Your retirement investment options will depend on where you are now and where you would like to be some time in the future. Understanding that both your personal conditions and situations in the world will change as you head towards retirement.
As a result of the uncertainty and changes your retirement investment planning needs will also change.
Before getting too involved in the details it is important to have an overall view of where and when the various retirement investment options can and should be used. These will differ based on how close you are to retirement and how close you are to your retirement goals.
Certain primary elements need to be understood before deciding on which retirement investments are a best fit. There are two basic schools of thought about retirement investing.
- The first says that the younger you are the more risk you can bear and therefore you should invest in riskier investments.
- The second says that your risk profile will depend on how much money you need to make and how quickly you need to make it.
But if you are young and lower risk retirement investment options will achieve your goal, why take on additional risk?
Conversely if you are older and require higher returns to meet your goals then you should be looking at the riskier high return investments.
Defined Benefit Pension Schemes
Traditional pension funds were provided by employers as a defined benefit lifetime annuity. This was effectively a deferred compensation scheme which enjoyed certain tax benefits for the employee and the employer. Simply, depending on your length of service you were paid a defined amount until you died. These funds evolved to also include spouses and to increase every year with an inflation adjustment.
With changing conditions in the workplace and demographics these were later amended to having the employee paying a portion (in the United States these schemes are known as 401k). The effect of this change was that retirement funding responsibility was shifted towards the employee.
This was the thin end of the wedge. With more recent changes putting more and more burden on employees.
Pension Schemes and Tax
Different countries have adopted different rules regarding the tax liability on the different retirement investment options. Many of these are quite confusing but usually the contributions and the interest earned is not taxed until the funds are withdrawn. When held over long periods of time the compounding interest with delayed taxation as well as the company contributions is a major benefit of the 401(k) deferred tax type plan.
However the risk is in how these funds may be taxed in the future as governments face growing deficits and the need to raise money. Variations to pension schemes that have been introduced include schemes where the contributions and earnings are taxed and then withdrawn tax free (Roth 401k).
Another option to consider is annuities. This particular type of investment is sometimes seen as complicated but it simply provides for a fixed income for as long as the investor lives.
The capital is either built up over time or paid in as a single lump sum. Based on this capital the insurance company will calculate the amount which they will pay through the life of the investor. Care should be taken when choosing the annuity as returns and risk may vary with different companies.
Investors must look carefully at how this type of retirement investment will benefit or supplement their financial needs. With careful planning and prudent investment strategies an annuity will provide a guaranteed lifetime income.
Diversified Retirement Portfolio
Most retirement advisers believe that a diversified retirement portfolio is the ideal choice as it reduces risk. The different options should be combined to maximize income with the lowest element of risk. However this is very difficult to achieve as macro economic upheavals can seriously damage the best of portfolios.
With the amount of uncertainty around, and which is likely to be around for a long time, it is important that retirement investment options are regularly reviewed and rebalanced. To ensure a real return (greater than the rate of inflation) it is very likely that the portfolio will include stocks. As these differ significantly in terms of risk and return they must be carefully chosen.
Independent Financial Advisor
Most people are in the dark when looking at, and deciding on their retirement investment options. In this case it is essential to use the services of an independent, fee only, experienced, qualified financial adviser who can guide you through the different retirement plan options.
However, the use of their services does not mean that you just leave your fate in their hands.
Another often overlooked element is the costs involved in the different options. These often look like insignificant percentages but over a long period will crush your portfolio returns.
Proper personal evaluation needs to be done on which different types of annuities, pension, investments or IRA meet your own requirements.
It is an extremely important task which should not be neglected. Any mistakes will hit you at a time at which you can do very little about them!
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