No IRA or 401(k)? Start one, or both

Getting Started

Your Money

February 22, 2004|By JULIE CLAIRE DIOP

The older generation is forever warning the young that we'd better start saving for retirement before it's too late. But that's easier said than done.

Since I left college, I've worked at several companies that did not let me contribute to 401(k) plans, and I've gone back to school.

Plus, there's always something important to spend my money on.

Ready for a reality check? Go to the government's Social Security Web site, www.ssa.gov, and click on "Calculate your benefits," then "Calculators."

FOR THE RECORD - The "Getting Started" column in the Business section Sunday gave erroneous information about limits on 401(k) contributions. While some plans still have percentage limits, government regulations now permit a maximum annual contribution of $13,000 or 100 percent of an individual's salary, whichever is less. People over age 50 can contribute up to $16,000.

If you're 25, earn $32,000, and expect your salary to keep up with inflation, at 67 you will be eligible for $14,500 a year in today's dollars. In the Dominican Republic or Djibouti, that could go far, but not here.

But how can a wage slave save enough for a comfortable retirement even if you start now?

The least painful and most cost-effective place to start is your company's 401(k) plan, especially if the company matches the money you put in. You can put in up to $13,000 a year - as long as this is no more than 25 percent of your salary - and it's deducted automatically from your paycheck. You don't pay income taxes on the part of your salary you contribute, and the money grows tax free.

Stuart Ritter, a financial planner at T. Rowe Price, advises that you contribute as much as you can but at least enough to take full advantage of your company's match. Otherwise, you're passing up free money.

It's nearly impossible to beat the return on 401(k) money. If you earmark $100 of your salary for a 401(k), it's $100 before taxes. If you invest it on your own, you would pay roughly $30 in taxes, so you actually would have only $70 to invest.

You pay taxes when you take the money out, but it has grown tax-free and not even the savviest investors could beat the overall return.

Many people in their 20s work as freelancers, in temporary jobs or are still students, and don't have access to 401(k) plans. They can invest in individual retirement accounts. The maximum you can contribute to an IRA is $3,000 a year, and the tax advantages are comparable to what you get investing in a 401(k) plan, but without the company match.

You can choose between two types of IRAs, a traditional and a Roth IRA. Your contributions to a traditional IRA are tax deductible, while you pay taxes upfront on what you contribute to a Roth. But you pay income tax on what you take out of the traditional IRA, and there are no taxes due when you collect from your Roth. Choosing an IRA depends on your circumstances, so it's best to get outside advice before deciding.

The next step is to invest wisely. Advisers seem to agree on two things: Don't buy too much of one stock, and take more risks when you're younger. With a 40-year investment horizon, put 70 percent to 90 percent of your money in stock funds. Your goal is growth.

To minimize the risk of betting on the wrong sector, many people put a good portion of their retirement money in index funds, such as an S&P 500 fund. Then you do as well as the market and don't pay the management fees you would pay in an actively managed fund, which often doesn't have a return as good as an index fund does.

It seems daunting to realize that you'd need to have saved $1 million if you were 65 today and wanted income of $45,000 a year for 25 years. But keep this in mind: If you invest $3,000 a year in an IRA starting at age 20 and make an 8 percent return, when you're 70 you'll have $2 million.

Between a 401(k) plan and a Roth IRA, the maximum you can save is $16,000 a year. While that may be enough for an adequate income in retirement, you won't do as well as former New York Stock Exchange Chairman Richard A. Grasso, who used to watch over the buyers and sellers of the stocks that make up your accounts.

Grasso, who resigned in September amid controversy over his more than generous compensation package, ended up receiving $140 million.

E-mail Julie Claire Diop at yourmoney@tribune.com.

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