If you have young kids or you’re still building your career, retirement may not be top of mind at this point in your life. But someday, if you’re lucky and save on a regular basis, it will be.
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To have the best retirement, it’s wise to create a plan early in life — or right now if you haven’t yet done so. By diverting a portion of your paycheck into a tax-advantaged retirement savings plan, for example, your wealth can grow exponentially to help you achieve financial security for those so-called golden years.
Retirement benefits are so important that they should be a top consideration when you’re shopping for a new job. Yet only about half of current employees understand the benefits offered them, according to the Employee Benefit Research Institute.
“Plan design is individualized, so one company’s benefit formula may not be as generous as others,” explains David Littell, professor of taxation and a retirement planning expert at The American College of Financial Services. “It’s really important that you read the summary plan description that is provided to all participants so that you can understand the design of the plan.”
Bankrate picked Littell’s brain about the best retirement plans available to workers to discover their pros and cons.
Key plan benefits to consider
Virtually all retirement plans offer a tax advantage, whether it’s available up front during the savings phase or when you’re taking withdrawals. For example, 401(k) contributions are made with pre-tax dollars, which reduces your taxable income. Roth IRAs, in contrast, are funded with after-tax dollars but withdrawals are tax-free.
Some retirement savings plans also include matching contributions from your employer, such as 401(k) plans, while others don’t. When trying to decide whether to invest in a 401(k) at work or an individual retirement account (IRA), go with the 401(k) if you get a company match – or do both if you can afford it.
If you were automatically enrolled in your company’s 401(k) plan, check to make sure you’re taking full advantage of the company match if one is available. And consider increasing your annual contribution, since many plans start you off at a paltry deferral level that is not enough to ensure retirement security. Roughly half of 401(k) plans that offer automatic enrollment, according to Vanguard, use a default savings deferral rate of just 3 percent. Yet T. Rowe Price says you should “aim to save at least 15 percent of your income each year.”
If you’re self-employed, you also have several retirement savings options to choose from. In addition to the plans described below for rank-and-file workers as well as entrepreneurs, you can also invest in a Roth IRA or traditional IRA, subject to certain income limits, which have smaller annual contribution limits than most other plans.
Best retirement plans in 2019
Pensions, more formally known as defined benefit (DB) plans, are the easiest to manage because so little is required of you. Pensions are fully funded by employers and provide a fixed monthly benefit to workers at retirement. But DB plans are on the endangered species list because fewer companies are offering them.
Just 16 percent of Fortune 500 companies enticed workers with pension plans in 2017, down from 59 percent in 1998. Why? DB plans require the employer to make good on an expensive promise to fund a hefty sum for your retirement.
Pensions, which are payable for life, usually replace a percentage of your pay based on your tenure and salary. A common formula is 1.5 percent of final average compensation multiplied by years of service, according to Littell. A worker with an average pay of $50,000 over a 25-year career, for example, would receive an annual pension payout of $18,750, or $1,562.50 a month.
Pros: This benefit addresses longevity risk – or the risk of running out of money before you die. “If you understand that your company is providing a replacement of 30 percent to 40 percent of your pay for the rest of your life, plus you’re getting 40 percent from Social Security, this provides a strong baseline of financial security,” says Littell. “Additional savings can help but are not as central to your retirement security.”
Cons: Since the formula is generally tied to years of service and compensation, the benefit grows more rapidly at the end of your career. “If you were to change jobs or if the company were to terminate the plan before you hit retirement age, you can get a lot less than the benefit you originally expected,” says Littell.
What it means to you: Since company pensions are increasingly rare and valuable, if you are fortunate enough to have one, leaving the company is a major decision. Should you stay or should you go? It depends on the financial strength of your employer, how long you’ve been with the company and how close you are to retirement. You can also factor in your job satisfaction and whether there are better employment opportunities elsewhere.
2. Cash-balance plans
This is a type of defined benefit, or pension plan, too. But instead of replacing a certain percentage of your income for life, you are promised a certain hypothetical account balance based on contribution credits and investment credits (e.g. annual interest).
One common setup for cash-balance plans is a company contribution credit of 6 percent of pay plus a 5 percent annual investment credit, says Littell. The investment credits are a promise and are not based on actual contribution credits.
For example, let’s say a 5 percent return, or investment credit, is promised. If the plan assets earn more, the employer can decrease contributions. In fact, many companies that want to shed their traditional pension plan convert to a cash-balance plan because it allows them better control over the costs of the plan.
Pros: It still provides a promised benefit, and you don’t have to contribute anything to it. “There’s a fair amount of certainty in how much you’re going to get,” says Littell. Also, if you do decide to switch jobs, your account balance is portable so you’ll get whatever the account is worth on your way out the door of your old job.
Cons: If the company changes from a generous pension plan to a cash-balance plan, older workers can potentially lose out, though some companies will grandfather long-term employees into the original plan. Also, the investment credits are relatively modest, typically 4 percent or 5 percent. “It becomes a conservative part of your portfolio,” says Littell.
What it means to you: The date you retire will impact your benefit. “Retiring early can truncate your benefit,” says Littell. Working longer is more advantageous.
Also, you’ll get to choose from a lump sum or an annuity form of benefit. When given the option between a $200,000 lump sum or a monthly annuity check for $1,000 for life, says Littell, “Too many people,” he says, choose the lump sum when they’d be better off getting the annuity for life.”
If you’re married and don’t want to leave your spouse in the lurch in the event you predecease him or her, consider a joint-life annuity rather than a single-life annuity.
3. Profit-sharing plans
Some companies offer a profit-sharing plan to their workers as an incentive for them to be productive so that they can both help boost and share in the company’s profits….