Retirement Investment Options

Worksheet
Directions: You will research the following retirement options and compare/contrast the different options: IRAs, EmployerSponsored Retirement Plans, and Annuities. Include at least 2 advantages and disadvantages for each retirement option. After you
compare/contrast the different types of retirement options, identify the one that you think would be most beneficial to use for your
personal retirement goals. Type a summary explaining which retirement plan you would invest in and why. Be sure to use
characteristics of the plan you have chosen when typing your summary. You will want to use this information to build the next stage of
your investment portfolio.
Retirement
Option

Definition

Individual Retirement Accounts

Traditional
An individual
IRAs
retirement
account (IRA)
that allows
individuals to
direct pretax
income, up to
specific annual
limits, toward
investments that
can grow taxdeferred (no
capital gains or
dividend income
is taxed).

Advantages

The primary benefit of any tax

deferred savings plan, such as an
IRA, is that the amount of money
available to invest is larger than
would be the case with a post-tax
savings plan, such as a Roth IRA.
This means that the multiplier effect
of compound interest, or for example,
larger reinvested dividends, will yield
a larger sum over time. Financial
institutions also generally give higher
rates of interest to larger sums
invested in instruments such as
certificates of deposit. The risk is that
over a significant period of time the
eventual rate of income tax levied on

Disadvantages

One must meet the eligibility

requirements to qualify for tax
benefits. If one is eligible for a
retirement plan at work, one's income
must be below a specific threshold
for your filing status. If one's income
(and thus tax rate) is that low, it
might make more sense to pay taxes
now (Roth IRA) rather than defer
them (Traditional IRA).
All withdrawals from a Traditional
IRA are included in gross income are
subject to federal income tax (with
the exception of any nondeductible
contributions; there is a formula for
determining how much of a

withdrawal is unknowable and could

be higher than originally anticipated.
While many people think that the
reduction in taxes in the year of
contribution is a benefit, that is not
necessarily the case. While it is true
that the unpaid taxes can be
immediately invested and continue to
grow, taxes on these gains will need
to eventually be paideither on an
ongoing basis, if invested in a nontax-deferred vehicle (e.g. if pre-tax
options are already maximized), or at
withdrawal otherwise. Assuming that
both the tax deduction and the tax on
its reinvestment gains only affect the
individual's top tax bracket, the
results are tax-neutral. Any potential
benefits of claiming and reinvesting a
tax deduction come from the
expectation that the taxpayer may be
in a lower tax bracket during
retirement.
The only benefit that everyone
receives is the income's protection
from tax. This equals the dollars of
tax that would have been paid on the
income if earned in a taxable account.
It exactly equals the benefit of a Roth

withdrawal is not subject to tax). This

tax is a repayment of the original tax
on employment income deferred in
the contribution year. It is not tax on
the growth inside the account.
Because taxes (and maybe penalties)
must be paid before cash in the
account can be withdrawn and used,
this account is hard to use for
emergencies.

IRA.
Roth IRAs

Individual
retirement
account allowing
a person to set
aside after-tax
income up to a
specified amount
each year. Both
earnings on the
account and
withdrawals
after age 59 are
tax-free.

Assets in the Roth IRA can be passed

on to heirs.
The Roth IRA does not require
distributions based on age. All other
tax-deferred retirement plans,
including the related Roth 401(k),
[5]
require withdrawals to begin by
April 1 of the calendar year after the
owner reaches age 70. If the
account holder does not need the
money and wants to leave it to their
heirs, a Roth can be an effective way
to accumulate tax-free income.
Beneficiaries who inherited Roth
IRAs are subject to the minimum
distribution rules.
Roth IRAs have a higher "effective"
contribution limit than traditional
IRAs, since the nominal contribution
limit is the same for both traditional
and Roth IRAs, but the post-tax
contribution in a Roth IRA is
equivalent to a larger pre-tax
contribution in a traditional IRA that
will be taxed upon withdrawal. For
example, a contribution of the 2008
limit of $5,000 to a Roth IRA may be

