Feature Stories - January 2001

Planning for Your Retirement

How to Amass a Comfortable Nest Egg

by Patricia Martin

Once upon a time, the majority of American workers could depend on their employers’ pension plans to provide a secure nest egg for retirement. But today, that comforting option is rarely available. Indeed, 21st century workers must take an active role in setting up their own retirement accounts, and the options they have can seem muddled and confusing at best. These include employer-sponsored 401(k) programs, as well as Roth, regular and non-deductible individual retirement accounts (IRAs). There are tax-free municipal bonds, corporate bonds, junk bonds and annuities as well. It’s enough to make a worker’s head spin. But financial experts say there’s no need to panic. Just take a deep breath and make Nike’s "Just do it" motto your investment mantra.

IRAs and 401(k) Plans

The first must-do is to participate in the 401(k) plan that most of today’s employers offer. Many companies will match employee contributions to the plans. The most common formula is 50 cents on the dollar, up to 6 percent of the employee’s pay. The golden rule of thumb is to invest roughly 10 percent of your income, or as close to that percentage as possible. "With a 401(k), it’s all pre-tax dollars, and it’s automatically deducted from your paycheck so you’re not tempted to spend it," said John Futrell, portfolio manager at Futrell Financial Management, a Las Vegas wealth management firm. "The key is to pay yourself first, and develop a savings discipline as early in your working years as possible." Take the example of a 25-year-old worker who invests just $2,000 a year for seven years and then quits investing. An 8 percent return on that investment will grow into a nest egg totaling nearly $270,000 when he reaches the age of 65. If that same worker doesn’t start saving his $2,000 a year until he reaches age 35 and continues to do so until he reaches 65, an 8 percent return on his 30-year investment will be worth about $245,000. "It shows just how crucial it is to start investing at a young age," Futrell said.

Most 401(k) plans allow participants to choose from a variety of mutual funds. They include stock and bond funds that are categorized by their levels of risk. Workers are able to contribute to several different funds in an effort to diversify their portfolio and spread their investment risk. For example, one fund may include a mix of conservative investments such as government-backed securities and/or corporate bonds from blue-chip companies, while another may be a bit riskier and include a diverse mix of stocks from various industries. The riskier an investment, the higher the potential return.

Some financial planners believe it’s best to invest a larger portion of your dollars in higher-risk funds at a younger age, since these investments could likely weather a bear market and bounce back once the bull returns. Older investors, who are closer to retirement, don’t have the luxury of waiting, and need to be more concerned with preserving their nest egg. "Still, the key is doing what you feel comfortable with," Futrell said. "If you’re watching the market everyday and can’t sleep, you haven’t chosen the plan that’s best for you."

A typical case study of a worker in his mid-30s would likely show an investment portfolio that includes 70 percent stocks, 25 percent bonds and 5 percent cash. The type of stocks held in that portfolio would again depend on several factors including the investor’s risk-tolerance level. For instance, stocks of highly-rated blue-chip firms with a history of strong earnings and dependable dividends would appeal more to conservative investors. Again, choosing a mutual fund with a diverse mix of stocks enables investors to find a fund that best matches their needs and personalities. "Remember, never keep all your eggs in one basket," said investment advisor Ted Schlazer, president of Paragon Asset Management Co., a Las Vegas firm that manages securities for corporations and individuals. "It’s crucial to have a diversified portfolio of both stocks and bonds."

After you get through pouring money into your 401(k), financial planners advise you to take a look at the Roth IRA, which allows you to withdraw money tax-free after retirement. Income withdrawn from a 401(k) or traditional IRA can be taxed at rates as high as 39.6 percent. Remember, however, that a Roth contribution comes from taxable income, unlike a traditional IRA, which enables you to contribute pre-tax dollars. In other words, there’s no tax break the year you fund a Roth. Currently, you can contribute up to $2,000 a year in a Roth if you’re single and you earn less than $95,000 a year. If you’re married, you can contribute $2,000 per spouse providing your gross income is less than $150,000.

If you prefer immediate tax gratification and want to contribute to a traditional IRA, there are several limiting factors. You cannot belong to an employer-sponsored retirement plan, or if you do, you can’t earn more than $42,000 a year if you’re single, or $62,000 if married, to get the tax deduction.

Other Investment Alternatives

A great way to save outside of an IRA is the tax-free municipal bond market. Tax-free muni bonds are securities that municipalities sell to finance capital improvements. "Yields on some of these can be as high as 9 percent when you factor in the tax break," said Schlazer. "And in a lot of cases, these bonds are exempt not only from federal taxes but state taxes as well."

If you’re an art aficionado and are wondering whether purchasing a Van Gogh will reap rewards in your retirement, take note - the art world is fickle. Hence, you can never ensure your acquisition will increase in value at the rate you would like or need it to. Second, you’ll always have to find a buyer before you can pocket any financial payback, and that could be a long and costly process.

Some of the same holds true for private real estate holdings. Financial experts say it’s best to invest in real estate through a publicly-traded real estate investment trust or REIT. "You can hold one that’s traded on the New York Stock Exchange, but a REIT tends to be more conservative than a growth stock," Futrell said.

Some financial experts say it’s also wise to consider putting extra dollars into an annuity - an investment fund offered and backed by an insurance company - since it basically has the same tax-deferred advantages as a qualified retirement plan, and there’s no limit to how much you can contribute.

How Much is Enough?

Generally, financial planners say your investment vehicles should generate roughly 75 percent of your annual income for a comfortable retirement. Several assumptions are written into that rule of thumb including that certain current fixed costs, such as a home mortgage, won’t be a factor in retirement. But financial planner Brian Loy, president of Sage Financial Advisors Inc., a wealth management firm in Reno, said most of his clients will need all of their income, if not more, to maintain their desired lifestyle during retirement. "There are a lot of costs, such as healthcare, that people might have to pick up on their own dime in retirement. And they don’t want those costs affecting their quality of life," he said.

Loy said it’s crucial that today’s workers have a long-range strategy and investment plan. It helps, said Loy, to remain focused on what matters most when life’s little surprises come along. "Things change. Catastrophic events are going to take place in our lives. Some of those risks we can assume, others we can assign or transfer to others. Having a plan helps investors make wiser decisions."