As the global population ages, the need to provide financial security for people in retirement has become a concern for policymakers throughout the world. Along with the increase in life expectancy, risks have been transferred from employers and government to workers, who are increasingly made responsible for managing their retirement savings plans.
Defined Contribution (DC) retirement plans, in which employees contribute a fixed amount or a percentage of their salary to an account that is intended to fund their retirements, are one of the primary mechanisms to ensure adequate financial resources after retirement. However, choosing a retirement plan is no easy task and involves financial skills that people may be lacking.
Around the world, the primary responsibility for providing an adequate retirement income has been shifting from the defined benefit form to defined contribution, in which plan participants must make investment decisions. Evidence shows that people consistently make certain mistakes because of lack of financial knowledge, faulty logic, cognitive dissonance, and biased statistics.
The financial educational materials at these websites generally agree on the following set of principles for investing money earmarked for retirement:
• Investors should genuinely diversify their total portfolio across asset classes, and the equity portion should be well-diversified across industries and companies.
• The longer your time horizon, the more you should invest in equities.
Unfortunately, the complex problem of investing, to provide a guaranteed income after retirement, is being transferred from governmental institutions and private sector employers to people who lack the knowledge and the training to handle the risk. As we have seen, the educational materials and investment advice provided to those people by financial service firms are often dangerously misleading. One practical solution to the risks posed for individuals and for society at large is to design and produce a new generation of investment products that insure people against severe market declines. Advances in the science of finance and market innovations over the past several decades have made this a feasible task.
How Much Should Individual be Saving for Retirement
It’s highly personal and depends on many factors. However, it’s important for people in their early ages to take advantage of their earning to build a good retirement plan.
Fidelity recommends saving 15 percent from the salary, and that amount includes contributions from your salary as well as any contributions from your company.
The recommendation emphasizes that if you can’t save 15 percent right away, make sure that you’re saving at least enough to get the full match that your employer offers. For instance, make a commitment to yourself that you’re going to increase your contribution by 1-2 percent every year until you get the 15 percent.
Individuals should have saved the above amount at the certain mentioned age and then continue to save at less than 15 percent monthly. However, each individual should have a different estimated retirement plan and the amount of money saved for retirement.
Company Stock and Retirement Plan Diversification
More than two decades of growth have firmly established the central importance of defined contribution (DC) plans in the United States retirement marketplace. There are more than 700,000 corporate-defined contribution pension plans in the United States alone, covering about 55 million workers and managing over 2 trillion USD in assets.
The 401(k) pension plans, a form of individual account pension that has grown rapidly since the 1980’s, now represent over half of all defined contribution plans, more than half of all active pension participants, and over 80 percent of private defined contribution plan assets.
Looking to the future, defined contribution pension plans, 401(k) plans in particular, seem highly popular and continue to maintain and expand their prominent role in the United States retirement market.
After the historical success, following the United States model, countries around the world, for instance, Japan and Germany, have recently adopted variants of the United States 401(k) model, hoping to boost retirement savings and eventual economic security.
Risks In Retirement Plan
Despite defined contribution plans’ strong appeal in the United States retirement context, people have been questioning the effectiveness and the benefit of these retirements, which might threaten their popularity and policy support. Poor capital market performance over 2000-2001 eroded investment returns received by many plan participants, leading some to ask whether a form of guaranteed benefit might be more compatible with retirement income promises.
Disadvantages associated with the 401(k) are, for example:
· Individual might pay more in taxes
· Also, may be paying more in fees
· Household can’t easily invest or use the money before he or she retire
· Investment choices are limited
Because of some disadvantages in the 401(k), some individuals are turned to other opportunities, such as stock. However, other plan participants, who turned to stocks, have found themselves suffering significant losses after they invested heavily in their own company’s stock and saw its price sink suddenly and precipitously.
Unfortunately, the existing policy for defined contribution plans seeks to both encourage employee ownership and provide a secure retirement income, which permits concentrated stock positions, will inevitably produce some defined contribution participants who will lose their plan assets to firm bankruptcy.
More broadly, for participants with concentrated stock positions, there are likely to be both greater extremes of accumulated retirement wealth and lower wealth for the median participant. Higher single-stock volatility not only contributes to a wider range of extreme outcomes for company stock winners and losers, but it also means lower median wealth for participants due to the compounding of more volatile returns.
What are the other retirement plans than 401(k)
A majority of employees have not been participating in the 401(k). However, most of these people have other alternatives for retirement. For instance, 35 percent of private-sector workers over the age of 22 don’t work for a company that offers a 401(k) plan. But don’t let that be a deterrent for not saving for the future. Whether or not you have access to a 401(k), at some point, you will want to retire, and you will need to have money saved.
Investment in Alternative Assets.
As an alternative to qualified plan contributions, superior returns may be gained through investment in other valued assets, such as individual valued stocks, mutual funds, or tax-free municipal bonds. For some, the advantage is to reduce exposure to the excise tax, since investments are made outside the plan. However, earnings from such investments are not tax-deferred, which may result in lower total after-tax returns.
In the case of tax-exempt bonds, earnings would be tax-free, but the rate of return would be lower than taxable investments. However, in certain cases, particularly for older investors approaching retirement, alternative investments, both taxable and tax-exempt, may produce a higher after-tax return due to the high present value of the excise tax.
Deciding how much to save for retirement is a complicated task. For approximately two-thirds of Americans whose employer offers a retirement savings plan, such as a 401(k), employees must decide whether to participate in the plan, how much to save, and which plan fund to invest.
These decisions are frequently complicated by uncertainty over future expenses, the timing of retirement, and even the nature of one’s own risk or time preferences, especially for employees who lack financial education. Therefore, we strongly recommend that individuals must research the features of the different retirement plans and then decide for their best interest.
To learn more about the best investments for retirement plan, you can purchase THE FIRST INVESTOR book and receive a discount by clicking on The First Investor .