Investing for Your Future
 New Ways to Save for Education
Three Sources for Retirement Security
Tax-Advantaged Investing
Preparing for tomorrow's expenses is one of the most important things you can do for yourself and your family. The financial decisions you make today will directly affect your ability to achieve long-term goals, such as paying for your child's education and securing your own retirement. Sending your child to college is one of the best investments you can make. According to the College Board, the average difference in lifetime earning potential between a high school graduate and a college graduate is more than $1 million. Most parents want their children to attend college, but without preparing financially, meeting the rising costs of a college education can be a challenge. Retirement planning also is more challenging today than it was for past generations. For example, most Americans today won't work for a single company during their entire career and don't expect to receive a significant pension benefit upon retirement. And, retirement is likely to last considerably longer for future retirees than for their parents and grandparents, thanks to health and medical advances. It's important to take the time to review your financial goals now, and to renew your efforts if you're not on track to reach those goals. New Ways to Save for EducationSaving for education is a long-term investment. The more you save, the less you'll need to borrow or seek from other sources. While the cost of college may be daunting for many families, the cost of skipping college will likely be much greater. The graph below shows differences in annual earnings depending on level of education attained. To encourage families to save more for higher education expenses, federal and state lawmakers have developed innovative college savings programs, such as 529 plans and the Coverdell Education Savings Account (formerly known as the Education IRA). Median Annual Earnings of Full-Time U.S. Workers
(age 25 and older) 
Source: U.S. Census Bureau, 2001 income data 529 PlansRecent tax law changes are making 529 plans an increasingly popular way to save for college. Officially known as qualified tuition programs, these state-sponsored investment plans offer families a tax-advantaged way to save money for college. Although there is no federal income tax deduction for contributions to 529 plans, several states allow residents to claim a partial or full state income tax deduction on contributions. There are two types of 529 plans: college savings plans and prepaid tuition plans. Every state offers at least one type of 529 plan and many states offer both. College savings plans let parents prepare for college expenses through a 529 account that typically invests in mutual funds. Contributions to the plan grow free from federal income tax. Withdrawals used for qualified educational expenses, including room and board, also are tax-free. Funds in your college savings plan account may be used at any eligible educational institution, whether your child decides to go to a private or public college or university, a trade or graduate school, or a school in your state or another state. Prepaid tuition plans allow parents, grandparents, and even family friends to begin saving for the cost of college tuition at a fixed rate today. Prepaid tuition plans are guaranteed to increase in value at the same rate as college tuition. For example, if a family purchases shares worth one year's tuition at a state college, these shares will always be worth one year's tuition, even 10 years later when tuition rates may have doubled. Coverdell Education Savings Accounts (ESAs)These accounts allow parents, grandparents, other family members, and friends to save for a child's education expenses from kindergarten through 12th grade as well as for higher education expenses. A maximum contribution of $2,000 can be made each year until the child's 18th birthday. Contributions are not tax-deductible and must be made with after-tax dollars. But, because taxes have already been paid on contributions, withdrawals are tax-free for qualified education expenses, such as tuition, equipment, and room and board, anytime before the child reaches the age of 30. The age restrictions do not apply for children with special needs. Three Sources for Retirement SecurityAs the chart below indicates, retirees today depend on part-time employment to help provide financial security in retirement. These earnings are combined with three other sources of retirement income: Social Security, employer-sponsored pension and retirement plans, and individual savings. Sources of Retirement Income
(U.S. retirees age 65 and older) 
