Though it may be many years away, retirement is something all of us think about. Certainly you don’t want to work until you’re 80, but you’re not sure how you’ll live if you retire at 65. And what about your child’s future? Should you start a retirement fund for him now? Is that even an option? And what should you know about the 401(k), an IRA and a Roth IRA? Is one better than the other?

“By the time a parent reaches retirement, they should have enough funds saved to replace approximately 80 percent of their income,” says Sean O'Neill, a financial planner in Highlands Ranch, Colo. “The general recommendation is to save at least 10 percent of your paycheck each month. However, that may not be enough, or it may be over-funding retirement depending upon your circumstances.” He suggests sitting down with your financial consultant or if you don’t have one, sitting down with your spouse to start crunching some numbers.

Plan Ahead
“Saving for retirement is one of the most important things you can do, but it is also vital to be realistic,” says Debbie Webb, a CPA in College Station, Texas. Often she says young married couples who earn a modest living will tend to save as much as they can for retirement. “The trouble is that they suddenly realize they would like to buy a home before they retire, and then they are stuck for the down payment.”

“They take it out of their retirement plans, but everything they withdraw will become taxable, and the bad part is that the large withdrawal may push them up into a higher tax bracket,” she says. “To top it all off, they didn’t withhold near enough to pay the resulting high tax bill, so they find they are deeply in debt to the IRS when they file their tax return. They would have come out ahead to put less into a retirement account and more into a regular savings account.”

While saving as much as you can for retirement is a good idea, it’s always best to maintain a regular savings account for large purchases.

Making Sense of It All
“When a parent is employed with a company that matches the 401(k) contribution, this should be the first place the parent saves for retirement,” says Tracy B. Stewart, a CPA and financial planner in College Station, Texas. “The employer contributions are ‘free money.’ It is important for the employee to contribute the amount or percentage that will trigger the maximum matching from the employer. Lower contributions by the employee will reduce the amount of ‘free money’ from the employer matching.”

Additionally, the employee contributions will reduce their taxable income during the year of the contributions because the contributions are before-tax money, Stewart says. “The employee should contribute to an IRA (preferably a Roth IRA) after he/she has maximized his/her 401(k) contribution, not before. No one matches the IRA contributions. And those contributions do not reduce his/her earnings number on the W-2 like the 401(k) contributions do.”

However the drawbacks of 401(k) contributions can come about in the company’s policy. “If the company requires the employees to invest their 401(k) accounts in company stock, the employee is putting all his eggs in one basket – both his employment and his retirement hangs on the financial situation of the one company,” says Stewart.

The drawbacks of an IRA, however, are that choosing where to open one can be confusing and expensive (some places charge high fees, some don’t). You either pick your own investments (from a huge array of choices out there), or you pay someone else to do it for you – do it well or do it poorly. ”The benefits of IRAs are that you get to direct your own investments,” Stewart says. “You can diversify your investments. You can choose where to put your IRA account, thereby (hopefully) choosing better investment choices.”

How Much is Enough?
The amount of money one should save for retirement really depends on the person. “If you are contributing to a 401(k) plan, you should put away the amount that will get you the maximum employer contribution match,” says Stewart. “We are talking about ‘free money’ here.” Otherwise, the target amount is 10 percent to 15 percent of your gross income (before withholdings). “Get used to saving this much, and you will have a much better chance of being rich down the road,” she says.

Here is Stewart’s quick (and by no means thorough) method to calculate how much to have saved by age 65:

1. Figure out how much money you need to live on if you were age 65 today. Be sure to include the money you need to pay income taxes. (This step is the most difficult for people to do realistically.)
2. Take this amount from step one and do your algebra: This amount is X percent of what number? That “what number” is the amount – in today’s dollars – you should have in savings when you retire at age 65.
3. Using an anticipated compounded inflation rate, calculate how much the “what number” will be when you reach age 65. (Yes, this is tricky, so it’s best to have a professional do this for you.) Note: If you were born in 1960 or later you are probably going to start getting Social Security checks at age 67. Therefore, you might be retiring at 67 instead of at 65.

Including Your Kids
“Mom and Dad can start a savings account for Junior, but they can’t start a retirement plan for him,” says Webb. “Most teenagers won’t have access to retirement plans through their work, but they can contribute up to $3,000 to an IRA once they start earning income.”

Saving for college, however, might be a more important goal to have first, depending on the circumstances. "If a high-income mom and dad plan to pay for college anyway, the family may agree that Junior should put money into an IRA,” she says.

“A traditional IRA will save Junior taxes," says Webb. "But a Roth IRA should provide for spectacular long-term growth of the savings that will remain tax-free even when withdrawn after age 59. Consider this, too: Junior must have earned income to contribute to his IRA, but it doesn’t have to come from his own money. Say Junior gets a job earning $4,000 during the year while in high school. He is on a budget to buy his own clothes, pay for movie tickets, gas, etc., and he really doesn’t earn enough to save much of anything. But Mom and Dad (or Grandma and Granddad) can gift him $3,000 to contribute to his IRA. Junior can learn the value of a dollar and get a marvelous jump-start on saving for retirement. What a great thing to do for your child.”

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