Retirement funds 101

It's never too early to start making sure you have enough in retirement savings, especially since the average life span and healthcare costs are rising, according to the U.S. Census Bureau and the Health Care Cost Institute, respectively. Learn the essentials about different types of retirement funds, when to start saving for retirement and how to choose an account that's right for you.

What is a retirement fund?

A retirement fund, generally speaking, is a special account either sponsored by your employer or established on your own to invest contributions for future retirement income.

When should I start saving for retirement?

As soon as possible. The best time to start saving is when you start earning a paycheck and have money to put away. This way, your savings have more time to accumulate and earn interest.

If your employer offers a retirement plan with a contribution match, you should consider contributing at least enough to take advantage of that additional money. The more money you put in, the more you have working toward your future retirement income.

Consider revisiting your contribution amount every year and raise it if you can.

Starting a retirement fund

If you haven't started saving, it might seem overwhelming to put $500 or $1,000 every month into a retirement fund, but by saving any amount, no matter how small, you're helping build your retirement future. Consider putting away what you can, raise your contributions when possible and take advantage of what your company has to offer.

Also consider setting up automatic contributions so the money comes straight out of your paycheck.

Different types of retirement funds

401(k)

One of the most common retirement funds is a 401(k), which is the retirement fund often offered by employers. When you start a job, you'll likely receive information on plan eligibility and how to enroll if one is offered.

Once you are eligible to participate, you might have the opportunity to receive matching contributions from your employer. This matched contribution is commonly viewed as “free money." To build your retirement savings you should consider contributing as much as you can afford up to the limit set by the IRS if your specific plan allows it. For example, in 2023 the limit is $22,500 with an additional $6,500 catch-up contribution available for those over age 50.

If you leave your job before you retire, you likely won't be able to add more money to that particular plan, but it is important to know that you will not lose that money if you're fully vested. You can leave it in that employer's plan or roll the funds into a Rollover IRA or a different retirement plan should your next employer offer one and accept rollovers.

IRA

Anyone can open an IRA or individual retirement account. Unlike the 401(k), it doesn't have to be tied to your employer. You can choose between a traditional IRA or a Roth IRA. The key difference between these two is that a traditional IRA allows you to save for retirement with pre-tax dollars, while the Roth IRA is an after-tax retirement account, meaning that you can make qualified withdrawals in retirement tax-free. Roth IRAs also come with income limits that may prohibit contributions.

Annuities*

The most common uses of annuities for retirement planning are their tax-deferred growth and potential for guaranteed income. 

Immediate annuities offer a way to convert a lump sum of money into an income stream to meet your financial needs for the future. Depending on the payout option chosen, immediate annuities can provide lifetime income. Payments can continue even if you live long enough to collect more than the amount of principal and gain in the contract. The way immediate annuities work is very simple: you, the investor hands a lump sum of money over to a life insurance carrier and the carrier promises to pay a guaranteed stream of income to you for the rest of your life or for a specified period, even if, as mentioned previously, the carrier ends up paying you more than you paid them. The amount of income that you receive will be based on your age, your gender, the payout option chosen, and the amount of money that you pay to the insurance carrier.

The arrangement just described is the simplest form of immediate annuity. In this scenario, the insurance company will keep any amount of unpaid principal that you gave them if you die before you can collect all of your initial payment. This is known as a straight-life payout, and it poses the risk of loss for you if you do not live long enough to recoup your principal. To help lessen this specific risk, you can opt for a joint life payout that is calculated based upon your joint life expectancies. You may opt for a joint first-to-die payout, where the payout will stop as soon as one of you dies, or a second-to-die payout where payments will continue as long as one of you is living.

Under the second scenario, payments may remain level throughout the payout phase, or they may be reduced by a certain amount after the death of the first spouse. (The right choice here will depend upon the couple’s financial circumstances, risk tolerance and investment objectives.) It is sometimes possible to add guarantees to the contract that will promise at least the return of any unpaid amount of principal to the payee’s beneficiaries or even the return of the owner’s entire original investment amount.

What are required minimum distributions?

Required minimum distributions (RMDs) are mandatory, minimum yearly withdrawals that must be taken out of retirement accounts in which you contributed tax-deferred dollars or have had tax-deferred earnings. The IRS requires you to begin taking out required minimum distributions from your accounts in the year you turn age 73. While you can withdraw more than the RMD, you must take out the minimum amount or be subject to severe penalties. Retirement accounts that typically require a RMD at age 73 include:

• Most 401(k)s
• Most 403(b) plans
• Traditional IRAs
• Rollover IRAs
• SIMPLE IRAs
• SEP IRAs
• Most Keogh accounts

The exact amount of your RMD can change from year to year, and is calculated by dividing your retirement account's year-end value by the life expectancy factor set by the IRS. You can calculate your RMD by using one of the IRS's worksheets, or an online calculator.

Three retirement planning essentials

As you dig into the details of retirement planning, here are three essential components to consider.

Essential #1 — Owning your home free and clear

Entering retirement with a home that’s paid off can be a huge relief. Not having to budget for mortgage payments will allow you to have more money to allocate to other needs and wants. And if you ever need the money, owning your own home means you can always downsize and pocket the extra cash, or even take advantage of a reverse mortgage.

Essential #2 — Having an emergency fund

An emergency fund is a necessity in just about every retirement strategy. Having that extra money can help cover unexpected expenses such as medical bills, home and car repairs – expenses that you can’t always plan for or predict. Moreover, a savings account can prevent you from dipping into your retirement and investment accounts early or, even worse, incurring more debt when dealing with emergencies. 

Essential #3 — Plan ahead for medical expenses

Healthcare can easily become one of your largest expenses in retirement, eating away at a significant part of your retirement savings. Thankfully, your Medicare benefits can help. However, you need to be proactive and sign up for your Medicare benefits three months before your 65th birthday. By doing so, you’ll not only have the coverage you need, but can avoid paying higher premiums in the future. If you’re retired and under the age of 65, then secure health insurance to help bridge the gap until you become eligible for Medicare. Paying for healthcare on your own can be costly, but not as expensive as an unexpected hospital stay for a serious illness or accident.

For more articles on retirement planning, visit the Protective Learning Center.

* Annuities are not qualified plans as defined under the Internal Revenue Code.  They may, however, be used to fund a qualified retirement plan.