In the good old days, many important financial decisions in your life were taken care of for you, and it generally worked out well for people. But those days are over. Today, you'll have to take control of your money to make sure that you'll reach all of your financial goals.
It's up to you
Decades ago, both career paths and personal finances were simpler than they are now. Many workers chose an employer for whom they worked their entire lives, with steadily increasing salaries and benefits that would seem extravagant to many by today's standards. Employers saved money from their own profits to fund pension plans that would pay for retirement benefits after you quit working, and they took care of investing all of that money so that you never had to worry about whether an ill-timed drop in the stock market would endanger your retirement.
Things have changed a lot since then. Workers now change jobs frequently, either because of employer personnel moves, or to seek their own advancement. As a result, the single-employer model of retirement planning no longer really applies, and the old-style pension is quickly becoming a thing of the past. In 2005, Verizon (NYSE: VZ ) froze its pension plan for more than 50,000 of its managers. IBM's (NYSE: IBM ) pension freeze took effect in 2008, affecting 117,000 current employees. Under the freezes, employees stop earning new benefits but are entitled to keep what they've earned to that point. New employees, however, are typically locked out of the pension going forward.
The health of pensions at the few remaining companies that have them remains in question. Alcoa (NYSE: AA ) and Disney (NYSE: DIS ) both have pension plans that are underfunded by 25% or more, which will require those companies to put aside billions of extra dollars to make up their shortfalls. Other companies, including UAL (Nasdaq: UAUA ) and US Airways (NYSE: LCC ) , have simply terminated past pension plans, leaving the government's Pension Benefit Guaranty Corporation to shoulder the burden of paying workers' benefits.
Even Social Security, the sole pension-like program left for many workers, is in financial peril. Especially for young workers, taking for granted that you'll get the benefits you've earned is a dangerous way to plan your finances.
Stuck with bad investments
As companies have backed away from taking care of your financial life, you've gotten tools to help you take care of yourself. But those tools aren't all they're cracked up to be.
401(k) plans, for instance, let you set aside substantial amounts of money toward retirement with great tax benefits. But with a 401(k), you're completely reliant on what your employer gives you. Because setting up and administering a 401(k) plan costs money, many employers don't have the incentive to establish plans with good investment options, leaving you with inferior choices that can make 401(k)s a lot less useful.
Similarly, 529 plans have become exceedingly popular as a tax-advantaged way of putting money aside for college expenses. Yet again, 529 plans give you only a select slate of investment choices. At least with 529 plans, you can choose among dozens of different plan programs -- but in some cases, you'll have to give up valuable state tax benefits if you want to go with a plan outside your home state.
Make the most of your choices
Even though you're stuck with a restrictive set of tools to help you with your finances, you've been given sole responsibility for making them work. That makes it all the more important to make the most of the areas in which you have complete control over your investing.
In particular, that means:
- Use your IRA. An IRA has maximum flexibility to let you pick exactly the investments you want. Discount brokers and mutual fund companies make opening an IRA cheap and easy.
- Consider a Coverdell. In the college savings arena, Coverdell ESAs fulfill the same function that IRAs do for retirement. You can only contribute $2,000 per year per child, but once you do, you again have latitude to invest in whatever you want.
- Save outside of tax-favored accounts. Tax deferral is a valuable benefit of retirement accounts, but if you're a long-term investor, you can create your own tax deferral by avoiding frequent trading of the individual stocks you own. Tax planning takes some extra effort, but having money in a taxable account also means that you can do whatever you want with it without worrying about things like early IRA withdrawal penalties.
Now more than ever, you can't afford to lose control of your finances. By making the most of all the investing methods at your disposal, though, you can do what you need to do to make sure your finances work the way you want.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.
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