The calendar may have flipped to the new year, which means most tax tricks, tips, and deductions have closed the book on last year’s taxes, but that isn’t the case for your IRAs. Individual Retirement Accounts are unique in that they give you up until when you file your taxes on or before the April 16th tax deadline. That means you have a full three and a half extra months in the new year to catch up on an entire year of Roth IRA or Traditional IRA contributions if you choose to.

This is good news for many people because it’s easy to forget to miss a contribution during the year and the first instinct is to expect that once the calendar year is up you’re out of luck. There also may be situations where the new year means a new job, a pay raise, or bonus that could be applied to a contribution and catch up on what you missed out on. Whatever the situation, you have over three months to do something good for your retirement nest egg, and if you contribute to a Traditional IRA, lower your tax burden.

Get a Late Tax Break

As mentioned above, if you have a Traditional IRA account those contributions generally count as a tax deduction. If you’re like me and typically get your taxes done early you’ll be able to see your possible tax liability before you officially file, and before the deadline. If you notice you’ll be on the hook for a few hundred, or even a few thousand dollars you can use the time before filing to make a Traditional IRA contribution to offset part or all of that liability. That is of course assuming you haven’t already maxed out your IRA for the tax year. But consider this: if you’re at the 25 percent tax rate and haven’t contributed anything to your Traditional IRA yet, a quick $5,000 contribution before April 15th (April 16th in 2012) you’re basically cutting $1,250 from your tax burden. Of course the tax break is nice, but you’re doing something even more important by putting more money aside for retirement and giving it more time to grow.

Spread Out the Contributions

Say you’ve found yourself in the new year and want to make up the IRA contributions you missed, but you don’t have a large chunk of cash available to do so. Don’t worry. Nothing says you have to make that prior contribution all at once. In most years you’ll have around 15 weeks from January 1st through the tax deadline. So think about it in small chunks. If you want to max out the IRA contributions you have 15 weeks in the new year to contribute $5,000. That means you could achieve that by just contributing $333 per week until the deadline. If you did make some contributions last year and just want to put in enough to reach the limit, just take what you have left to contribute and divide it by the number of weeks left before the tax deadline. Then you can make small weekly contributions or double the weekly amount and set up direct deposit or create an automatic contribution that coincides with your bi-weekly paycheck.

Whatever you do, don’t stop making those contributions once the tax deadline passes. Now is the time to adjust your weekly, bi-weekly, or monthly contributions so that you can max out your current year’s contributions. It’s a lot easier to contribute slowly throughout the year than play catch up every January through April. After the April tax deadline you’ll generally have 37 weeks, give or take a week, to make current year IRA contributions. So, take $5,000 and divide it by 37 and now you only have to contribute $135 per week to hit the maximum limit, or $270 every two weeks if you’d rather contribute directly from each paycheck. This is obviously far more manageable than trying to cram it all into a few short months. And here’s the best part. Once you do this and make your maximum contribution within the calendar year you can start fresh next year and have a full 52 weeks to spread the contributions out across. That is less than $100 a week, or less than $200 from each bi-weekly paycheck. Suddenly, saving for retirement has never seemed to easy.

Getting Started

If you haven’t opened an IRA yet, Roth or Traditional, you can still open one this year and make prior year contributions. If you’re contributing money electronically the brokerage will ask which year you’d like to make the contribution for. If you’re depositing via paper check you will want to make sure you write on the check which year the contribution is for, or use a special deposit form provided by the broker that allows you to specify. Otherwise they may assume that any money coming in after January 1st is for current year contributions.

If you’re looking for a good cheap place to get started with your IRA I’d recommend either Zecco, Scottrade, or TradeKing. Accounts at either of these providers allow you to invest in stocks, bonds, mutual funds, index funds, ETFs, and almost anything else. And commissions are about as cheap as they get in the business. And remember, you’re never stuck with a single company. You’re always free to do an IRA rollover or transfer the funds to any other brokerage or fund company in the future. The most important thing is to get an account open and put that money to work before the deadline passes.

After listening to a conversation about how this is a great strategy in this recession, I had to set the record straight and educate my friends at work.  Someone has to do it right?  Well, to sum up the multiple conversations I’ve had, here are five of the reasons why you should never tap into money from your 401k.

If you do borrow, time is no longer your best friend

Money grows over time, everyone knows that.  And if you are investing regularly, time is truly your best friend.  I’ll take a known statistic for example.  Most of the time, your money doubles every eight years on average. For someone who is investing and not tapping into their 401k plans like a savings account, this is great news.  However, if you withdraw money from your 401k plan you are missing out on serious growth opportunities.  There are many reasons people take 401k loans, but many Americans take out money for a mortgage.  401k rules allow for these loans to be taken out for up to 5 years, and up to 15 years for a home purchase.  If you borrow from your 401k, you are missing out on opportunities for your money to grow among other things.  Over the long haul, this could mean the difference between $50,000 and $500,000.  I don’t know about you, but I don’t want to miss out on the potential long-term growth prospects for my retirement money.

