How to Play the New Game of Retirement Saving

When it comes to life after work these days--this isn’t your father’s retirement.

A variety of factors--the growing costs of covering retirees who are living longer, market volatility, and funding difficulties stemming from the Pension Protection Act of 2006--have changed the game of retirement saving. Namely, it’s shifted the responsibility of paying for retirement from employers to employees.

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“The bottom line is we are in a crisis,” said Kathy Boyle, CFP and president of Chapin Hill Advisors, Inc. “We are under funded for the majority of defined benefit plans [defined sums of money a company sets aside for employees to give to them upon retirement]. That has to go the way of the highway. There’s an aging population. The bottom line is the burden comes down to you now.”

In the past few years, Americans have watched major corporation after major corporation freeze or completely cut their workers’ defined benefit plans. In 2005, United Airlines (UAUA), amid bankruptcy, terminated their defined pensions for more than 119,000 employees. That same year, Verizon Communications (VZ) said it was freezing benefits for 50,000 managers. In 2006, General Motors (GM) announced it was doing away with the pensions of 42,000 of its employees.

For those workers fortunate enough to still be receiving some kind of retirement option, defined benefits are steadily being replaced with defined contribution plans --think 401k’s-- where what one receives upon retirement depends heavily on investment strategy and market gains and losses.

“Retirement is on the backs of employers these days,” said Nancy Langdon Jones, a California-based certified financial planner. “It’s a scary thing, because fewer and fewer companies are offering pensions. It’s up to [employees] to figure out what to do with their own retirement.”

So what should you be doing to make sure that, in these shaky economic times, you’ll be financially OK when it's time to retire? Aside from winning the lottery, there isn’t a magic trick or fancy loophole. It all comes down to the basics: saving, smart investing and beginning early.

The Benefits of Planning Early for Retirement

Most financial planners will give it you straight: There’s no excuse for 20 and 30-somethings not to be thinking about retirement already, especially considering the fact that by now, most have seen what’s happened to workers at United, GM, Verizon and more. They should be knowledgeable that employer defined benefit plans are going the way of VHS tapes and Polaroid cameras: soon to be a fad of the past.

“You can’t be an ostrich and put your head in the sand,” said Boyle. She points to a major incentive to start putting away money now for retirement: the beauty of compound interest.

“Let’s say a 19-year-old starts putting $2,000 a year away into a tax-deferred vehicle, like an IRA and then stopped at age 30,” she said. “Then let’s say another 30-year-old decides they want to try and catch up and put $2,000 of their own into an account every year, all the way up to the age of 65. Assuming the rates of return are the same, the 19-year-old who stopped at age 30 would still have more money -- by almost $100,000 -- if you compared the two funds at the end.”
  
And speaking of tax-deferred vehicles--the experts agree, if you’re eligible to contribute to a Roth IRA, do it.

Roth IRA Funds

“I think the Roth IRA is not recognized enough” said Langdon Jones. “It’s just such a great retirement vehicle.”

What makes Roth investment retirement accounts so attractive? Namely, their tax structure. To boil it down: When you contribute to a regular IRA account, you can be taxed on your initial contribution and whatever profits are generated over time.

With a Roth IRA, if the account has been open five years and you are older than 60, you can’t be taxed on any earnings from it--only on your initial contribution, which comes from your already earned, non-deductible income. And if you have done well and saved and your net-worth is high, you can leave the money to your heirs – income-tax free.

“We love Roth IRAs'” said Richard J. Drew, director of Financial Planning for Hayden Financial Group. “Given our rising national deficit, combined with social security, Medicare, defense and economic stimulus, the prospects for higher taxes in the future are much greater. Consequently, Roths offer an attractive tax-shelter for investment funds. Many baby boomers who are now approaching retirement look forward to year 2010 when they can convert (all or part of) their traditional IRAs to Roth IRAs without the current $100,000 MAGI limitation.”

Personal Accounts

If you don’t meet the requirements for a Roth IRA and your employer isn’t offering a 401(k) or pension plan – then you must take matters into your own hands, head to the bank, and set up a money market fund specifically for retirement.

“You don’t have to have an account that says ‘this is a bona-fide government account,’” said Langdon Jones. “You can take any investment account and just earmark it for retirement. It can be an account you develop yourself. Just put that money away and treat it as if it were a 401(k) plan. Don’t touch it.”

One of the added values of setting up your own retirement fund in what she calls a ‘plain old vanilla savings account’ is that upon reaching retirement and withdrawing money from the fund, the only items on which you’ll be taxed are the capital gains --whereas with any money taken out of a pension plan or 401(k), 100 percent of it is taxable.

With today’s uncertain economy, personal savings are greatly needed, said Kathy Boyle.

“We tell our clients there are four sources of retirement income: Social Security, some kind of pension benefit, and retirement plans like IRA’s and 401(k)’s,” she said. “The first three legs are not enough to carry you. The rest has to be made up in savings.”

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