Sunday, January 12, 2020

Long-Term Planning

â€Å"Pay yourself first† is a standard commitment device used by financial planners seeking to encourage disciplined saving and budgeting; it is also the principle underlying US payroll-deduction 401(k) plans. These plans are one of the most successful commitment devices in current use, and they are formulated such that contributions are automatically deducted from workers' pay before the money can be spent. As such, saving in 401(k)-type plans would be best for my personal situation, as participation rates in 401(k)-type plans, where payroll deduction is the norm, are at least four times as high as for Individual Retirement Accounts (IRAs) (Mitchell and Utkus, 2004), where structured payroll deductions are uncommon. Additionally, I am given the liberty to exert some control over how my money is invested (subject to some constraints), and receive the risk and reward for those investments. Since my tax rate when I retire would be presumably higher than my tax rate before retirement, I would likewise be better off with a Roth IRA than a traditional IRA because I won’t have to pay tax on my withdrawals at the higher rates. I can withdraw the money I contributed to a Roth IRA penalty-free anytime, since I already paid tax on it so the government would not care. Since I would not probably need my money I invested in Roth IRA for at least five years from now, my money will be tax-free on withdrawal. The catch is that I cannot know for sure what my tax rate would be when I retire, but I can find several online calculators that will help me compare results with a Roth IRA versus traditional IRA. Further, the new Roth IRA provisions apply even if I am covered under my employer’s retirement program. Lastly, the SEP proves to be a promising retirement plan based on my personal situation. Although the SEP is an employer-provided retirement plan, record-keeping and tax reporting are simplified, a plus factor for me. The higher limit in a SEP makes this plan as attractive as the profit-sharing plan, but easier and less costly to administer, which are two of my foremost criteria when choosing a fitting retirement plan for myself. WORK CITED Mitchell, O. & Utkus, S. (Eds.). (2004). Pension Design and Structure: New Lessons from Behavioral Finance. Oxford, England

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