Losing money is not fun

You wouldn’t throw money out your car window, now would you?  Yeah, didn’t think so.  So why do it with your 401k money?  Because that’s essentially what you’re doing when you borrow from your retirement account.  And don’t use the excuse that paying yourself back the interest is boosting your savings.  The long term return on your money makes the average interest rates today look like chump change.  Don’t buy into this and avoid borrowing from your 401k.  And don’t let me get into tax implications.  To repay a 401k loan, you are using after tax money from your paycheck, which means anything above and beyond the principal repayment will be taxed a second time when you make a distribution from your account. That’s a bum deal.

Like a bird in tar, you are trapped

While speaking with my coworkers, many did not realize that a 401k loan stipulates that if you quit or lose your current job, the 401k must be repaid almost immediately.  In effect, this is a type of leash that could force you to stay at your job and prevent you from seeking other higher paying opportunities.  I can’t imagine having this freedom taken away from me. Even worse, if you unexpectedly lose your job after borrowing a large chunk of your retirement plan you’re stuck with the bill. And if you can’t repay the loan you get stuck with then a big tax bill for the early distribution. Talk about making a bad financial situation even worse. Borrow from your 401k and you are at the mercy of your employment.

Makes you look like you are chasing the Jones’s

If you can’t live within your means and need take out a 401k loan for anything other than an absolute financial crisis, what does that say about your character and spending habits?  This is a huge wake-up call.  Are you managing your money well?  Are you keeping track of costs?  These are questions you need to ask yourself if you find yourself borrowing from your 401k for frivolous purchases.  Is that LED TV or kitchen remodel really worth the sacrifice of potentially a hundred thousand extra dollars in retirement?

Don’t listen to Nike, just DON’T do it!

Look, is it really worth it?  There are plenty of sources of income and savings.  You could even open up a zero interest credit card if you needed a short-term influx of cash.  Sacrificing future gains to make a purchase today is not wise and I highly advise against it.  Instead, look at your lifestyle and evaluate your choices and decisions.  Are you making bad ones?  If so, seek out help.  You will be glad you did.  If you want to be living on a beach at 65, you will NOT tap into your 401k account.

So what’s a scared American to do?  Well, that’s where individual Roth IRAs are king. The combination of a private retirement fund and tax free growth is music to anyone’s ears.  I’ve said it time and time before that a Roth IRA is the fastest way to a million dollars for the average American.  The biggest factor contributing to this is that your money is taxed from day one through your paycheck and is never taxed again with a Roth IRA.

A Roth IRA is truly the “king” of retirement accounts.  Even 401k plans often pale in comparison.  One of the only reasons why a 401k makes sense is because many employers contribute to your account.  Let’s take a look at the tax benefit of a Roth IRA and why you should open one today.

ZERO taxation when you withdraw at retirement

This is the kicker for choosing a Roth IRA.  Not having to pay tax on withdrawals like you would with a 401k is simply astonishing to me.  As long as you are 59 1/2 years old and the account is five years old, you can withdraw any or all of your retirement savings tax free during your “golden years.”  This means all money in will stay in and will utilize the magic of compound interest.  With the uncertain economy a Roth IRA is a clear winner because who knows how high taxes will be 30, 40, 50 years from now…

You can remove your money invested at any time

If you are regularly putting money into your Roth IRA, you are able to withdraw your money invested without any penalty!  Most people don’t realize this, but it’s a huge selling point.  However, I don’t recommend doing this because you’re taking money away from your retirement account.  But, at the end of the day, it’s nice knowing your principal is accessible unlike money in a 401k.  what you’re NOT allowed to take out is the interest on your money. With a 401k you’re usually only left with a hardship withdrawal or a 401k loan. So, as long as you only take out money that you originally put it, you don’t get dinged with a tax penalty.

You can take it all out or leave it all in

No more worries about having to take out a portion of your money because of federal regulations.  Now, with a Roth IRA, you can leave your money in your account and let it keep gaining interest during your retirement.  This is a much appreciated feature because most people’s retirements last 15+ years.  You don’t even have to spend the money if you don’t need it! Unlike a 401k or traditional IRA, you are required to make minimum distributions once you reach 70 1/2.  If you have saved more than you had to, you can just leave the money in the accounts for your kids or whoever is set as your beneficiary.  This is huge for out of the blue deaths or just giving your grand kids a gift of money.

