IRA/401(k)/403(b)/457, etc).
  • Also consider getting HSA, life insurance and 529 for kids education. 
  • One good strategy is to contribute enough to the retirement accounts like 401k to get all available matching dollars from employer. Then, max out your HSA, Roth-IRA, IRA (in any order you wish), and then max out your 401k.
  • Post-Tax plans might offer a better saving than pre-tax (if not similar). Consider this example:
    Case 1: If you make 150k salary and work for 15 years (with 5% increase, 5% to 401k and 50% match) then you will have 403,690 at retirement (assuming 8% ROR). If you retire in 30 years, after incorporating 3.1% inflation, 4% ROR, 25% tax, you will make $1404/month
    Case 2: If you have a private pension account where you deposit 1000/month for 15 years post-tax, you will be getting $1177/month tax free at retirement. 
  • Broker accounts can be used to buy equities (or stocks). Find one which doesn't charge too much fees. These fees may be broker fee (to open account or provide research data), transaction or trade fee, expense ratio (annual fee for some funds), sales load (fee for selling), management fee (for managing your money), etc. Robinhood is one option that doesn't charge any fee. Fidelity Roth IRA charges $4.95 per trade and 1-3 cents per $1000 principal in selling fee.
  • Some Useful Terms: 
    • Stock: Sold as shares (part of ownership for publicly traded companies) ===> for long term investing 
    • Bonds: Is a loan, Exp: Treasury: average maturity of 10 years and annual interest for 2% ===> These are for income generation thing hence only used when closer to retirement or when you need money, for short term! 
    • Short-term/Liquid: preserve money; 3-6 month emergency, or something to buy in next year or so. 
    • Investment Strategies:
      • Conservative : 6% (more closer to retirement, 1-8 years) => 50% short term/bonds, 50% stocks
      • Balanced: 7.93% (9-12 years or less)
      • Growth: 8.89% (More than 13 years) - more stable version of aggressive growth
      • Aggressive Growth: 9.5% (if you have stomach for risk) - i.e, between 90-60% stocks)
Final Recommendations: 
  • Perhaps the best course of action in regard to pension plans is to consider them to be a bonus. Establish and fund self-directed retirement plans, such as 401Ks and 403Bs if your employer offers them; or traditional or Roth IRAs if they don’t. Then plan your own savings. 
  • Use HSA (if you are able to choose high-deductible plan) and max it out. It has triple tax benefits 
  • Save in 529 and Get Life Insurance (outside current employer)
  • Key: Get employer contribution (and save some in employer retirement plan), max out HSA, and then max out Roth-IRA and/or IRA; then save in 529. After that, keep cash for 3-6 months of expenses and finally put rest of the money in Broker Account. You may also want to invest somewhere else, like properties, international, etc. Don't put all eggs in one basket (i.e., in one country or in one type of stock). Evaluate your strategy every 1-2 years.

Related links:
http://www.valuepenguin.com/investing/investment-account-types
http://www.rothira.com/blog/factoring-pensions-into-your-retirement-plans
https://www.youtube.com/watch?v=p925UP6WxEE

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