Every area of your life has its own language. Oh it may still be in English, or Spanish or even Mandarin Chinese, but the terms, phrases, and meanings change depending on the application. For example, when a carpenter mentions the word “stud” it has a whole different meaning to a horse breeder, a tire changer, someone trying on earrings, or looking for a husband.

Other terms are confusing because they are rarely used in any other arena and a lot of the terms used in retirement plans fit that bill. To make certain you can make the best decision between your plan choices, you need to know what all these various terms mean. Deciding which plan fits you best is a decision that’s best made after you’ve done just a little research, asked a few questions, and educated yourself on retirement plan terminology.

Enrollment and Contribution Deadlines

The IRS has firm annual enrollment deadlines and contribution deadlines for each type of retirement plan:

• Enrollment deadlines: Specify the date by which you must set up the retirement plan account
• Contribution deadlines: Specify the date by which you must make contributions into the account

These deadlines vary from plan to plan and are separate from any deadlines that your company might impose.

Eligibility Requirements

Every retirement plan requires you to meet certain criteria. These may include age, length of employment, amount and type of income, marital status, and whether or not you already participate in other retirement plans. Eligibility requirements frequently vary from plan to plan, but two general rules apply to all retirement plans:

• Earned income vs. passive income: Retirement plans require you to have earned income in order to open an account or contribute. Earned income is income from salary, commissions, or other work-related sources, or from alimony. Passive income, such as income you receive from investment-related dividends, annuities, or rental properties, does not qualify you to invest in retirement plans.
• Individual vs. joint ownership: All retirement plans are owned solely by the person who establishes the account. Qualified plans cannot be owned jointly, even by married couples.

Vesting Schedules

Any money you contribute to a retirement plan is yours immediately. Employer matched contributions, though, may not be yours to keep right away. The vesting schedule of a retirement plan refers to the timeframe in which your ownership of your employer’s contributions vests, or takes effect. For instance, your employer’s contributions might vest one year from each contribution date. If you cancel the plan or leave your job, you won’t receive any unvested employer contributions (though you’ll keep all vested contributions, as well as money that you yourself contributed).

Contribution Limits

Each type of plan has strict contribution limits that specify the total amount of money that you can contribute into your account each year. Contribution limits vary widely from plan to plan based on many factors, such as your total annual income and the other types of retirement plans you own. Certain plans allow participants who are 50 or older to make catch-up contributions, which increase the plan’s contribution limit by several thousand dollars per year.

Contribution Sources

You can fund retirement plans in two main ways (though your employer may also contribute to your plan).

• Payroll deductions: Employer-sponsored plans deduct money directly from your paycheck each pay period. These deductions can consist of pretax or after-tax dollars, depending on the plan.
• Independent earnings: Plans not affiliated with employers, such as most IRAs, require you to use your own savings (from earned income) to fund your accounts, either on a pretax or an after-tax basis. In this case, “pretax” contributions sometimes qualify for an immediate income tax deduction since they can’t be deducted directly from your paycheck.

Pretax Dollars vs. After-Tax Dollars

• Pretax dollars: Money deposited into a retirement account (or elsewhere) before it’s taxed. Using pretax dollars to contribute to a retirement account is among the few ways you can use your “raw” pay before taxes reduce it to the amount you actually receive. Employer-sponsored plans, such as 401(k)s, can be funded with pretax dollars.
• After-tax dollars: Money deposited into a retirement account (or spent elsewhere) that has already been subject to tax. Your “take-home” pay—the amount of money you actually receive after taxes have been taken out of your paycheck—consists of after-tax dollars. Some retirement plans, such as Roth IRAs, can be funded only by after-tax dollars.

Beneficiaries

Retirement plans allow you to specify the primary and contingent beneficiaries who will receive your plan’s assets when you die. Contingent beneficiaries receive your plan’s assets only if your primary beneficiaries are deceased or otherwise unable to receive your assets upon your death. Some plans may also allow tertiary beneficiaries.

Required Minimum Distributions

All retirement plans (except Roth plans) require you to start taking required minimum distributions (RMDs), or withdrawals from the plan, after age 70 1/2. The amount of the withdrawals varies based on a number of factors, including your specific age and retirement plan account balance. You can make withdrawals periodically throughout the year, and you always have the option to withdraw more than the RMD amount. Failure to make annual RMDs can result in an excess accumulation penalty equal to 50% of the amount that you should have withdrawn.

A few exceptions apply. For instance, if you continue to work past age 70 1/2 for the company that sponsors your 401(k) plan, you don’t have to take RMDs.

