Financial Pillar VI: Retirement

When running a marathon, sometimes quitting seems to be the best option. Life seems to follow a similar course. Similar to a marathon, while in the middle of the journey, it seems as if there is no end in sight. However, we must remember that retirement is the finish line we all hope to cross; a time of peace and relaxation from all our labor. We have two options: to neglect our retirement and be forced to run the marathon of life with no end in sight or to strategize and set goals in order to ensure that we cross the finish line. As a Clever African, we must adhere to the latter.

The Life expectancy in the United States has been rising. Thus, to retire does not mean that life is over; it does mean that you don’t have to work every day, allotting you new freedoms to travel the world and experience new things. Will you have the ability to enjoy these new freedoms? If you retire at 60, will you have enough stored away to meet your needs for 20+ years? There are various avenues by which people can save for their retirement (see table below), today we will examine 401k’s and IRA’s.

401k

For years many people have been planning for their retirement through deferred compensation from their employer. A 401k is a retirement fund that is sponsored by an employer. You have the option to choose a traditional 401k or a Roth 401k based on your individual circumstances. One of the key features of contributing to a 401k plan is that many employers offer to match your contributions partially or in full. This is essentially free money that should be taken advantage of by every Clever African who has this opportunity. Other comparable options are the 403b contribution plan used for employees at nonprofit organizations and the 457b plan used by government employees.  

Individual Retirement Account (IRA)

An Individual Retirement Account is essentially a savings account specifically designed to help you save for retirement. The advantages of an IRA over a typical savings account are the tax benefits. There are primarily two types of IRA’s: Traditional and Roth.

Traditional IRA:

The biggest difference between a Traditional and a Roth IRA has to do with the way taxes are applied. A Traditional IRA allows you to make contributions pre-tax. For example, if you receive a paycheck wherein your gross income is $1,000 but your net is $700- you can contribute $100 to your Traditional IRA “pre-tax” and you will only be taxed on the $900 remaining versus the $1000 originally earned. With a Traditional IRA, you will pay taxes on the withdrawals you make in retirement. The benefit to paying taxes at retirement and not while in the workforce is the likelihood that you may be in a lower tax bracket in retirement.

Roth IRA:
A Roth IRA brings new options to the investor. The Roth IRA is essentially the opposite of the Traditional IRA when it comes to taxation. Contributions to these accounts are made “post-tax”. For example, if you receive a paycheck wherein your gross income is $1,000 but your net is $700- you can contribute $100 to your Roth IRA “post-tax”- this $100 contribution would be taken from the $700 net payment. With a Roth IRA, you do not pay taxes on the withdrawals you make in retirement. This means there are no taxes on money that may accrue in your account over time with interest.

 

Both Roth and Traditional plans have restrictions and penalties when it comes to withdrawing money before retirement age, but the Roth is less restrictive which makes it more appealing to some individuals. If you are someone who expects to have more income in retirement than during your time in the workforce, then a Roth IRA would be better for you.

The graph above clearly shows that there is an increasing perception that social security assistance will soon become extinct. It is becoming more apparent that younger individuals will not receive government assistance in old age, which is even more reason to have an individual retirement plan. We discussed investing your money last week. Retirement plans generally contain a variation of stocks and bonds that allow your money to grow over time. Similar to your personal investments, contributing to a 401k or an IRA earlier in life will allow for more growth potential in your account. We cannot be certain what tomorrow may hold; ensuring your future financial security begins with planning for your own retirement today!

 

THE CLEVER AFRICAN: INVEST IN YOU
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