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Saving for the Future Is No Free Lunch

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If you were given a choice between a hamburger today or $105,000 in cash when you retired, which would you choose? While the answer seems obvious, even to the hungriest among us, a lot of small business owners are unwittingly choosing the hamburger.

The reason for it lies in the fact that small business owners, like most Americans, are pitiful savers, saving only about one-third of what they need to maintain their present standard of living after retirement. Because of this, they face an uncertain future when they retire or they dispose of even a profitable business. Instead of looking to their "golden years" for some well-earned relaxation and recreation, they may face these twin worries: Will Social Security still be there when I need it? And, if it is, will I be able to live comfortably on what it provides me?

The Social Security system has always been able to meet its payment obligations to retirees. However, questions about its ability to do so in the future has led to a healthy debate--and some action--aimed at shoring it up to meet the needs of the so-called baby boomers when they start drawing benefits early in the next century. Because this issue is so vitally important to so many Americans, it seems safe to assume that the federal government will not let the Social Security system fail.

So let's assume that Social Security will be around when you need it. But will it meet your retirement needs? You can look for clues to answer this question the next time you stop by your neighborhood fast-food restaurant for a hamburger. Is that senior citizen flipping the burgers because he or she enjoys being active and around people? If so, tremendous!

But the sad fact is that may retirees are forced by economic needs into low-paying post-retirement jobs just to make ends meet. The median family income of families headed by a person who is at least 65 years old is about $17,000--not poverty level by federal standards, but certainly well below the amount needed for a financially comfortable retirement. Social Security, even if it's still around, just won't be enough to sustain you in retirement.

The way to avoid the retirement income crunch is clear: begin saving now! But saving now for retirement usually is not much fun. Unless you have piles of money, a dollar saved for your retirement today usually means one dollar less to spend on something that you could enjoy today. So most of us know that we should begin a retirement savings plan, but always seem to put off doing so, often for what we believe are good reasons.

We rationalize our spending. How big of a difference would it make, we ask ourselves, if I take a well-deserved vacation, rather than saving the money? After all, I can always start saving next year!

Unfortunately, too many of us wait much too long before we start getting serious about putting away money for retirement. Maybe it's your daughter's graduation from high school that finally triggers your thoughts about retirement, or maybe it's the increasing legion of gray hairs that stare back at you in the mirror each morning! In any case, there are several safe, high-yield, and tax-advantaged ways to build up a retirement fund. Naturally, these savings plans will work best if they are started early, but no matter what your age now, it will be to your advantage not to put off starting your savings plan any longer.

There are several tax-favored ways to save money for retirement, including pension and profit-sharing plans, Keoghs, and 401(k) plans, but for the sake of simplicity let's look at saving through an Individual Retirement Arrangement (IRA).

As a small business owner, the amount you can contribute to an IRA is tied to your income; you can't contribute more than you earn. If your earned income is at least $5,000 per year, you can contribute up to $5,000 a year to an IRA. Also, if neither you nor your spouse is covered by another tax-qualified retirement plan, you may be able to get a current tax deduction for such a contribution. If, for instance, you are in the 28 percent tax bracket, a deduction for a $2,000 contribution will save you $560 on your income tax return. But because there are income limitations on claiming the deduction, let's assume that you don't qualify for this deduction, but still are interested in investigating an IRA savings plan.

Let's look at how a $2,000 yearly IRA contribution--that's $5.48 a day, about the cost of a fast-food burger lunch--would have on the retirement saving picture of a 28-year old business owner.

Assume that John, our 28-year old owner, reads this article and starts looking into the possibility of making yearly contributions to an IRA. After talking to people at several types of financial institutions that offer IRAs--banks, brokerage houses, insurance companies--he learns that although he won't be able to get a tax deduction for his contributions, the income that accrues in the account will not be taxed until he begins to withdraw it at retirement. (If he chooses to withdraw it before retirement, a tax, and most likely a penalty, will be imposed.)

Based on his investigations, John is seriously considering making a yearly investment of $2,000 in an IRA-qualified mutual fund that invests primarily in small, growth company stocks. While his broker advises that "past performance is no guarantee of future performance," he notes that the fund over the last year, over the past 10 years, and over its entire life, has a track record of annual yields exceeding 14 percent. Feeling he doesn't want to be overly optimistic, John asks the broker to project what a $2,000 IRA contribution would grow to at his retirement (at age 65), assuming an annual yield of 12 percent.

Assuming John will begin his annual $2,000 contributions this year on his 29th birthday, the broker's projections show the following:

Age Projected Account Balance
on birthday (not guaranteed !!!)
30 $4,240
35 16,230
40 41,309
45 85,507
50 163,397
55 300,679
60 542,604
64 863,357
65 $968,959

So, by contributing $2,000 each year beginning at age 29, John will have something approaching one million dollars at retirement. But if he waits just one year later to begin his investment plan, but still retires at 65, he will have $863,357, which is $105,602 less! Thus, by failing to save the equivalent of $5.48 per day in that first year, John loses over $105,000. So, OK, he can get 365 days of burger lunches for the $2,000: Do you think they would be worth it?

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