3/22/2012 2:00 PM ET|
How to finance life to 100
Building a nest egg that will last until a ripe old age demands a disciplined and savvy savings strategy. These steps can help you accomplish that goal.
Living to 100 sounds wonderful -- until you start thinking about how to pay for it. If you retire at age 65 and live until 100, that's 35 years of retirement you'll need to finance. Here are some ways to build a nest egg that will last you until age 100.
Claim retirement saving tax breaks. Your savings will grow faster without the drag of taxes. In 2012, retirement savers can defer paying income tax on up to $17,000 in a 401k, 403b or the federal government's Thrift Savings Plan, and $5,000 in an individual retirement account. For investors age 50 and older, those limits jump to $22,500 in a 401k and $6,000 in an IRA. Low-income workers whose modified adjusted gross incomes are up to $28,750 for singles, $43,125 for heads of households and $57,500 for couples can also claim a tax credit (worth up to $1,000 for individuals and $2,000 for couples) when they save for retirement in a 401k or IRA.
Add tax diversification. While traditional retirement accounts give you a tax break in the year you make contributions, income tax will be due on each withdrawal. Roth IRAs and Roth 401k's allow you to tuck away after-tax dollars for retirement, which means withdrawals after age 59½ from accounts that are at least five years old are tax-free. (Should you convert to a Roth IRA? Find out with MSN Money's calculator.)
To decide which type of retirement account is better for you, compare your current tax rate to your expected tax rate in retirement. Those who expect to be in a higher tax bracket in retirement have the most to gain by paying taxes upfront using a Roth account. Roth accounts also give you easier access to your money before retirement and greater flexibility to time your withdrawals in retirement.
"Having some money in a pretax IRA can give you some options to lower your tax rate later in life," says John Ameriks, the head of the investment counseling and research group at Vanguard. Traditional IRA and 401k account balances can be converted to Roth accounts if you pay income tax on the amount rolled over. The Internal Revenue Service removed a $100,000 income limit in 2010 that previously prohibited high earners from making the switch. (Check MSN Money's calculator to see if your 401k is likely to provide enough for retirement.)
Avoid fees. The costs and fees associated with your investments add up significantly over the course of your career and retirement. An investor paying 1% a year in fees who holds an investment for more than 25 years will pay 25% of what he or she would have earned to a service provider, according to Vanguard calculations.
"The lower you can get that fee, the more money you are going to have in retirement," says Ameriks, who advises choosing funds with expense ratios of 20 basis points or less. Sometimes you can negotiate lower fees by consolidating the bulk of your investments with a single financial institution.
Maximize Social Security. Social Security is your first line of defense against outliving your savings, because the payments will continue for the rest of your life and are adjusted for inflation each year.
"One of the most effective things you can do to protect yourself against both inflation and longevity is to postpone taking Social Security until age 70," says Zvi Bodie, a Boston University professor and co-author of "Risk Less and Prosper." Between ages 62 and 70, Social Security payouts increase for each year you postpone claims. Delaying claiming increases the amount you will receive in your later years, when you are most likely to need the money.
Consider an annuity. Traditional pensions generally provide annuity payments that last the rest of your life. Those without a pension can create their own by turning over a portion of their savings to an insurance company in exchange for a promise of lifelong steady payments.
"If you buy a solid annuity from an insurance company, it doesn't matter how long you live, because you have transferred that risk to the insurance company," says Bodie.
When deciding how much of your wealth to annuitize, consider the proportion of your annual expenses that are covered by other sources of income.
"You want to make sure that between Social Security and any defined-benefit plan you have and any annuities you purchase that all your basic expenses are covered for the rest of your life," says Jack VanDerhei, the research director at the Employee Benefit Research Institute.
Protect yourself from health care costs. Medicare will protect you from many but not all of the health care expenses you will incur in retirement. Consider purchasing a supplemental policy to Medicare that fills in some of the gaps that Medicare doesn't cover. Middle-income retirees may also want to purchase long-term-care insurance in case they require assisted-living or nursing home care, which Medicare alone generally doesn't cover.
"Assisted living can be horribly expensive," says Frank Armstrong, a certified financial planner and founder of Investor Solutions. "The very poor are going to be covered by Medicaid and the very rich can afford it, but the middle class needs to insure against long-term-care costs."
Draw down smart. Once you accumulate a large nest egg, you need a plan to spend it at a reasonable rate. Armstrong recommends spending 4% or less of your savings each year to help ensure that it will last the rest of your life.
"If you can't make it with the amount of money that a 4% withdrawal rate provides, then maybe you ought not retire," he says. Remember that you will be required to take annual withdrawals from traditional retirement accounts after age 70½ and pay income tax on the amount withdrawn.
"The million dollars you think you own in a 401k is actually only $750,000 after taxes," says Armstrong.
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