Be prepared: Invest heavily in your own retirement
The Individual Retirement Account was created through the 1974 Employee Retirement Income Security Act and has been a tax-free savings boon for individual investors since.
In 2013, according to the Investment Company Institute, IRAs represented $5.7 trillion of U.S. household assets and 25 percent of total retirement assets. Additionally, 38 percent of households owned an IRA with investment levels double those two decades prior. For many Americans, the IRA serves as their primary retirement plan.
Still, a chorus of pundits warn that Americans are woefully unprepared for retirement. In "The Women's Guide to Successful Investing," I discuss a 2012 retirement study sponsored by Ameriprise Financial and conducted by Koski Research. One thousand employed adults with investable assets of $100,000 were interviewed; only 46 percent expressed confidence in being able to afford retirement. Yet 78 percent expected to be "extremely happy later in life."
The disconnect is clear: We likely are not saving enough to fulfill our retirement expectations.
But a recent article in Barron's titled "Don't Panic" argues that most Americans are in good shape for retirement. The article cites the 2008 Census Bureau's Current Population Survey, which seemingly undershoots calculation of retirement income. The census data showed that retirees reported $222 billion in income — less than half of what they ultimately reported to the Internal Revenue Service. Census figures undercount any income that isn't "regular" — such as, for example, mandated withdrawals from IRAs. It turns out undersaving may not be retirees' biggest worry. Income tax, on the other hand, may be. It is one of the primary costs faced in retirement and one that we are often unprepared for.
An IRA account grows tax-free until distributions are taken beginning at age 591/2 with mandatory distributions required at age 701/2. These distributions are taxed at ordinary income rates. Yet a Roth IRA grows tax-free, carries no mandatory distribution and is not taxed upon distribution. Roth IRAs, however, carry income-eligibility requirements. But if you are 591/2 or older, you can convert your regular IRA into a Roth without restrictions.
You will be taxed at your ordinary income-tax rate at the time of conversion (ideal for smaller IRA accounts or partial conversions), but future distributions will be tax-free. And, importantly, once the Roth account has been open five years, your heirs will pay no taxes upon distribution.
Conversion to a Roth is not for everyone, to be sure. Consult an adviser or the numerous online publications that detail the pros and cons of conversion.
In the meantime, consider placing the maximum allowed annual savings into a retirement-savings vehicle. That way your biggest retirement problem may not be whether you have enough money to meet your life goals but the inevitable result of prosperity — a higher income-tax bill. Which isn't necessarily a bad problem to have.
Next week: Asset-allocation considerations before and during retirement.
Nancy Tengler spent two decades as a professional investor. She is an author, financial-news commentator and university professor. Her book, "The Women's Guide to Successful Investing," is out now. Reach her at nancy.tengler@cox.net.