No age limit, no problem

I love that anyone can open a Roth IRA and contribute as long as they have some sort of income.  I first found out about them when I was 18 years old.  Boy, am I glad I found out about them then!  It’s great because you can open a Roth IRA for your kids and help the start investing at a young age and encourage stewardship habits early on.  At any age, it’s easier than ever to convert your traditional investment vehicles to a Roth.  If you’re young and in a relatively low current tax bracket I recommend switching and start enjoying tax free growth for life. Although there are potential pitfalls in converting, so make sure you understand the tax implications of doing a Roth IRA conversion.

Now that you know about the amazing tax benefits of a Roth-IRA, what are you waiting for? If you don’t have one, open one today. Here are a few great places to set up a free account:

• Scottrade
• Tradeking
• Zecco

Money management is the main driving goal during retirement and, for starters, it’s recommended that you withdraw 4 to 5 percent from your overall savings and no more than that. On average, people put money into various accounts like a 401(k), IRA, and if you’re lucky, a pension. Minimizing what you’re withdrawing is the key so you’re not faced with dwindling finances the older you get. Plan out what you have and factor in what you need to live on. This doesn’t mean you should live poorly, just wisely. There’s a lot of savings and retirement information on the web, like RetirementCalculator.com, that helps people with some of the myriad issues that come along with retirement.

You’ll also want to begin to minimize the taxes that are hitting you. Simply put, if you have money invested in a 401(k) or a traditional IRA, you have to pay taxes on the money when you withdraw it. more money you leave in you accounts, the more they will grow. With a lager balance your interest for that account will compound much faster. Now, eventually, you’ll have to withdraw the money but you want to minimize the hit you’ll take in taxes and waiting can often prove a very handy approach. This is why retirement planning is more than just thinking about putting money away for retirement. It’s also about managing that income in retirement so you don’t pay any unnecessary taxes.

Finding the right mix in your accounts isn’t impossible. If you think you’ll be withdrawing money at an earlier age then there are certain accounts that you should look at. Roth IRA’s, as stated above, are perfect for early withdraws. The difference with this type of IRA is that you’ve already paid all of the taxes on contributions. Everything was taken out when you put your money in so when it comes time to withdraw, you’re not caught off guard and hit with huge penalties and taxes.

Much of this information is about building your savings and having a low impact but it’s also important to note one of the worst mistakes retirees often make. It’s essential that you, under no circumstances, treat your 401(k) or other retirement accounts like it’s a savings account. Constant withdraws, penalties, and taxes will decimate your savings. Don’t touch it unless you absolutely need to and only withdraw after the account’s term limit.

Managing your money today is easier than every. With tools like the Internet and Retirement Apps that help you plan and manage your spending, you can have a much better idea of what you can and can’t afford. You want to stretch your money as far as you can and make the most from your retirement savings and accounts.

If retirement seems like it is a lifetime away, planning for how you’ll spend that time may  be difficult. But one thing is certain: you’ll need to have money in retirement. If you don’t plan on working in retirement, where will this money come from? Most people have three sources of income that work together to fund retirement: Social Security, pensions, and personal savings.

Retirement Planning Problems

Even with three potential income streams there are some problems to consider. First, we aren’t certain what the future holds for Social Security. Even in the best-case scenario where you receive your full Social Security benefits, the average person only receives 40% of their pre-retirement income. That can certainly help, but with increased costs on things like health care in retirement that money doesn’t go very far.

The next problem has to do with pensions. These employer-sponsored plans not very common today, and even if you are lucky enough to receive a pension benefit, the amount you receive in retirement will likely only supplement around 25% of your pre-retirement income. Younger generations have all but written off pensions as a source of retirement income, so if you have one, count your lucky stars.

With all of the uncertainty and limited payouts of Social Security and pension plans you’re left with finding ways to save some of your current income for retirement. Thankfully, the government realizes the importance of saving for retirement, so they have created tax incentives to encourage you to save for retirement. The problem is that most people simply aren’t saving enough for retirement.

Time is Your Greatest Asset

The most important component of retirement savings is to start as soon as you can. The power of compound interest requires time to work its magic, so the more time you have, the more your money will grow. If you have a 401(k) plan at work or a traditional IRA, begin saving as much as you can, even if it is only fifty dollars a month. Every little bit helps. In addition to saving money for retirement, by making these contributions you’ll also be reducing your taxable income today. That means less money in Uncle Sam’s pocket and more for you when you retire.

In addition to the common pre-tax plans like a 401(k) or traditional IRA, you should also consider a Roth IRA. While you don’t receive an immediate tax deduction from contributions into a Roth, the benefit here is that your money will grow tax-deferred and can be withdrawn in retirement tax free.

Investing for Retirement

Aside from starting early, the biggest obstacle in saving for retirement comes down to the investments. Where should you invest? How do you know if your investments are appropriate? Investing doesn’t have to be complicated as long as you follow the golden rule�’don’t put all of your eggs into one basket. You’ve probably heard that before, but it is worth mentioning again. As long as you spread your investments out across many investment types and asset classes you will maximize your returns while minimizing risk. There’s no way to completely eliminate risk, but diversification works. Take a look at how diversification generated positive returns during the “lost decade” of investing.

