2003-12-10 / Business & Finance

How To Save More For Your Retirement

How To Save More For Your Retirement

"What, me worry?

Alfred E. Newman

This is the mantra of today. There is a mountain of evidence that says we Americans do not save a sufficient amount of money for our retirement. Well, you don’t need to save unless you don’t need to eat, drink or play golf after retirement. Estimates are that Americans will need 60 to 80 percent of their pre-retirement income - lower in-come earners may need up to 90 percent - to maintain their current standard of living when they stop working. Yet few families have amassed the capital to produce those levels of income.

Ok, we need to save more. The question is, "How to best do ‘it?" The answer is, "Inside a qualified plan." Next question, "What is a qualified plan?" Answer, "One that has the blessing from Uncle Sam to have certain benefits."

These benefits include an income tax deduction on contributions to the plan. Employer and employee contributions are not taxed until they are distributed to the employee, and money in a retirement program grows tax deferred. The first federal rules on pension plans, ERISA, came in 1974; there have been endless changes since then.

The latest change can be found in the pamphlet Choosing a Retirement Solution for your Small Business which is a joint project of the U.S. Department of Labor’s Pension and Welfare Benefits Administration, the Internal Revenue Service, the U.S. Small Business Administration, and the U.S. Chamber of Commerce. It contains some goodies for almost everyone.

If you are an employer, retirement plans can help you recruit, retain, retire, and reward employees (including yourself and your family). If you are an employee, by funding your employer sponsored retirement plan as fully as you can, you too can achieve the above. If you are self-employed, you can establish a plan for yourself whether you are incorporated or not. And if you do, according to the government, you will not be alone because "More than one million small businesses with 100 or fewer employees offer workplace retirement savings plans."

Here’s a primer on qualified plans. Most private-sector retirement plans are either IRAs (Individual Retire-ment Arrangements), defined contribution (DC) plans, or defined benefit (DB) plans.

An IRA is the most basic sort of retirement arrangement. Although many people set these up themselves, an employer can also help employees set up and fund their IRAs. With an IRA, the amount that an individual receives at retirement depends on how much has been put in and on how much that money is able to grow and earn. Time is of the essence. The earlier it is started, the more likely it is to achieve significant growth.

Defined contribution plans are employer-established plans that, rather than promise a specific benefit at retirement, base the retirement amount on the sum of what’s contributed and what that earns and grows to. In other words, an employer (and sometimes employees, or both) contribute to retirement accounts established for employees, sometimes at a set rate (e.g. 5 percent of salary annually). At retirement, the employee receives the accumulated contributions plus earnings (or minus losses) on those invested contributions.

As the name implies, when an employer sets up a defined benefit plan, the company promises an employee a specified benefit at retirement. For instance, the promise might be to pay $ 1,000 a month at retirement. Actually, the amount of the benefit is often stated as a specified percentage of the employee’s last three years’ average pay - or some similar formula - multiplied by the number of years the employee worked for the employer offering the plan. Obviously, the employer typically will set up a fund that will be sufficient to provide the promised benefits as they are payable.

Although there are "prototype IRS pre-approved" plans, there are also tailor-made customized IRAs, DC plans or DB plans.

Recently enacted higher contribution limits make it possible for employers and employees to set aside more money than ever for retirement. Special "Catch-up" rules allow employees aged 50 and over to set aside an additional $500 (or $ 1,000, depending on the type of plan) this year. There’s a new provision in the law for small employers that makes it possible to claim a tax credit for part of the ordinary and necessary costs of starting a SEP (Simplified Employee Plan), SIMPLE, or certain other types of plans.

This credit equals 50 percent of the cost to set up and administer a new plan, up to a maximum of $500 per year for each of the first 3 years of the plan; and there’s a tax credit for certain low and moderate in-come individuals (including self-employed) who make contributions to their plans ("Saver’s tax credit"). The amount of this credit is based on the contributions participants make and their credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10 percent or as high as 50 percent, depending on the participant’s adjusted gross income.

It is not difficult to get Publi-cation 3998 (Rev. July 2002 and released Aug. 6, 2002), "Choosing a Retirement Solution for Your Small Business." For a complete list of PWBA publications, call toll-free: 1-866-275-7922. This material is also available to sensory impaired individuals upon request. Voice phone: 1-202-693-8664; TDD phone: 1-202-501-3911. The pamphlet is also available from the Internal Revenue Service at (please indicate Catalog Number when ordering): 800-TAX-FORM (1-800-829-3676).

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