Beating Broke

Personal Finance from the Broke Perspective

Retirement Products: What are the Differences?

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There are excellent tax benefits associated with official retirement products, but these products often come with restrictions. Always understand your options and the rules of the product upfront.

Deciding to start investing for your retirement is the first step. Next you need to choose which tools to use. This requires you to compare products and note their differences.

This step can be quite daunting since there are many products available, but the best way to approach this is to consider your needs and level of self-control.

You are locked in, but with tax benefits

Retirement products are the logical choice for most people saving for retirement due to their tax efficiency. The government provides generous tax breaks to encourage people to invest in provident funds, pension funds and retirement annuities (RA) for their retirement. The catch? Your money is not easily accessible before your retirement.
To limit investment risk, retirement products impose limits on the amount that can be invested in higher risk assets such as offshore investments and equities. These rules can hinder your growth, particularly if you start your retirement savings in your twenties.

Do you want accessibility and tax benefits?

The benefits of retirement products compared to tax-free investment (TFI) products have been heavily debated. Both products grow free of income tax on interest, dividends tax and capital gains tax.

The main difference between the two is that retirement products offer you tax savings now. You end up paying less tax now since you make contributions with earnings on which you haven’t yet paid tax. You only pay the tax later once you start drawing an income. This means you defer paying the tax. TFI products are completely tax-free. You invest money after paying tax, but you pay no tax later.

In a TFI product you are allowed to withdraw your money at any time. This is an advantage if you prefer or require accessibility. Remember though that you could also lose out of the effects of compound interest by dipping into your savings and you have an annual and lifetime limit on contributions, which cannot be replaced once withdrawn. It is important to note that using a TFI in conjunction with a normal retirement product could give you greater access to higher risk investments such as offshore investments and equities.

Do you want an investment with no limits?

You could also consider investing directly into unit trusts. Your contributions, like with TFIs, aren’t tax deductible. And, unlike the other two options, your returns will be taxed. This will reduce your returns, but you benefit from the freedom to invest as much as you want to in any assets and have access to your funds whenever you choose. Once again, the temptation to withdraw your money before your retirement might rob you of the benefits of compound interest.

Understanding the rules of a product is essential before you commit to it. Changing midway could have massive tax implications and may even result in penalties. If you’re uncomfortable doing this by yourself then consult an independent financial advisor to help you review your options.

The Five Most Common Retirement Planning Mistakes

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Planning for your retirement very well may be the longest project you ever embrace. Most Americans spend about 50 years of their life working at least part-time, which amounts to a stunning 35% of your total life. It can be tough to envision what retirement will be like, let alone remain on track for multiple decades. Ninety percent of retirees needlessly suffer due to these retirement planning mistakes, so make sure you don’t make them!

Not Having a Retirement Plan

It’s easy to put off retirement planning until tomorrow. Then tomorrow becomes next week, next month, next year, next decade. Sure, it can be tough to look at where you’re going wrong or to realize that you’re not saving enough. But the only way to get your retirement on track is to have a plan. After all, if you do not know how much money you need, you’ll be chronically plagued by a sense of anxiety that you’re not saving enough—even if you’re making great progress.

Not Saving Enough for Retirement

Retirement planning is not magic. There’s no single account that will make planning for retirement easy. Instead, retirement is ultimately about the hard work of socking away money week after week, month after month, year after year—even when you’d rather spend it on something else or are worried about other financial obligations. No time is more valuable than now, because beginning now means benefiting more from interest payments than you will if you wait another five years. Thus failing to save enough money is the single most significant retirement mistake.

Counting on Government Programs

Medicare and Social Security are great benefits in retirement, but there is no guarantee they will be there forever—and there’s certainly no guarantee that you can expect the sort of payments your parents are currently getting or once received. Don’t count on these programs to supplement your income, and don’t factor them into your retirement plan. Instead, hope that they’ll be there. If they are, then you’ll have a nice cushion you can use to do something fun, rather than jut keeping you afloat.

If you’re nearing retirement and concerned about paying your bills, it’s fine to take into account Social Security and Medicare. You may also want to look into reverse mortgages, which offer reliable income with no requirement that you repay the loan. You need only be over the age of 62 and to own your own home.

Waiting for a Convenient Time to Save

Saving money is always difficult. When you’re 25, you’re probably broke. At 35, you may be starting a family or buying your first home. By 45, you might be concerned about saving for college or supporting your parents. Don’t wait for the right time, or you’ll wait right through retirement. Start saving today. Even if all you can afford is a dollar a week, some savings is better than none at all.

Wasting Your Money

It doesn’t matter how great the investment seems. If you spend more money on the financial advisor or investment fees than the investment offers, you might as well light that money on fire. The same is true of employer-matched retirement contributions. If your employer will contribute money to your 401(k), that’s free money! Max out your contributions every year. If you don’t, you’ve abandoned the easiest, lowest stress way to save, and neglected one of the most significant benefits of employment.

There Is No Ideal Time to Contribute to Retirement

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“Do you really think you should be voluntarily putting money into your retirement account?  It just seems like there are so many other things you could be using the money for right now.  Why don’t you wait to contribute to your retirement until you get more financially stable?”

Recently, I was lamenting our financial situation to a good friend.  I just had a dental procedure at a periodontist, I was just told my 6 year old has 8 cavities (that’s another story) that will cost $400 out of pocket to fill, and that my 10.5 year old will need braces to the tune of $5,000 or so.

Add on top of that the fact that our car has 150,000 miles on it, and we refuse to borrow for a new one, and well, I’m looking at a lot of financial stress.

Still, these expenses don’t have to be paid immediately.  I’m saving money every month for a new-to-us car when our old one finally gives out.  I may be able to wait a bit to get my son braces.

I just wanted to vent a bit to my friend and express my frustration.

I was really surprised by her answer.  She simply couldn’t understand why we would contribute to our retirement when we have so many impending expenses.

Yet, as Tracy Chapman sings, “If not now, then when?”

Good Time to Contribute to RetirementThere’s no good time to save for retirement.

You could always use the money for something else.

When my husband and I were newly married 14 years ago, I made a little over $30,000 a year.  We lived in the suburbs of Chicago, which wasn’t cheap.  My husband was a graduate student and didn’t work.  We were flat out broke.

And my employer had a mandatory rule that 8% of my gross income would go to my retirement savings.

I HATED that rule.  There were so many other things that I could have used that money for, but I had no choice.

Eleven years later, when I left the job and walked away with 11 years of retirement savings at 8% of my gross salary plus an equal match by my employer, I was ecstatic that I was forced to save for retirement.

Now, my husband is working for an employer who has the same rule, and we’re happy that 8% of his gross salary goes to his retirement account.

We’ve learned our lesson so well, in fact, we are also contributing to our Roth IRA even though money right now is T-I-G-H-T.

But really, for most Americans, money is almost always tight.

I would rather scrimp and save now, while we still have many working years left before retirement than scrimp and save during retirement, constantly worrying if I had enough money to last me until the end of my life.

So, no, my well-intentioned friend, I don’t think I should stop contributing to my retirement.  In fact, there’s no better time than now to save for retirement.

If not now, then when?

Do you continue to contribute to your retirement when facing large expenses, or do you wait to contribute until your finances improve?