If you are primarily saving in a retirement plan through your employer, check to see if your plan offers any asset allocation investment funds. These are funds that automatically invest your money in a way that is appropriate for your age or investment objective. If you do a lot of investing on your own and aren’t comfortable making any drastic changes, you may want to seek professional help to ensure you’re doing what’s best. Working with a financial planner can help you make the most of your current investments and work with you to create a plan to reach your retirement goals.

What is probably more shocking is that many of the people coming in looking to take money out of their retirement plan only need a small amount (generally under $1,000) to cover some unexpected expenses and I’ve even seen people take out $500 loans  from their 401(k) on three year terms. With so many people tapping into their employer plans for minor emergencies I think this highlights the importance for keeping a cash emergency savings account available even if it isn’t a significant amount.

Congratulations on Saving for Retirement, but Your Responsibilities Don’t Stop There

I have to applaud those who actually take the time to enroll and begin contributing to their plan, especially if money is tight as it often is. Generally, the people who need to borrow against their 401(k) are earning modest incomes and are just able to make ends meet. There is a lot to be said for someone in such a situation. They understand the importance of saving and have learned to make due without that little extra money coming home in their paycheck.

But taking the step to actually save for retirement is only the first step. That money doesn’t do any good if you’re constantly tapping into your nest egg via loans, premature distributions, or cashing out instead of doing a 401k rollover. Saving is good, but not managing those funds properly can be just as bad as not saving anything at all.

Taking the Next Step

While participating in the plan is a great initial step it is often the only savings many people are taking part in. It is automatically taken out through payroll so it is simple to set up and easy to forget about. The problem is that people stop there and don’t apply the same technique for other savings. If you can spare $50 every two weeks from your paycheck for retirement you should strive to save at least $25 as well for your emergency savings so you don’t have to treat your retirement plan as an emergency fund.

The problem is that this takes additional work and you either need to change your direct deposit to put money into a savings account or you need to manually set up the transfer or deposit. The other big problem is how easy the money can be to access. Most people simply set up their savings account where they do the rest of their banking and more often than not the savings account is linked to the checking or even their ATM card. The ease in accessing this money can make it difficult for some people to keep the money in savings where it belongs and occasionally tap into it for things that aren’t quite emergencies. The benefit of a retirement plan is that the money isn’t as easy to access, so after a few years of constant contributions and no withdrawals people are surprised at how much they have saved and see that as money that can be used for other things.

So, if you can manage to get by saving automatically in your retirement plan, you can just as easily set up an automatic savings plan with a savings account. The best thing to do is to open an high-yield online savings account. Ally Bank currently offers a high APY. The rates are probably better than you’ll get at the bank, and the money will physically be separated from your other cash. Then, all you have to do is establish a regular and automatic transfer to fund the account. Maybe you set the transfer up for payday so you don’t even miss the money. Whatever you do, it has to be automatic and require little action from you. If you have to force yourself to remember to make a deposit every two weeks how long will that last before the habit fades away?

Loans Should Be Your Last Resort

If your 401(k) plan allows you to take a loan it should be treated as a last resort. Some people argue that taking a 401k loan isn’t all that bad of an idea because it is your money and you are simply paying yourself back the interest. While that is true, you are still hurting yourself over the long run. Money that you take out of your plan can no longer earn interest or see capital gains. For some loans this could be a period of five years of foregone compounding interest. Second, most people who take a loan end up stopping their regular contributions as well so that they can afford to make the loan payments. This just compounds the problem of foregone gains and what is even worse are those who end up forgetting to begin contributing again once the loan has been repaid.

Another thing to consider are the tax consequences on the loan. Money you borrow from your plan is pre-tax money, but your loan payments are from after-tax dollars.  This means you are effectively going to be taxed twice on some, not all, of the money that you borrowed. If that isn’t a raw deal I don’t know what is. Finally, in the event you default on your loan because you change jobs and stop making loan payments the IRS will treat that as a premature withdrawal resulting in taxes owed on the distribution with a 10% penalty on top if you were under the age of 59 and a half. You say to yourself it won’t happen, but I have seen people take out $10,000 loans only to find themselves out of work a month later, fail to repay the loan in time, and get hammered with a $10,000 early distribution and all of the taxes that go with it.

Check to See if Your Employer Offers an After-Tax Retirement Account or Christmas Club

If you find it difficult to save money the traditional way and want to avoid the pitfalls of tapping into your qualified retirement account there may be another option available to you in the form of an after-tax portion of your 401(k) or 403(b). Some employers actually offer the option to also contribute after-tax dollars into your retirement account, either within your current plan or through a separate account like a Christmas Club program.

