RETIREMENT PLANNING: CREATING A NEST EGG
Last time, we discuss the different income sources for building a retirement fund. We shall now tackle the ways to create a retirement nest egg.
A lot of financial products, investment accounts, and savings plans are available in the market if you wish to create a retirement fund. Also, several countries offer government-sanctioned retirement accounts that provide for tax-deferral while your savings grow in the account.
Majority of developed countries provide government-sponsored investment accounts for those who seek to build retirement savings and enjoy tax-saving advantages. However, bear in mind such offers have limits in terms of contribution amounts and age limits at which you will stop receiving the benefits of these plans. It is advised to use up the contribution room for government-backed accounts before looking for other avenues.
This voluntary investment account allows up to a specific percentage of an employee’s pre-tax income to be contributed to this account. Meaning you need not to claim a part of your salary you contribute to 401(k) as employment income for the year it is generated. All investment gains from the 401(k) are not taxable, provided they remain in the fund. Plans, contributions, and percentage of earnings differ from company to company.
Individual Retirement Account
IRA is a retirement savings account enabling an employee to make a contribution of their income up to a particular amount. Known for tax-rate optimization, IRA contributions can reduce an individual’s taxable income, and capital gains are tax-deferred until he or she starts withdrawing funds as income. Rules, as well as whether contributions are tax deductible vary depending on the person’s income levels and other related factors. By deferring taxation on funds you contribute to your IRA, not only you will likely to be taxed later, but also enjoy lower tax rates on the funds.
Believe it or not, some private entities still offer defined-contribution plans or defined-benefit pension plan to their employees. Let us differentiate the two.
A defined-contribution plan can either be a money-purchase pension plan or profit-sharing plan where only the employer makes contributions, or a 401(k) plan in which an employer matches the contribution of their employees. An employer gives regular contributions, normally monthly.
The value from this plan depends on the amount of time invested over time, as well as the returns generated by its investments. If the investments perform well, you will reap the benefits. Otherwise, you suffer the effect of poor market performance. In simplest terms, the eventual size of your nest egg is not assured.
On the other hand, in a defined-benefit plan, the employer uses a formula to compute a specific monthly retirement allowance each employee receives when they retire. It also requires monthly contributions. Benefits are determined according to various factors, including the number of years an employee has become a member of the pension plan, average salary, and retirement age.
Unlike a defined-contribution plan, the employer guarantees the specific amount an employee receives each month for the rest of his or her golden years, regardless of the market’s overall performance.
Other retirement products are available also, such as annuities (via insurance companies), term life insurance, and whole life insurance. All it takes is finding the right vehicle which best suits your financial situation.
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