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Ask Money

Options for retirement savings

Chris Farrell Aug 2, 2011
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Question: What are my options for saving for retirement when my employer does not offer 401K retirement plan? I have a traditional IRA account (rolled over from my previous employer) and my understanding is that the contribution to that is limited to 5K/year. I want to maximize my retirement savings. Note that we expect that this year our household income will be around 250K. Thanks for the wonderful programming and keep up the good work. Geeta, Fremont, CA

Answer: I don’t like it, but the main option available to you is a traditional IRA or a Roth-IRA. As you say, the annual contribution limit is $5,000 ($6,000 if you’re 50 and over).

The current retirement system doesn’t make sense. We have an aging population. We’re told again and again and again that it’s important to save for retirement. Yet our Byzantine retirement savings system throws up all kinds of obstacles toward savings instead of making it simple to set money aside for old age. For instance, why is the maximum contribution $16,500 for an employee with a 401(k) at work while an employee like you without access to a retirement savings plan at work or a stay-at-home spouse taking care of the kids and aging parents can only set aside a maximum of $5,000 into an IRA.? Go figure.

What else can you do? I would encourage you to set up a low-cost well-diversified portfolio in taxable accounts.

You’ll pay taxes on dividends, realized capital gains, and interest payments along the way. Yet the savings comes with a number of advantages. For one thing, long-term savings in taxable accounts is flexible money.

Specifically, if you pull money out of a 401(k) or an IRA you’ll pay a 10% penalty plus your ordinary income tax rate on the withdrawal. Yet with a taxable account you can tap the money at any time without penalty. You’ll pay Uncle Sam a long-term capital gains tax rate when you cash it in–assuming you’ve owned the investment for more than a year–but it’s still at a lower rate than ordinary income tax rates. For many people the low long-term capital gains rate compared to ordinary income tax rates is another advantage of taxable savings.

You’ll also get tax diversification. For instance, in retirement it may be a tax smart move to leave tax-sheltered savings alone (such as your IRA) and tap into taxable accounts, and vice versa. The good news is that you will have the option of choosing the best course at that distant time.

I would set up an automatic savings plan so the long-term savings contributions are on auto-pilot.

There is one retirement savings product you can buy on your own that allows you to sock away a lot of money: Variable annuities. They’re popular. A variable annuity is essentially a mutual fund wrapped in a tax-deferred insurance firm account. Individuals buy variable annuities with after-tax dollars, but earnings compound tax-deferred until retirement, when any gains are taxed as ordinary income. A variable annuity comes with a death benefit, too. When the owner of an annuity dies, the estate or beneficiary gets back the original investment, plus some guaranteed minimum return.

I’m not a fan of many variable annuities. They tend to come with a number of drawbacks, including steep fees and limited financial flexibility. ”They are the fifth-best option for retirement planning, behind everything else,” Ross Levin, president of Accredited Investors, an Edina (Minn.) financial-planning firm, told me years ago.

However, if you do decide on a variable annuity shop for one that comes with very low expenses. A low fee makes a huge difference over time.

Does anyone else have another suggestion? Thanks.

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