The benefits of doing this are that you can begin saving money easily through payroll deduction just like your current retirement plan and yet you have access to 100% of this money without needing to take a loan or worry about IRS early withdrawal penalties. While you won’t receive the tax benefits of a qualified plan you can at least create a cushion of money that is available without excess penalties or taxes. Most plans allow this money to go into a savings type account or in some sort of fixed fund so your money is usually not at risk.

In a real practice dealing with real people, the results are even more shocking and really hit home. I’ve worked with people, affluent people such as doctors and lawyers who are nearing age 65 and are looking to retire. When we begin to dig into their investments and retirement plans it was typical to find out that these individuals earning sometimes upwards of $200,000 a year had as little as $50,000 saved up and expected to retire inside three years. On top of that, they still had mortgages, auto loans on luxury cars, and vacation homes, yet they said they couldn’t afford to max out their 401(k).

And these are people you’d think would have it easy and built up a nice nest egg. When you work with the typical middle-class employee the situation wasn’t much better. The real problem is most of these people weren’t saving at all. The good news is that those who were saving typically put a larger percentage of their paycheck away than those who made far more money.

So, the evidence is out there, and for the majority of people they simply aren’t saving nearly enough. But, that hasn’t stopped one man from proclaiming we are actually saving too much for retirement. Too much, too little. How much should you save for retirement?

The Man Behind the Claim

Laurence Kotlikoff is an economics professor at Boston University and he claims that most Americans are saving too much money for retirement while sacrificing spending money today. This is a pretty bold statement that goes against most of what we’ve been taught. But this idea isn’t new. The first time I came across it was in a 2007 Registered Rep article. “The rules of thumb are the rules of dumb,” scoffs Laurence Kotlikoff. Kotlikoff is one of the leading members of what could be termed a school of retirement heretics who question much of the conventional retirement financial-wisdom, and even received truths about the retirement period itself.

It is All About Consumption

Kotlikoff argues that current financial planning doesn’t take into account consumption smoothing. That is, most savings plans revolve around a fixed amount that is put on autopilot and doesn’t change according to what is going on in people’s lives. With major life events such as weddings, college education, career changes, and so on, the amount you need to save will fluctuate and not remain constant.

I can agree with this, and just sticking to the rules of thumb that say you need to save X percent of your income or you need to have X amount of dollars by retirement are just that–rules of thumb. Sure, rules of thumb aren’t supposed to be perfect and exact for everyone, but people need to start somewhere. Especially those who may not have much of a financial background as it can be intimidating to even fathom what kind of numbers should be considered.

To quote Kotlikoff again: “You don’t want to be putting your savings on autopilot, because if you put your saving on autopilot it means that your consumption is going to be disrupted.” And to that I have to say, “so what?” Making retirement savings automatic is the number one thing most people should be doing. The average person isn’t in a position to constantly adjust their savings amount year to year based on every little detail that’s going on in their lives so the best course of action is to set it up and let it happen automatically. So what if consuming (spending money) is affected? I’d argue that it’s better if somebody isn’t blowing a little extra money on Starbucks or a new car and instead keep putting money aside for retirement, which is probably still far short of what needs to be saved anyway.

Striking a Balance

All that being said, there is a hint of truth to this, but I don’t think people saving too much is hardly the problem as he suggests. The key takeaway is that you need to strike a balance between spending money today and planning for the future. Clearly, you don’t want live a life of poverty for 40 years just so you can retire and finally enjoy the fruits of your labor. On the other hand, you don’t want to spend like there’s no tomorrow only to realize you’re going to retire in poverty.

The fact is, most people are not saving enough, and not saving too much as Kotlikoff suggests. Just because people are using rules of thumb as a starting point for retirement savings doesn’t mean they are saving too much. Most people get a late start when it comes to saving, so even using the rules of thumb it may mean too little too late. Either way, people need to save for retirement, and it’s true they also need to be sure to enjoy life today. But I can guarantee you, the typical person making $50,000 a year and who’s putting 10% of their paycheck away (a common rule of thumb) is not going to have enough put aside by the time they retire to have the retirement they want.

Is There a Motive for This?

You bet there is. Kotlikoff has developed software that will help investors and advisors “smooth out” their consumption so that they can take into account the changes in their lives to more appropriately plan for retirement. The software is called the Economic Security Planner. The software starts at $149.00 and goes as high as $750 for the financial planner version.

It is starting to make sense now. If you make an outrageous claim that goes against everything we’ve been taught, you’ll generate a lot of attention in the media. Then, if you have developed a product that can address the concerns you mention, you can stand to make a lot of money. You’ve just created your own market for your new product. While that’s excellent marketing, I’m not so sure it’s good economics.

My Problem With This

Clearly, Kotlikoff has impeccable credentials given his background and academic qualifications, so I’m certain that many of the ideas surrounding this claim are sound. I agree that the typical retirement advice that is dished out by investment companies and many advisors is too simplistic and cookie cutter to be of much use on an individual level. But the claim that many or even most Americans are saving too much, I don’t buy that.