Source: Social Security Administration, 2000 income data Social SecurityThe current average Social Security benefit for a retired worker is $922 per month. According to the Social Security Administration, Social Security benefits currently account for approximately 40 percent of an individual's retirement income. Most individuals supplement their Social Security benefits with their own savings. Employer-Sponsored Retirement PlansIncreasingly, employers are sponsoring plans that give employees more options for investing their retirement dollars and more responsibility for their own retirement savings decisions. The most common employer-sponsored retirement plan is the 401(k) plan. Other types of so-called defined contribution retirement plans include the SIMPLE plan for small businesses with fewer than 100 employees; 403(b) plans for employees of certain tax-exempt organizations and public educational systems; 457 plans for employees of state and local governments and other tax-exempt employers; and Simplified Employee Pensions (SEPs) in which an employer makes tax-deductible contributions to an IRA maintained for the employee. There are many benefits to contributing to your employer-sponsored retirement plan. Your contributions are made pretax, so you are only taxed on the income remaining after the contribution; many employers will match part of your contribution, and that's like getting free money; and most employers offer several types of investments from which you can choose. Another benefit is the "catch-up" provision: if you are over age 50, you can contribute additional money into your employer-sponsored retirement plan. Individual SavingsYour personal savings and investments will be the source for any retirement income not provided by Social Security and employer-sponsored plans. In addition to personal investments, federal income tax laws permit you to establish an Individual Retirement Account (IRA) for the tax-deferred accumulation of retirement funds. There are three main types of IRAs: traditional, Roth, and rollover IRAs. If you are under the age of 70½, you may set up a traditional IRA and deduct all or part of your contribution depending on your income level. You might also be eligible to make an annual contribution to a Roth IRA, which is not tax-deductible but allows investment earnings to accumulate tax-free, and you pay no income tax when you take distributions during retirement. However, contributions to all your IRAs cannot exceed the annual contribution limit. If you are over age 50, there is also a "catch-up" provision for IRAs. Rollover IRAs are used when you leave an employer. You may move the money in your employer-sponsored retirement plan to your rollover IRA. Federal legislation passed in 2001 increased the maximum annual contribution limits on individual retirement plans - such as 401(k)s and IRAs - as shown below.
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Contribution Limits |
| |
Year |
401(k) &
403(b)
Plan Limit |
457 Plan Limit |
IRA
Limit |
401(k),
403(b), & 457
Catch-Up |
IRA
Catch-Up |
| |
2002 |
$11,000 |
$11,000 |
$3,000 |
$1,000 |
$500 |
| |
2003 |
$12,000 |
$12,000 |
$3,000 |
$2,000 |
$500 |
| |
2004 |
$13,000 |
$13,000 |
$3,000 |
$3,000 |
$500 |
| |
2005 |
$14,000 |
$14,000 |
$4,000 |
$4,000 |
$500 |
| |
2006 |
$15,000 |
$15,000 |
$4,000 |
$5,000 |
$1,000 |
| |
2007 |
$15,500 Indexed for
inflation
in $500
increments |
$15,500 Indexed for
inflation
in $500
increments |
$4,000 |
Indexed for
inflation
in $500
increments |
$1,000 in
later years,
not indexed
for inflation |
| |
2008 |
$5,000 |
| |
2009 |
Indexed for
inflation
in $500
increments |
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2010 | By investing in your employer-sponsored retirement plan or IRA, you can build a nest egg for your retirement. You should note, however, that there are tax implications and substantial penalties for the early withdrawal of funds from employer-sponsored plans and IRAs. Tax-Advantaged InvestingThe saving and investment plans discussed here all offer tax-advantaged growth. By investing in tax-deferred or tax-free accounts, your money grows faster because of the power of compounding. In a taxable account, you pay tax on the dividends or interest earned in the year you receive them, leaving less money available for compounding. That's also why it's important to start early - to take advantage of the power of compounding. Whether you're saving for a child's education or your own retirement, the earlier you start, the easier reaching your savings goals can be because your money will have more time to work for you. (For more information, please see Investing for Success: The Importance of Starting Early.) Remember: planning for tomorrow today is one of the most important things you can do for yourself and your family. Growth of Taxable Versus Tax-Deferred Investments
(monthly contribution of $200, 7% annual return, 28% federal tax bracket) 
Source: Investment Company Institute 
Copyright © 2004 by the Investment Company Institute Education Foundation
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