How to Plan for Retirement

Marc Palatucci, Intern

David Bach is the best-selling author of the Finish Rich book series. In his latest work, The Finish Rich Dictionary, Bach provides definitions for over a thousand financial words and terms. Interspersed throughout the definitions are ten essays designed to help the reader navigate today’s financial environment, and avoid it’s many pitfalls and perils. In this excerpt, Bach gives seven rules to follow in planning for ones retirement.  To read other excerpts from this book click here.

Here are seven rules for planning for retirement:

1. Invest for growth. Even with the recent downturn in the stock market, it’s still critical that, when you invest in your retirement accounts, you invest for growth. Many people are now making the crucial mistake of thinking that the stock market will never go up again and, as a result, they are putting all of their money in guaranteed investments (like certificates of deposit). The problem with investing in something that is guaranteed is that the return may be less than inflation, which means you are actually losing money each year. The cost of living has been climbing steadily, at an average of slightly more than 3 percent a year. Playing it safe will not allow you to beat that rate. If your retirement account doesn’t grow faster than inflation, you’re not going to have enough money to live on when you retire, 20, 30, or 40 years from now.
While seeking growth requires you to invest some of your money in stocks (and that means more risk), over the long term, you should come out ahead and be able to build a bigger nest egg.

2. Take advantage of free money. One of the smartest things you can do when it comes to saving for the future is taking advantage of the free money your employer may give you. In many cases, employers will supplement your retirement plan contributions with contributions of their own. These matching contributions usually start at 20 percent of what you’ve put in and sometimes go as high as 100 percent. At the same time, you should still make the maximum allowable contribution, not just the percentage of your paycheck that your company will match. If your employer stops matching your contributions (as many companies have recently started doing), don’t make the critical mistake of stopping your contributions to your retirement account. With or without a match, you want to use your retirement account at work.

3. Don’t borrow from your retirement plan. Although your retirement plan may allow you to borrow money from your account without paying taxes or penalties, don’t do it. Why? For starters, imagine being laid off from work. At the worst possible time, your company tells you, “You have to pay back your 401 (k) loan.” Without a paycheck, you can’t pay back your loan, right? Your company then reports your loan as a distribution, and now you owe the IRS taxes on the loan, plus a 10 percent penalty fee. But wait, you’re not working. How will you pay the IRS? See the problem here? This is happening to thousands of Americans right now. Don’t let it happen to you. Leave your retirement money alone until you’re ready to retire.

4. Consolidate your accounts. Many people remember Grandma’s advice about not putting all your eggs in one basket, but they often misunderstand it. Not putting your eggs in one basket means diversifying your risk – putting your money into different kinds of assets, such as stocks, bonds, mutual funds, and other investment vehicles. It doesn’t mean opening an IRA at a different bank or brokerage firm every year.

There is simply no way you can do a good job managing your retirement accounts if they are spread all over the place. If that’s what you’ve done, consider consolidating them into one IRA custodial account. Not only can you completely diversify your investments withing a single IRA, but you’ll also find it much easier to keep track of everything.

5. Be careful who you list as the beneficiary of your retirement account. Many people follow their lawyer’s advice to create a living trust to protect their estate, put all their assets in their trust’s name. This is a big mistake. When you do this, your rollover, which allows, for example, a widow to take over her late husband’s IRA and put it in her name, without having to pay any taxes on it until she actually starts taking the money out. If the husband has transferred ownership of his IRA to a trust, the wife can’t take it over in the event of his death. Instead, the account goes to the trust, and the proceeds become taxable. For much the same reason, you shouldn’t make a trust the beneficiary of any of your IRAs or 401(k) plans. You should also make sure that, if you or your partner has been married before, your ex isn’t still listed as the beneficiary on any of your retirement accounts. Finally, if you’re newly married, make sure that your spouse has put you down as the beneficiary of his or her accounts. Many people when they marry have “Mom” down as a beneficiary. No offense to “Mom” or “Sis,” but you want your name on that beneficiary statement. Also, make sure you list your kids as contingent beneficiaries.

6. Always take your retirement money with you. When you leave a company where you’ve been contributing to a 401(k) plan, don’t leave your retirement money behind. Rather, immediately inform the benefits department that you want to do an IRA rollover. Your former employer will then transfer your retirement funds either to a new custodial IRA that you’ve set up for yourself at a bank or brokerage firm, or to the 401(k) plan at your new employer (assuming there is one and it accepts money from other plans). If you leave money in an old 401(k) plan, your beneficiary, upon your death, would have to go back to a company where you may not have worked in years to get your money. The process can take as long as a year, and the money could be subject to taxes before your beneficiary can collect it.

7. Don’t shortchange yourself. Whatever else you do in your financial life, take retirement planning seriously. There is nothing you can do that will have more impact on your future financial security than maximizing your contributions to a retirement account and making sure that money works really hard for you.