Maybe in the wealthy tier of individuals that Kotlikoff deals with this is true. I can see how those who can afford to save a lot may be dumping a ton of money into retirement while foregoing consuming today, but I simply cannot believe this to be true with the vast majority of your typical working Americans.

If I had to guess, I’d say that 9 out of 10 people I work with are not saving enough for retirement, by a long shot, let alone saving too much. Only between 60-70% of all employees are saving money at all, and the majority of those are saving a couple percent their pay. Virtually nothing. I find it very hard to believe that these working families are sacrificing things in their life today because they are saving $200 a month for retirement.

I do think that the argument about how retirement planning is too general is very true, and this is certainly a wake up call for those who blindly follow these rules of thumb, but the notion that most people are saving too much is a bit much. You should carefully examine your savings and retirement needs before reducing your retirement savings contributions or dropping a few hundred dollars on his software. Instead, start by sitting down and spending some time carefully thinking about your own situation and find out how much you need to save for retirement.

Employees saving for retirement are not getting any favors from the government this year. The contribution limits for the major employer-sponsored retirement plans: 401(k)s, 403(b)s, and 457(b)s will not get an increase. That means like in 2010, the 2011 limit remains $16,500 for those under age 50. Those who are age 50 and older get the benefit of a catch-up contribution of an additional $5,500.

While this may not seem like a big deal if you don’t max out your contribution anyway, you have to wonder why. They say there isn’t enough inflation to warrant an increase, yet everywhere we look prices are rising. Not only that, but politicians remind us regularly that as a whole we aren’t saving enough and have problems with Social Security, yet no new incentives are ever put in place to encourage people to save more.

Going Beyond the 401(k)

Thankfully, we don’t need to rely on our employer-sponsored 401(k) plan. Don’t get me wrong, they are a great way to save and you should certainly take advantage of any matching contributions they might offer. But instead of relying entirely on an archaic section of the tax code you can put your retirement into your own hands. The ball is in your court.

First of all, do you have an old 401(k) sitting around from a previous employer? It’s time to do a 401(k) rollover into an IRA. Why leave your money tied up in an account that isn’t fully in your control? The plan administrator can change investments, fees, and plan features on a whim and you’re stuck with those changes as long as you’re with that plan. When you roll over your 401(k) you can choose what company to move the funds to and how you want to invest it.

If you don’t have an old 401(k) to roll over, it’s time to focus on your existing IRA. Don’t have one? Open an IRA today. Sure, the government also didn’t increase the IRA contribution limits, but it’s still better than nothing. If you’re looking for a tax break today, the Traditional IRA may be what you’re looking for. But if you’re hedging your bets and expect to have higher taxes or be in a higher tax bracket when you retire you’ll probably be looking at a Roth IRA.

Places to Invest

The options are almost endless. There are many investment companies to choose from and you can invest directly with a fund company, with a discount brokerage, or even a full-service branch. It all depends on what you’re looking to get out of your account and the level of service you need. Personally, I’m a do-it-yourselfer so I typically hold my accounts at discount brokers so I can keep my expenses low. Not only that, but I prefer to go with brokerage companies because within that single account I have the option to invest in individual stocks, bonds, ETFs, mutual funds, index funds, and even options, and do so for virtually free.

So, if you’re looking for flexibility and low transaction costs, here’s what I would recommend:

• Zecco – Cheapest of the cheap, and even free trades if you meet some criteria.
• Tradeking – Only a few cents more than Zecco, no maintenance fees on IRAs, and a great trading platform.
• Scottrade – 7 dollar trades, but they also have local branches all across the country if you prefer to meet with someone.
• Fidelity – Slightly higher trade commissions, but access to their incredibly low-cost index funds is nice.

Every so often I receive questions from readers. I try to answer them all directly, but occasionally a question comes up that is very broad and is one that more people are thinking about but not asking. Everybody wants to know how much they should be saving and how large their account should be once they reach retirement, so I wanted to tackle that question for everyone today.

When it comes down to it there are two methods to help guide you. Some basic rules of thumb that anyone can quickly use to get an estimate and then the process of creating a detailed estimate of retirement expenses and income.

1. Retirement Rules of Thumb

The most common method is simply by using one of the general rules of thumb about retirement income. For years people have been told that you need to generate 75-80% of your pre-retirement income during retirement to maintain your current lifestyle. This is a fine place to start, but there are simply too many problems with this method.

First, we can’t predict the future. We can make some assumptions as to why we will need less income during retirement such as not having a mortgage payment or no longer commute to work, but nothing is certain Epecially if you have a number of years yet before retirement. Another huge factor is health. While you may not have a mortgage payment during retirement you could find that you replace that with high insurance premiums or medical care that wasn’t expected.