Funds that reside in a Roth IRA

cannot be used as collateral for a loan
per current IRS rules and therefore
cannot be used for financial
leveraging or cash management tool
for investment purposes.
Contributions to a Roth IRA are not
tax deductible. By contrast,
contributions to a traditional IRA are
tax deductible (within income limits).
Therefore, someone who contributes
to a traditional IRA instead of a Roth
IRA gets an immediate tax savings
equal to the amount of the
contribution multiplied by their
marginal tax rate while someone who
contributes to a Roth IRA does not
realize this immediate tax reduction.
Also, by contrast, contributions to
most employer sponsored retirement
plans (such as a 401(k), 403(b),
Simple IRA or SEP IRA) are tax
deductible with no income limits
because they reduce a taxpayer's
adjusted gross income.
Eligibility to contribute to a Roth
IRA phases out at certain income

equivalent to a traditional IRA

contribution of $6667 (assuming a
25% tax rate at both contribution and
withdrawal). In 2008, one cannot
contribute $6667 to a traditional IRA
due to the contribution limit, so the
post-tax Roth contribution may be
larger.
Employer-Sponsored Retirement Plans
Defined-benefit
a
plans
company
pension
plan in
which an
employee
's pension
payments
are
calculate
d
according
to length
of service
and the
salary
they
earned at
the time

in other words it costs more to fund

the pension for older employees than
for younger ones (an "age bias").
less portable than defined
contribution plans
criticized as being paternalistic as
they enable employers or plan
trustees to make decisions about the
type of benefits and family structures
and lifestyles of their employees.

limits. By contrast, contributions to

most tax deductible employer
sponsored retirement plans have no
income limit.

The age bias, reduced portability and

open ended risk make defined benefit
plans better suited to large employers
with less mobile workforces, such as
the public sector (which has openended support from taxpayers).

of
retiremen
t.
Definedcontribution
plans

Annuities
Fixed Annuity

A retirement plan in which a

certain amount or percentage
of money is set aside each
year by a company for the
benefit of the employee.
There are restrictions as to
when and how you can
withdraw these funds
without penalties.

Control
Portability
Equal benefits

Fixed annuities pay guaranteed rates of

interest, which makes them appealing to
investors wary of the stock market's ups and
downs. What also makes them appealing are
their low investment minimums - usually
$1,000 to $10,000 - and the fact that the
interest they pay escapes taxation until you
pull it out.

The disadvantage of adefined contribution pl

an is the possibility that the investments will
not perform as well as expected, giving the p
ensioner a less secure retirement.

Their rates can also be fixed for a limited

period, and then drop say, after the first year.
If you don't like the new rates and want to
withdraw your money early, heavy surrender
charges could kick in and cut into your
returns.
Plus, if you decide to opt for fixed lifetime
payments, those payments will not rise to
keep pace with inflation. As a result, the
value of the money you receive will decline
over time as inflation erodes the purchasing
power of each dollar. So for example, if you
retire young and plan to keep collecting
annuity payments for a longer period of time,
the purchasing power of your money could

be a big concern.
contract between Unlike their fixed counterparts, variable
Investment Risk
you and an
annuities are designed to pump up your
Taxes
insurance
savings by giving you a chance for long-term
Fees
company, under
capital growth. They do this by allowing you
which you make to invest in anything from half a dozen to 20
a lump-sum
or so stock or bond mutual-fund-like
payment or
portfolios called subaccounts. As with fixed
series of
annuities, gains escape taxation until
payments. In
withdrawal.
return, the
Because of the growth potential, a variable
insurer agrees to annuity may be more likely than a fixed
make periodic
annuity to outpace inflation.
payments to you
beginning
immediately or
at some future
date.
Summary: I would personally invest in a traditional IRA because I would have to pay a fee up front and not have to worry
about it after I start to get money from the plan.
Variable
Annuity