Fees and Minimums

Some retirement plans charge annual maintenance fees of about $15–50. Typically, fees for most employer-sponsored plans are paid by your employer, not by you. In addition to annual fees, some plans require you to maintain a minimum balance and/or to make a minimum annual contribution.

Withdrawal Penalties

The IRS imposes a 10% penalty for most withdrawals made before you reach age 59 1/2. The 10% is in addition to any taxes owed on investment gains within the account.

Exceptions to the Withdrawal Penalty

The government allows penalty-free withdrawals from retirement plans for certain qualified expenses, such as medical emergencies, disability-related costs, college tuition, and the purchase of a first home. Penalty exceptions vary from plan to plan. Despite these exceptions, it’s always best to avoid withdrawing money early from a retirement plan. By not withdrawing early, your money stays invested and takes full advantage of the tax-deferred growth that all retirement plans offer.

Rollovers and Transfers

The IRS has made it increasingly easier to move and combine retirement accounts, so long as you keep your money within a qualified plan of some kind. There are two terms that refer to the process of moving assets from one retirement plan account into another: rollovers and transfers.

• Rollovers: When you leave a company, you’re typically allowed either to leave your retirement money in that company’s retirement plan, move it into your new company’s plan, or move it into a special kind of IRA called a rollover IRA. Transfers of employer-sponsored retirement plan assets are called “rollovers.“
• Transfers: “Transfers” occur when you move assets between retirement plans not sponsored by employers, such as IRAs. Note that transfers are sometimes also referred to as rollovers.

Borrowing Privileges

Employer-sponsored plans often allow you to borrow money from your retirement plan account, though some plans allow borrowing only for “hardship” circumstances, such as medical emergencies. Borrow from your retirement plan only as an absolute last resort: borrowed assets don’t benefit from tax-deferred or tax-free growth until the money is returned to the account.

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We’ve had it “drilled” into our heads for decades – reduce dependency on oil for the good of our planet, for the good of our air, for the good of our water. We’ve learned to drive less, drive smarter, recycle where possible, use natural or organic materials, and use less energy. No one would love to give the heave-ho to oil producing nations more than me, but what would happen if I followed that logic and reduced my dependency on money?

Isn’t that the definition of frugality?

What would my life and my future retirement look like if I didn’t NEED so much money? What would it be like to be retired and used much less to live comfortably? Could it even be done?

How I can reduce my dependency on money

1. Pay off debt. How much of your monthly income pays interest on your debts? Without no debt or interest charges eating up income, we could more easily finance our lifestyle.

2. Life a thrifty life. Thrifty doesn’t mean cheap, it just means being conscious of where your cash goes and willing to say no to things you don’t need. Frugality is all about efficiently using resources and avoiding waste.

3. Move to a smaller home. The recession has made it clear we don’t need huge houses – we really just want a home. Smaller homes have virtues all their own. Oh yeah, you could always consider renting!

4. Stay healthy. Medical costs can escalate very quickly, especially if you don’t have health insurance. Eat right (it’s cheaper), exercise, stop smoking, and reduce your overall stress level.

5. Take a bite out of your food budget. There are over 100 ways to reduce your food costs. Select the ones that apply to you and put them to use!

6. Reduce your need for energy. Adjust your thermostat, insulate and caulk your home, convert to energy efficient lighting, drive less and more sensibly, and use your slow cooker instead of the oven.

7. Use “free” services you’ve already paid for. Parks, museums, walking and biking trails, and even certain concerts were already paid for by your tax dollars. Enjoy them – you’ve already paid for them.

Really, there are thousands of ways to reduce our dependency on cash but the point is to NEED less money without surrender the quality of our lives.

How can you reduce your need for money? Remember that by saving today, you’re sending money to your future self. It isn’t a sacrifice, it’s just a delay in your usage.

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Okay, your 401(k) has become a 201(k) and you’ve lost a ton of money in the market. You actually believe those researchers who claim the sting of a financial loss is much more intense than the smug satisfaction of a large gain. Yeah, gains bring relief, but losses bring on sleepless nights and worry. If you’re in your 40′s, 50′s or 60′s, you’re probably more motivated than ever to instruct your financial advisor to take a little more risk so your portfolio can benefit from a little more reward.

Risk vs. Reward

But too much risk is probably what got you in trouble in the first place, even if that risk wasn’t fully recognized by you, your advisor, or the markets. The most important path you can follow at this point isn’t necessarily to pump up your portfolio with extra risk, but to bring down the cost of your anticipated retirement lifestyle through smart, thrifty, and frugal living.

