Wednesday, May 19, 2010

Retirment Finances Troubleshooting and Catch-Up

Troubleshooting

As you build your retirement fund, you'll likely experience some bumps in the road along the way. One of the most common problems you'll encounter is an inability to make your monthly retirement contributions. A number of financial pressures can arise to make the process difficult, but fortunately there are ways that you can tilt the odds in your favor.

First of all, set up automatic payments from your checking account (your bank should be able to help you do this) into the investment account you are building your retirement fund with. This is commonly referred to as "paying yourself first". Once it's set up, each time you get your paycheck, your desired savings contribution will go right out to your investment account before you have a chance to spend it.

Additionally, if you participate in a 401(k) plan, try to make the maximum salary deferral contribution allowed. If your employer offers a matching contribution, at least try to contribute enough to ensure you receive the maximum matching contribution.

Automatic savings will make it a lot easier to avoid spending your contributions on things you can realistically do without. And if serious financial problems do crop up that require the use of your investment funds, you can usually access those that are deposited to an after-tax account without incurring penalties. The point of the automatic contribution is to avoid any instances of spending too much and missing out on your contributions unnecessarily.

If you do dig yourself into a deep hole of credit card debt, however, it's important you deal with the problem as quickly as possible. Create a feasible budget to pay down your debt and stick to it. Consider consolidating your debts into one account - this can lower your overall interest rate and help you pay off those debts quicker.

Other problems may crop up, but provided you're able to maintain your monthly contributions, you should be in good shape. If you are having prolonged difficulty following your plan, consider seeking the help of a financial planner.

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What If I'm Late Getting Into the Game?

If you are beginning your retirement savings late in life, you will need to work hard to catch up. The first thing you can do is create a budget for your current expenses so that you can maximize monthly contributions to your retirement fund. With budgeting, a little goes a long way, and if you track your expenses for a month you will likely find that skipping the occasional dinner out can save you hundreds of dollars, which can go a long way to boosting your retirement savings. The main goal is to ramp up your savings rate as much as possible.

You might also consider alternative ways to boost your financial situation. Second jobs are an option, but not a particularly pleasant one. If you own your own home, consider renting out the basement or taking on a roommate in order to lower your living expenses. Converting part of your residence into an income-generating asset can do wonders for your overall retirement plan.

Once again, part-time jobs during retirement can be a feasible way to catch up. If you're able to earn a modest income during your retirement years, your financial picture can change drastically - especially if you are an active type of person. You may actually prefer semi-employment during your golden years instead of 100% leisure time.

Catch-up Contributions

Catch-up contributions are special provisions that allow you to contribute additional funds to your retirement accounts as you get closer to retirement. This has the double benefit of helping beef up your retirement savings while deferring taxes.

Someone maxing out a 401k with an 8% earnings rate would save just over $500,000 between ages 50 and 65. Someone taking full advantage of catch-up contributions would save over $667,000 in that same time period:

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Over 50 Catch up Contribution Limits

Most retirement accounts allow for additional contributions for account holders over 50:
  • 401(k), 403(b), 457: May contribute $5,500 above the limit of $16,500, for a total of $22,000. Remember that the 401k catch up limit applies to the total of all 401k and 403b accounts held by one employee, even across multiple employers. 457 accounts have a separate $22,000 limit.
  • Traditional IRA/Roth IRA: Up to $1,000 above the standard $5,000 maximum Roth contribution.
  • SIMPLE IRA: Up to $2,500 above the standard $11,500.
403b 15-year Catch-up

If you have 15 years of service with a public school system, hospital, home health service agency, church, or certain other organizations, you can increase your 403(b) contributions by the lesser of:
  • $3,000
  • $15,000 reduced by previous catch-up contributions under this rule
  • $5,000 times the number of years of service minus total contributions made in earlier years
The IRS explains further. Note that this applies to all employees with 15 years of service at a qualified organization, regardless of age. If you are over 50 you may take this AND the over-50 catch-up noted above.

457 Double Limit Catch-up Contribution

In the three years before normal retirement age (as defined in plan document), government and certain non-government employees may take what’s known as the “double limit catch-up.” If you did not contribute the maximum possible amount in previous years, you can contribute the lesser of double the current year’s maximum amount ($16,500) OR the sum of “missed” contributions in previous years. For example:
  • If you have $10,000 of unused contributions, you can take an additional $10,000 in any one of the three years before retirement.
  • If you have $30,000 of unused contributions, you can take an additional $10,000 in each of the three years before retirement.
  • If you have $100,000 of unused contributions, you can double maximum contributions for three years before retirement, but won’t ever be able to make up that $100,000 completely.
If you always maxed out your contributions, this rule does not apply to you. If you take this catch-up you cannot take the over-50 catch-up for 457s.

Note that current tax and catch-up rules allow you to contribute up to $25,000 to a $403b and $33,000 to a 457 in one year – not to mention another $6,000 to an IRA!

Invest with caution

Direct your extra contributions to investments that will correct imbalances in your portfolio. For instance, if you were smart or lucky enough to pile into stocks when values were way down, put most of your catch-up money into fixed-income investments. This is no time to try to make back your losses with high-risk investments. With just 10 to 15 years to retirement, you need to avoid another big hit.

A prudent mix for fifty-something: around 55% stocks, 45% bonds and cash. "It's no longer about shooting for maximum gain," says Clifford Michaels, a financial planner in New York City. "It's about matching your investments to your time frame." 

Your Home May Be a Source of Funding for Your Retirement

If you own a home, it could serve as one of the means of financing your retirement - either by selling it and moving to a smaller, less expensive home or by using a reverse mortgage. A reverse mortgage allows you to convert a portion of the equity in your home to tax-free income while retaining ownership (of the home). A reverse mortgage can be paid to you as a lump sum, as a line of credit and/or as fixed monthly payments. If you decide to pursue a reverse mortgage, be sure to factor in the costs, which are similar to those that would usually apply when a house is being purchased. This includes origination fees and appraisal fees.

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First, to be eligible, you must be over sixty-two years of age, own your home, and be living in it as your primary residence. The amount you are eligible for depends on your age, interest rates and the value of your home. Most reverse mortgages for seniors are set up so the home owner can receive monthly payments.

Advantages
  • Reverse mortgages for seniors can be set up as a monthly payment, line of credit or a lump sum—whatever works best.
  • No matter how the reverse mortgage is set up, the home owner does not make any monthly payments.
  • No monthly payment is due from the home owner unless he or she dies, moves or sells the home. At that time, the loan is due in full, plus interest and fees.
  • The home owner can receive monthly income from a reverse mortgage as long as he or she lives in the home as a primary residence. A home owner could potentially continue to receive monthly payments even after the loan balance is higher than the amount that the house is worth.
  • Neither the home owner nor his or her heirs will ever owe more than the home is worth, no matter how many payments are received or how high the interest rates become.
  • It’s fairly easy to qualify for this loan since credit scores and income are not part of the qualification process.
Disadvantages
  • Reverse mortgages for seniors have high closing costs. The senior must pay origination fees that are about double what they are for conventional mortgages and mortgage insurance. The interest rates are adjustable.
  • For seniors who depend on Medicaid or other state or federal programs, it’s important to consider if reverse mortgage payments will affect their eligibility.
The senior is required to attend counseling by an independent HUD counselor prior to receiving a reverse mortgage. These are complex loans and this is a measure of consumer protection, and this point should be high on your reverse mortgage pros and cons checklist.


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