At the turn of the 20th Century, most folks had about ten years to enjoy life. That decade fell between the day that a person was born and age ten. From then on, it was work 'til you die, literally. The age expectancy was 62.2 years, so a person really didn't live long after he stopped working. Retirement, as we know it today, didn't exist until within the past fifty years as life expectancies increased. Today, if you plan to retire at 55 and if you actually to live to 90, you might be retired longer than you worked.

So, despite all the flack that you've heard about Social Security over the past couple years, the simple problem with this program is that it can't support an American for more time than that American spent working. It's that simple. How do you plan to support yourself for those last 35 years? Additionally, when do you begin to plan for those Golden Years and where do you put those savings?

I refused to invest in my future when I was younger, because I had too much fun spending all the money that I made. Then Cora was born, and that event began to soak up most of my discretionary funds. Now that I have some money to put aside, the total amount that I currently have saved represents barely enough to cover one years' worth of expenses. My plan is to work 'til I die, but I intend to cajole my daughter into saving for her retirement now.

Yes, my daughter's just a teen, but the compounding of returns over a 45-year period can be staggering when compared to 35 years, especially in a tax-deferred account. If Cora begins to invest in a tax-deferred account now, at age 17, and if she invests $2000 per year after paying taxes and earns 10 percent per year, she'll have $1,437,810 in that account by the time she's 62. Taxes do make a difference. If Cora pays a combined 30 percent state and federal tax rate on the earnings from those investments, by the time she's 62 she'll have only $571,491 for her retirement.

I need to make you aware that the securities markets are subject to the risks of fluctuating prices and the uncertainty of rates of return and yields inherent in investing and past performance is no guarantee of future results.

I'll add some years to my daughter to show the difference a decade can make. If Cora begins to save at age 27 instead of at 17, and if she uses the same savings plan outlined above, she'll only have $542,049 at age 62 in that tax-deferred account, and $276,474 in a non tax-deferred investment plan.

Now that you've soaked in all that information, I'm going to backtrack and tell you that sometimes a tax-deferred account like a 401(k) doesn't always represent the best way to go when you save for your retirement. You will, after all, pay taxes on those savings when you begin withdraw those funds just as you would for any ordinary income. Tax rates will be higher for you when you retire with a million bucks than they are now as you struggle to make ends meet, so the 401(k) represents a real problem in the end.

Additionally, the typical 401(k), according to the Employee Benefit Research Institute and the Investment Company Institute, has 67% in stocks and 33% in bonds, cash and other income securities. Since income from taxable bonds is taxed up to a 35 percent rate, it makes sense to put bonds into a tax-deferred vehicle like the 401(k). But it doesn't make sense to put stocks into a tax-deferred account when you pay a maximum of 15% in a taxable account when you realize a capital gain and the same for most dividends on long-term investments. When you place those long-term holdings into a 401K, you can double that 15% tax rate upon retirement.

I cannot explain how to currently allocate (or to begin to reallocate) your retirement funds better than Jason Zweig, a writer who focused on a solution for this problem in an article that he wrote for CNN in January 2005:

"Start by putting all your money (taxable or retirement) into a single mental pie. Say you opt for a basic asset allocation of 60% stocks, 40% bonds. The best way to do that is to bulk up your 401(k) with bonds until they make up 40% of your total financial assets. Only after you reach that point should you add stocks to your 401(k). If, for instance, you have $50,000 in your 401(k) and $50,000 in taxable accounts, you'll need to put $40,000 in bonds to reach the 60-40 mix. If that all goes into the 401(k), you'll have 80% of that account in bonds. And 100% of your taxable account will be in stocks. This strategy should raise your after-tax return, unless tax laws change in totally unprecedented ways."

Then, from my point-of-view, after you've spent so much in bonds to rebalance that 401(k), think about investing in a tax-managed Index Fund outside the 401(k). If you reach middle age and discover that, like me, you want to or need to work 'til you die, then you may not need the money that you placed into that Index Fund. Unlike a 401(k), you aren't forced to withdraw that money; so you don't need to pay taxes on it, ever, as long as you don't sell it. And, like Zweig mentioned, unless tax laws change in unprecedented ways over the next few decades, withdrawals from that Index Fund income will be taxed at a much lower rate than funds drawn from a 401(k).

The key to a healthy retirement plan is to defer taxes and to pay as few taxes as possible when you do need to tally up with Uncle Sam. Tax laws will change over the next few decades. I can rest my laurels on that one. Your job then, should you choose to save wisely, is to keep one eye on tax changes and reallocate your savings to meet those challenges as the years roll by.

Until Next Week,
Linda Goin