Your ability to retire in the future will be dependent on one thing: cash flow. If you can reduce your need for cash in retirement, your options really open up.

How to reduce the need for retirement cash

1. Pay off debt. Nothing sucks the wind from your portfolio’s sails quite like debt payments. If you want to retire in the next 20 years or so, learning to live on less by avoiding debt will be a key factor both then and now.

2. Pay off your mortgage. Personally, I plan to completely disregard the naysayers who claim that the tax deduction is a good reason to keep a mortgage. Why pay $10,000 in interest just to get $2,800 back on my taxes? Usually their calculations include some huge return in the stock market as proof you should invest instead of pay off the mortgage. We all know what can happen when you “count” on those type of returns. And there’s a better than even chance that I’m going to invest in safer, less risky investments when I’m retired.

3. Consider a side job. Consulting, blogging, babysitting, freelance writing, or anything that will make extra money will reduce your need for the interest from your retirement assets.

How much to draw?

Experts have traditionally recommended retirees draw from their portfolio at four percent per year, but given the dismal returns on guaranteed asset classes (CD’s, annuities, etc), that number should probably be closer to three percent … at least for the next few years anyway. Using a three percent number:

Every $1 in monthly after tax retirement income you wish to have means your portfolio requires $300 to sustain it (assuming three percent draw and a 28 percent tax bite).

Now, this is a very conservative model. Try the numbers out yourself: $300 at a 6 percent interest rate less a 28 percent tax bite divided by 12. It equals $1.08. I’m padding my calculations with that extra 8 cents to allow for the unexpected.

What is “the unexpected?”

• Unexpected medical expenses
• Unexpected drops in the value of your portfolio
• Unexpected needs of children or grandchildren
• Unexpected GAINS in your portfolio – just don’t spend it all in one place!

Retirement isn’t out of reach

Decide how much you’ll need

Think you’ll need $4,000 after taxes per month to live your perfect retirement? Using those numbers, you’ll need a $1.2 million portfolio. But before you get depressed and think, “In that case, I’ll NEVER be able to retire,” consider this, for every $1,000 in after tax monthly income you can generate with your side job, your portfolio can be $300,000 smaller. Generate a monthly income of $2,000 though your little side enterprise and you need to save half as much as you originally thought.

Decide what you’ll do

What will you do in retirement? If you plan to kick back and sit on your rocker, you obviously won’t need much, but if you’re planning an active retirement, you’ll need either interest bearing assets or some other form of cash flow.

Decide to live the frugal lifestyle now … and then

Living frugally now makes sense because it gives you the opportunity to save money and essentially send it to your future self in retirement. Living frugally in retirement (and maybe having a side income) makes sense because it reduces the amount you have to have in interest bearing assets.

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I read with great interest today a news article on a new White House initiative that calls on people to save for retirement. There will apparently be an option to get your tax return issued to you as US Savings Bonds as well as new legislation to make it easier for employers to automatically enroll workers in 401(k) plans.

If you work hard and meet your responsibilities, this country is going to honor our collective responsibility to you: to ensure that you can save and secure your retirement. –US President Obama

I didn’t know we all had a “collective responsibility” to ensure that someone has common sense.

Don’t get me wrong. I’m in agreement with anything that helps people save more money, and especially save for retirement. But the term “collective responsibility” and retirement shouldn’t be in the same sentence.

Consider this headline three weeks prior to the White House’s initiative to encourage Americans to buy savings bonds: China reduces holdings in US debt.

Since “US debt” and Savings Bonds are essentially the same thing, it appears to this writer that the White House is trying its dead level best to hold on to as much cash as possible. If the treasury can divert tax refunds BACK into the treasury, it means more money for the Federal Government to spend while keeping a check, albeit small,  on inflation. With the current dismal rate of interest on savings bonds, I would guess that only the uninformed would choose this option.

How long before the tax refunds converted into savings bonds are spent on ridiculous pet projects just like our (now) non-existent Social Security “Trust Fund?”

Also, the administration said the IRS will provide approved language for employers to use when amending their retirement-savings plans to include automatic-enrollment — a system whereby workers are put into the company’s savings plan automatically and must opt-out if they choose not to participate … Treasury and IRS are also releasing a ruling explaining how employers can automatically increase workers’ contribution rates over time, so a bigger portion of their pay is saved each year.

What’s your take? Would you like it if you were enrolled automatically in your employer’s 401(k) and had to opt out? Do you want to have to opt out of the automatic increases in the proposed plan? If you’re eligible for a tax refund next year, will you get it in savings bonds?

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