I started this story asking how much is too little. That is, how do I know if I have enough money for my future or is it too little? If it is too small, what do I need to do now? Life is supported by income streams. When we are born, we depend on our parents to pay for our food, clothing, home and so on. Then we leave home and start our own streams with a job or business or both. That stream needs to cover a number of things and how we approach those things is the real trick.
We need to know what we need versus what we want. If what we need exceeds our stream, we will do what we can to improve matters. We might get assistance from the government or family or we might find a second job or even just a better job. No matter, each has its own consequences and costs. Ideally, you want to find an income stream that meets your needs for the present and future. Along the way you would also like to have something you find interesting and challenging enough to keep you interested over the years. Reaching retirement is, afterall, a long journey, especially when viewed from our youth.
I have found that a general rule for retirement money is to take 5% from whatever savings I have and combine that with any pensions I might also receive. To do this assumes I will live another 20 years, and then I won't need any more. It also assumes that there will be an equal amount of money from year to year. What happened to retirees when the big crash hit is that they might have been on just year 10 or so with less than a few years left of funds. And when they took money out, it actually cost them more than when they had more value. For example, let's say I have $100,000 and I am taking my $5000 out each year. The first year I draw my account down to $95,000 then $90,000 and so on. But then the market crashes and my $90,000 is only worth $50,000. What can I do? I could just take 5%, or $2,500, but I need 5. That means the money I take out is going to cost me double what I would have had to take out when I had my value. That also leaves me with an even smaller fund to grow back when the market recovers. Doing this is called annuitizing the fund, or taking out a set amount annually. Unfortunately, I have no control over the value of the account as I draw against it.
I also need to be aware that taxes and inflation can eat up what I have earned. I need to find something that stays ahead; basically I need to row faster than the flow of the stream o rI will be pulled under. The most common savings plans available now are the pre-tax accounts such as 401k, 403b, and IRAs. These are all methods of saving as defined by our tax code. We are allowed to take a certain percentage of our pay before taxes are applied and save it in an account we can't touch. The rules of engagement are such that if we do take money out we pay a high penalty in taxes as a way to prevent us from using it too early. Saving and growing pretax is always better than allowing my earnings to be taxed each year. If you had one dollar and it was able to double every year for 20 years tax free, it would be worth over $1 million. (If you want to check the math, take 2, the first double and multiply to the 19th power. Isn't math fun?) If you did that with another dollar and taxed it at 35% at each growth, you would only have about $27,000. Big different, huh?
I like the tax free growth, but what I don't like is that my only choices are the mutual funds to invest my money. Mutual funds are basically clusters of stocks with different types of risk. Looking at the market in the last five years, though, it seems that all are just different ways of approaching a slot machine. A gamble, no matter how you look at. Or is it?
Enter my annuity. An annuity is a savings plan with a life insurance company. I can give them money that will be invested in a number of different ways and at some time I can begin to withdraw a payment from it. The beauty of the annuity is that I can have it pay me until I die, even if the original fund runs out of money. I can also set it up so that should I die before my wife, she will also receive a payment until she dies. Try to do that with a 401k. There are a number of different plans, depending on where you are financially. Annuities can be set up as traditional IRAs or Roth IRAs.
A traditional IRA is similar to a 401k in that it is funded with pre-tax money. A Roth IRA lets me invest with after tax money, my take home pay from work and invest it. The growth is tax free as it grows and, better still, all the money comes out tax free, assuming I follow the rules of the plan. If you have money from a previous employer, you can roll your money over as a rollover IRA. In my case, I rolled over money I had in previously rolled over money that was shrinking rapidly in the market. My plan lets me invest my money in the same sorts of mutual funds so I can still take advantage of market growth. But here is the real beauty of the plan. When the market value of my account drops, the insurance company keeps my fund at that highest amount and then pays interest. When the market recovers, the company allows my fund to grow again. What that means is I not only stay with the market as it grows, I also don't have to suffer the losses when it shrinks.
As my money went in from previous money I had invested pre-tax, I will have to pay taxes on the money someday when I withdraw it. Still, it is a far better solution than just praying the market will protect me. I am using the power of a company worth ten times the value of Microsoft. I think that is a pretty good deal.
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