Photo: Edwin Datoc

Saving for Retirement

Q: My employer recently began offering a Roth 401(k) plan and matching contributions up to 2 percent. I already have a Roth IRA worth $5,000. Should I invest through my company as well?

A: You should definitely contribute to your employer plan, and I think the Roth 401(k) is a great way to go. During retirement, you'll be able to make tax-free withdrawals from both your Roth IRA and your Roth 401(k). (Distributions from traditional IRAs and 401(k) plans are subject to ordinary income taxes.) You can't afford to pass up free cash, which is what you're getting when an employer contributes to your 401(k). Set aside money only up to the point of the company match—in this case, 2 percent of your salary. (You can contribute up to $17,500 per tax year; that amount increases to $23,000 if you're at least 50 years old.) If you can afford to invest more than that, I'd advise you to switch your focus back to your IRA. (The yearly contribution limit is $5,500; if you're at least 50, it's $6,500.) You can't access deposits you have made to a Roth 401(k) without penalty unless you have had your account for five years and you're at least 59½. With no such restrictions, a Roth IRA provides a better, more versatile option if you need to withdraw contributions pre-retirement.

Q: I'm in my early 60s and earn $2,000 a month from part-time work and Social Security. I rent my home, own my car, and have no debt, but I have just $3,000 in savings. I'd like to begin making monthly contributions of $250 to catch up on my retirement funds. Should I buy an annuity, a Roth IRA, or a regular IRA?

A: While it's never too soon to plan for retirement, a late start is better than none. At this point, a Roth IRA will give you the most flexibility: You can always withdraw money you contribute without penalty or tax.

Let's assume your Roth IRA earns 4 percent a year. (People in their 60s should keep no more than 40 percent of their long-term investments in stocks to limit their exposure to market risk.) If you contribute $250 a month, you could save approximately $37,000 in just ten years. In your situation, that would be a great achievement. To ensure that money could help support you for the rest of your life, plan to withdraw no more than 5 percent a year. (That works out to $1,850 in the first year you're fully retired.)

I think it's great to focus on setting money aside, but there's an even better way to prepare for retirement: Reduce your expenses. If you live in a pricey area, consider moving to a smaller home (as long as relocation costs don't exceed any potential savings on rent or utilities) or perhaps getting a roommate. Sharing your space can not only improve your financial situation but also—if you find a great roomie—provide an emotional boost.

In addition, you may want to suspend your Social Security benefits and restart them when you're older. (You're allowed this one-time mulligan only if you began taking benefits within the past year.) Since you're younger than 66, which I presume is your full retirement age, you're collecting less than 100 percent of the benefit you're entitled to. While you would have to repay money you've already received, in less than four years your benefits could grow by 25 percent. You can't earn a return that high on another investment without taking on a lot of risk.

Next: Determining the right amount to save up for your retirement


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