2. Creating a Detailed Estimate

A better way to determine how much you should save up for retirement would be to create a detailed estimate based on your specific situation. This means sitting down and taking a look at exactly what expenses you will or won’t have in retirement, what sources of income you will gain or lose, and any lifestyle changes you may have.

Some people will still carry a mortgage while others won’t. Some people may choose to buy a second home or move to a new location in retirement. And depending on what you do during retirement will have a huge impact on your income needs. Maybe you want to travel overseas frequently or maybe you want to join that private golf club you’ve always dreamed of, or maybe you plan on starting a business. You may find you can live comfortably on 25% of your pre-retirement income or you may find you need 150% of that income to reach your goals. Your plans will ultimately dictate how much money you need.

The problem with this method is that this really works best for those who are approaching retirement within maybe the next 5 to 10 years at the most. Beyond that it is difficult to get a real grasp on your financial needs because your situation may still change, tax laws are sure to change, and we obviously have no idea what the state of the economy will be a few decades from now. For those of us in our 20s, 30s, or even 40s, we have to rely on a lot of assumptions for the most part. We really don’t know where our careers might take us, how our income grow, and what our plans are 30 years down the road. Even if we can develop a detailed retirement income and expense plan there’s a good chance it will be completely wrong in thirty years. And nobody wants to retire broke and unhappy.

What The Experts Say

A relatively new study done by a few experts was published in the Journal of Financial Planning to tackle this exact topic. The study aims to address the following:

1. The annual cash flow needed in retirement
2. The capital needed to generate this lifetime retirement cash flow
3. The annual savings needed to build the capital that will provide the retirement cash flow

An interesting note as to why this study is a bit different can be summed up with this:

We used a more sophisticated approach by using the retirement ratio of 80 percent based on pre-retirement net income as defined as gross income less retirement savings. We used net income because someone who saves for retirement has reduced their pre-retirement living expenses and, for most, it typically follows that they also reduce their post-retirement expenses. For individuals who are saving a lot, this can be significant. Lower retirement expenses means less needed capital. You could say the more one saves, the less one needs to save.

In the past the assumption was simply based on gross income. If you earned $50,000 just before retirement then you need to have $40,000 coming in during retirement. This study factors in savings because if you are saving money each year for retirement, once in retirement you won’t be saving and instead withdrawing so that shouldn’t count towards your required income. For example, let’s say you make $50,000 a year and you are putting $6,000 into your 401(k) each year. Instead of just taking 80% of $50,000 you would take 80% of $44,000 ($50,000 – $6,000), or therefore  a retirement income of $35,200.

Capital Required to Generate Income

While it is fine to make estimates about how much money you need in retirement, whether it is based off 75%, 80%, 120% of your income, the other big question people have is how much money does it take to generate that stream of income? When I meet with clients they are often quite distressed. They hear things in the media about how they should have over a million dollars saved up and with $150,000 in their account and 5 years until retirement they think it is the end of the world.

The same study talks about how to estimate how much capital will be required to generate this stream of income. It goes into detail using mortality rates, social security, the Monte Carlo simulation and so on. Since it is complex I won’t go into detail here but I encourage you to check out the study and take a look at some of the tables they have provided that give some sample income levels you can use to compare with your own situation.

What This Means For You

After all of this discussion you are probably just as confused as before. Making general assumptions only goes so far, yet if you’re getting close to retirement and put together a detailed estimate you’ve already missed out on a lot of time needed to save, so what should you do? Ultimately you shouldn’t get hung up on some of the numbers out there. Just because some talking head on TV says you should have a million dollar portfolio by age 65 doesn’t mean that is what you should strive for, just as the rule of thumb saying you need to save 10% of your income or have 80% of your income during retirement might not be appropriate for you. People are unique and everyone’s situation is different.

Use these guidelines as a starting point. Read the study and go over some of the examples they provide. While in the end they are still general assumptions they are a great place to start, it is then up to you to monitor your progress and make changes as things in your life change. It is hard to say where life will take you so your actual savings goals may change significantly. If you start saving early and find out you’re saving more than you need to that is a good problem to have. It doesn’t hurt to overestimate because you can do even more in retirement or leave more to your heirs or charity, but if you realize at age 50 that you haven’t saved nearly enough you can’t go back in time and fix it. In the meantime, be sure you’re maxing out those IRAs and not hurting your retirement chances by taking a 401k loan.

Resource: National Savings Rate Guidelines for Individuals

I have not really given these new IRAs much thought until I saw a very brief piece in an old issue of Newsweek. Jane Bryant Quinn addresses the topic with a fairly hasty comment:

Funny–We pay a bundle to the rich to get them to save more money, but we pay almost nothing to the poor. When I say “pay,” I’m talking about the tax breaks offered for savings in retirement plans…the fatter your earnings, the bigger the government subsidy (deductions are always worth more in higher tax brackets).

