Nonqualified plans and other retirement benefit plans may be available to you if your skills are in high demand or if your employer is creative. For example, DB(k) plans provide a small pension-like guaranteed income stream, along with the ability to save money as you do in a 401(k). Other plans might promise you a lump sum payout every ten years or so.
With most retirement plans, you’re in the driver’s seat when it comes to choosing investments. The question is what investments to choose.
Because retirement earnings grow tax deferred and you have many years before you’ll make withdrawals, retirement plans are best suited for your most aggressive investing, which means putting a larger portion of this money in the stock market. You can balance some of that risk by directing part of your portfolio into bond investments. Most employer-sponsored funds offer a range of stock or bond mutual funds. With IRAs, you’ll have access to a much broader choice of investments, including ETFs (exchange-traded funds), REITs (real estate investment trusts), and individual stocks and bonds.
Many employer-sponsored retirement plans offer prepackaged options so you don’t have to select individual investments and build your own portfolio. Instead, you use a model portfolio designed by an investment company. While this option may be easier to deal with, that simplicity comes at a cost, normally in the form of very high fund fees.
ESOPs
ESOPs (employee stock ownership plans) give you an opportunity to own stock in the company that employs you. These plans can be a great benefit, but there’s one very important caveat: Don’t put all your eggs in one basket. If company stock is the only option available to you in your 401(k) plan, look at other investment vehicles for some of your retirement savings. If you invest heavily in company stock, consider a worst-case scenario. If something bad happens to the company, it’s likely that the stock price will fall. In addition, your job could be in jeopardy—if there are layoffs or if the working environment becomes unbearable. In this case you suffer a double whammy: Your retirement savings take a hit at the same time as your income.
In addition to providing diversification, many of these funds adjust their holdings over time; a target date determines how much risk the portfolio should have. For example, you might have the “XYZ 2060 Fund” as an investment option in your retirement plan. This fund might be used by a person planning to retire in 2060. When the fund has plenty of time left until maturity, it will hold a higher percentage of stocks and other riskier investments. As the years pass, the fund’s managers will gradually reduce risk by adding less risky investments.
When set up and used properly, annuities supply guaranteed steady income for life. The right annuity gives you a reliable monthly income stream that you know you can count on forever, no matter what happens in the economy or the stock market. That’s especially valuable for people who can rely only on Social Security for guaranteed income. Annuities are insurance products. You buy (or invest in) an annuity, and the annuity pays you regularly in the future, either with monthly, quarterly, or annual payments, or in a lump sum at a specified future date.
The amount of each payment depends on several factors, including the size of the annuity, how the payments are scheduled, and for how long the payments will be made. You’ll also have the option to receive payments for a certain number of years or for the rest of your life.
Like other types of retirement accounts, the money inside an annuity grows tax deferred, and you don’t pay any taxes on the earnings until you start taking the payouts.
Annuities are useful in some situations, but they are prone to abuse. Consumers and even professionals have trouble understanding them. All annuities have a cost, and you have to pay extra for any riders (add-on features). In many cases, you have to leave your money with the insurance company for years before you can do anything else with it. Therefore, be very careful when buying an annuity.
Be especially careful about putting retirement savings into an annuity. Don’t roll a 401(k) or IRA into an annuity unless you have a very good reason. Before retirement age, the most likely benefit you can get from an annuity is tax deferral. Retirement accounts already benefit from tax deferral, so annuities must offer you an additional benefit if you’re going to pay the costs associated with them. Putting retirement savings into an annuity for the purpose of tax deferral is like wearing a belt and suspenders at the same time to keep your pants up.
Social Security is a benefit plan that’s been around since 1935 for employed persons who pay into the system for the required amount of time; in other words, forty payroll quarters. In addition to retirement benefits, Social Security includes several other programs, including Medicare (the healthcare plan for people sixty-five and over), disability benefits, and survivor benefits for spouses or dependents. These programs are funded by mandatory taxes deducted from your pay and matching taxes paid by your employer.