Changing Retirement Landscape
If you have not been a devoted subscriber you may need to go back and listen to my last Podcast “Retirement in Crisis” to better appreciate how important retirement savings are to your future. The government recognizes that most individuals have been asleep at the wheel when it comes to saving for their retirement, and they are also unaware that Social Security is only a few decades from a funding disaster (don’t worry I am not going to go there on today’s show). As a result of this SILENT BUT DEADLY BUILDING DISASTER the government has made several changes that provide tremendous opportunities for you to save for your future retirement and financial independence.
What retirement option should you use and in which order should they be funded?
To answer such a question we must understand all the different retirement options
Traditional 401k: $15,000 annual contribution limit ($20,000 for those over 50). Contributions are tax deductible and earnings are not taxed until you start to take withdrawals. However, withdrawals are taxed at ordinary income tax rates instead of the lower capital gain and dividend rates.
ROTH 401k: ROTH 401ks became available at the beginning of 2006, but most employers did not change their existing plans to add the new option because they were not permanent, but that changed this past August with the signing of the Pension Protection Act of 2006. I am prediciting that with the new legislation that ROTH 401ks will become much more common.
Same contribution limits as normal 401k ($15,000 for 2006 & individuals over 50 can invest $20,000). The contributions are just like normal ROTH IRAs and are not deductible, but the earnings are never taxed. Unlike, ROTH IRAs there are no income limitations.
ROTH IRA: You can contribute $4,000/year ($5,000 for those over 50). The contributions are not deductible, but the investment earnings are never taxed. You can no longer contribute to a ROTH IRA once your income exceeds the following limits: Married Filing Jointly ($150,000-$160,000) Single ($95,000-$110,000).
Traditional IRA: $4,000/year contribution limit ($5,000 for those over 50). Fully deductible if you do not have an employer provided plan. Your earnings grow tax derred until you start to take withdrawals. However, just like traditional 401ks, traditional IRAs are taxed at ordinary tax rates.
So now that we know our options where do you invest your money and in what order???
My advice is to load up on the ROTH options. I can not stand to pay taxes anymore than anyone else, but there is a good chance that your taxes are going to be higher when you retire based upon research done on what the requirements will be for our US Government in the future.
I know that the conventional wisdom has always been you will be in a lower tax bracket in retirement than you will be at your peak earning years. However there are some issues facing our great country.
** Tax Revenues have not kept pace with future government obligations (Social Security, Medicare….)
** Congress has not fixed Social Security. Instead of investing the money to grow the funds were used to fund other general governement programs. When the IOUs come due money will have to come from somewhere. That will probably be higher income taxes.
** According to the US Government Accountability Office; Our Government will either need to cut spending by 60% or double federal taxes to balance the federal budget in 2040. Unfortunately, the Government is great at promising programs, but bad at ending programs. Therefore, I would count on higher taxes.
Items to Consider:
**If you are a high income earner and your company does not offer a ROTH 401k, start making some noise. This is very important since the ROTH IRAs have income limits.
**If you have maxed out your 401k and income limits do not allow you to use the ROTH IRA consider contributing to a nondeductible Traditional IRA. Part of the new legislation allows you to convert a traditional IRA (nondeductible IRA) into a ROTH IRA in 2010, and the only tax implications would be to pay taxes on the earnings. This conversion also does not have any income limitations.
With Thanksgiving and Christmas specials there will be large crowds and long lines. A good way to beat the system is to keep the sale circulars from one store and use it at a competitors. This allows you to get the great “Door Buster” special and avoid the lines and the mad dash during the peak period.
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