Right away I see the obvious argument that yes, clearly people who make more money have to pay more taxes, so any tax breaks they receive will have a greater benefit than those who don’t make much money and are paying little or no taxes. She goes on to criticize the fact that people who earn more receive a benefit from saving whereas lower earners receive nothing. She claims that only the well-to-do are able to save for retirement and receive investment advice. It is a “privileged realm” she calls it.

Quinn’s article was before the new Obama administration’s new proposal which throws another wrench into the mix by defaulting to a Roth IRA as the automatic enrollment vehicle. Now there’s little tax break up front but a tax break in the future. For lower income individuals I think they would see more value of an immediate tax break. A Roth still probably makes more sense for them financially, but the idea is to encourage people to save, period. If they can’t envision the tax break 30 years down the road they may see little benefit to contributing at all, and the whole premise of the automatic IRA has been wasted.

Here’s how the automatic IRA would work in a nutshell:

• Employers without retirement plans and have 10 or more employees and have been in business for at least two years would be required to make the new IRAs available.
• Workers could contribute on a percentage or fixed dollar amount basis just like the 401(k) counterpart directly through payroll deduction, but the automatic enrollment would default to 3%.
• Employers would have no obligations to this account, no requirement for matching money or any liability.
• They would receive a small tax credit to offset the start-up costs.

So the goal is to get lower income employees to save right? I guess if you’re creating an opt-out plan instead of an opt-in plan you will get a lot of people to enroll and never opt out. It could be just due to apathy, but at least there would be people saving who otherwise might not be. But there is one issue that bothers me, and that’s the details around liability and fiduciary duty.

If the employer isn’t responsible, who is? Who do they select for the IRA provider? Will the government select a dedicated investment provider? Will they be responsible? No. Remember, these are Individual Retirement Accounts. Everything falls on the individual for making decisions. Who is going to provide them with investment advice? Who is going to help them understand the importance of saving? Who is going to guide them when an employee gets fired or quits their job and wants to cash out all this “found money” they now have access to? And what about help with roll overs? I’m sure a lot of employers would love to wash their hands of any fiduciary responsibility, but this isn’t doing the common employee any favors.

A Good Idea on Paper

On paper this idea sounds great. You provide an easy way for employees to make contributions to an IRA directly through payroll deduction. Why wouldn’t that help people save? Well, I think it would help a few, but it is taking on the problem of our inability for people with lower incomes to save in the wrong way.

I’ve worked with retirement plans and my sole job was to educate employees and encourage them to sign up to the employer sponsored plan. The biggest problem I see is that even with a very generous company match, institutional funds with very low fees and a dedicated investment representative on-site 5 days a week the lower income employees still generally don’t enroll. If you can’t attract low income employees with a 100% match and professional investment advice that the high-paid executives in the same company are utilizing how on Earth will you ever get these people to stay enrolled in an IRA that has no match and comes with virtually no guidance?

We still don’t have standardized automatic 401(k) enrollment, which would help millions more people and is an infrastructure that is already in place, so why don’t we start there?

The Real Problem

If companies providing these so-called “privileged” retirement accounts aren’t even able to enroll their lower income employees I just don’t see how the automatic IRA would be any different other than making it an opt-out account. The real problem is that these employees are generally just able to make ends meet and don’t think they can afford to save. In some cases that may be true. Just because their employer lets them save easily and automatically doesn’t mean they will by any means. Some may obviously not realize they are saving or never get around to opting out, but for people who are literally living on every last penny of their paycheck will likely just opt out so they can get more money, especially if they aren’t seeing any financial incentive for saving.

The real way to get lower income workers to save is to give them free money. Those earning more money obviously get a nice tax deduction by saving in pre-tax retirement accounts, but when you have someone that isn’t paying any tax as it is there’s not much incentive. That’s where the saver’s tax credit comes in. This is a credit for those those who contribute to an retirement account with low incomes. Again, this is a great incentive for lower income workers, yet very few actually take advantage of it. It’s a tax break specifically for the working poor and it usually goes to waste. At least if the IRA became an automatic enrollment you could find a way to show these savers how much of a credit they would receive in order to encourage them to stay enrolled, but I usually find that trying to manipulate financial behaviors of those who make little money is not very effective.

You can decide for yourself, but while the thought of an automatic IRA sounds like it would help these people save I think it is only a tiny improvement for this situation. Much more has to be done in the way of educating people, and for those who truly do not make enough money to save I don’t see what can be done to encourage them to save with a plan like this. The majority of employers already offer a retirement plan and most companies struggle to get employee participation over 70%. So, why not start with automatic 401(k) enrollment? I wish I had the solution to the problem, but I don’t. I just don’t think a plan like this is ultimately very helpful or addresses the real problems.