Function
A retirement fund allows you to continue to maintain your standard of living after you retire. Most experts recommend that you amass a large-enough retirement fund that you can live off the interest of the fund (when combined with social security, pension income and other sources of income). By living off of the interest and not touching the principal, you won’t run out of money in retirement. If you have to tap into your principal, you reduce the amount of money available to you, and you also reduce the amount of interest you earn, since you have less invested. As a result, you could end up running out of money too early and having to lower your standard of living or turn to family or friends to help provide you with financial support.
Considerations
The main consideration most people have when it comes to retirement funds is how much they need to invest. If you want to insure a secure retirement, make sure you have enough saved. According to the “Thrift Savings Plan,” most people will need at least 60 percent, and as much as 100 percent, of their preretirement income upon retirement. This means that the money in your fund should be able to generate interest to provide you with the same amount you were making before you retire. If you make $50,000 per year, your retirement fund should be able to provide you with at least $30,000 (60 percent of $50,000) and as much as $50,000 in income. The exact amount required to do this depends on your rate of return. If you are earning 10 percent annually, you will need to have between $300,000 and $500,000 saved in your retirement fund. If you earn a higher rate of return, you can get by with less savings. If you earn a lower rate of return, you will need more savings.
Types
There are many different types of retirement funds available to you that you can invest in and draw income from. A 401(k) is one major type of retirement fund. You can contribute to a 401(k) with pre-tax dollars, and most companies will match a portion of your 401(k) contributions up to a certain percent. For example, if you are allowed to contribute 10 percent of your income to your 401(k), your employer may match the first 3 percent of contributions, so for every dollar you put in, they will put one in too. Some companies do a 100 percent match, others do a 50 percent match.
A Roth IRA or regular IRA are also options for retirement funds. A regular IRA allows you to invest with pretax dollars and pay taxes when you take the money out, while a Roth IRA allows you to invest with after-tax dollars but the money grows tax free and you don’t have to pay taxes when you take it out. Other types of retirement funds exist as well, such as variable annuities (a contract with a life insurance company where you are paid a set amount each year) and (SEP) IRAs for self-employed individuals.
Time Frame
The younger you are when you start investing in retirement funds, the less you will have to invest in order to achieve your retirement goal and amass enough money. This occurs because of compound interest. When you invest when you are young, that money earns interest. The interest earned is reinvested, and then you earn interest on the interest. So, for example, if you invest $100 and the $100 earns $10, then the next year you have $110 invested and earning interest. Over the course of your life, this can make a big difference.
Benefits
There are numerous benefits to having a retirement fund. First, for many funds, you get a tax savings so you have to invest less to make money. Second, a strong retirement fund will allow you to have a secure retirement and even leave an inheritance to your children. You will not be dependent on an uncertain Social Security system to provide your entire income, or on a pension in an era when fewer and fewer employers provide pensions to employees.
Warnings
When investing your money, invest wisely in things that you understand. Typically, when you are younger you have more invested in stocks, but you should switch to safer investments such as bonds as you age, since you will have less time for the market to recover in the event of a downturn. You should make sure the money in your retirement fund is balanced and diversified, which means that it is not all in one place. If you don’t understand how to invest your money in your retirement fund, your employer’s HR Department, a financial planner or a broker can help you decide on the best investments for your situation.