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26.03.2004 Feature Article

Saving for your Retirement

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Saving for retirement is something Ghanaians don't talk about. Ghanaians are political animals. Five minutes after Ghanaians congregate in any social setting, a lively debate will ensue on political issues. Many Ghanaians have grandiose dreams of going back home and engaging in politics. Some of them end up becoming political leaders. One question we need to ask is how can any leader plan and manage the affairs of the country when he or she has never owned an investment portfolio or made long term plans for retirement? If a leader does not know how to manage his personal finances, how can he or she manage the finances of the nation? One of the discredited legacies of the British colonial system is the creation of paternalistic social milieu under which the average Ghanaian looks to the government for everything at no cost. We look to the government to provide us with free education, free water, free medical care and free rent. When you get accustomed to government providing you free services, it becomes increasingly difficult for you to plan for yourself when you come to the United States where the social milieu is the direct antithesis of that of Ghana.

The target audience of this article is the Diaspora Ghanaian in the US or Canada. If you live elsewhere in Europe, Asia or Australia, you can apply the concepts in this article to start planning for your retirement. Coming from a culture that neither encourages retirement savings or personal accountability for old age, we frown on taking the initiative to prepare for our old age while we are young and strong. For a majority of Ghanaians in the US, savings means going to the bank and putting money in their account and drawing a meager 1% interest per year. Most don't set aside any thing at all. Their goal is to make money, build a big house in Ghana and hopefully retire and go back one day. The question then is, live on what money?

Most Ghanaians in the US are also self-employed. These include the cab drivers, private contractors in the delivery service, per-diem nurses, live-in and live-out homecare aides. If you live in the US and instead of getting a W2 at the end of the year from your employer, you get a Form 1099; or you don't get anything at all, you most likely may not be contributing anything to your retirement. That's where personal responsibility comes in. Retirement Savings Vehicles If you live in the US, there are many avenues for savings open to the average citizen to adequately prepare for old age.

The first is the government- that is social security.

The second avenue is your employer-that is 401(k) and 403 (b) and if your lucky to have a good employer, a pension.

The third avenue is you- that is IRA, stocks, bonds, the equity in your home or business. If you are self-employed, this might be the only avenue open to you as you save towards your retirement. Social Security Under US laws, you pay social security payroll tax. Your employer is obligated to take this money out of your pay check and send it to the government. The hope is that when you reach social security retirement age, currently between age 62 and 65, the government will send you a check every month. You qualify for social security benefits by earning social security credits when you work in a job and pay social security taxes. In order to receive retirement benefits, you should have contributed 10 years of work or 40 credits. I said hopefully, because with most baby boomers in the US nearing retirement age, the fear is that social security will go bankrupt and may not be there for most contributors. In addition to retirement benefits, social security also offers disability benefits. The eligibility rules for disability plans are different and I will not discuss them in this article.

What is a 401(k) or 403(b)? If you are living and working in the US and you don't know what 401(k) or 403(b) is, stop by your human resources office the next time you go to work and ask how you can start participating in the plan.

401(k)

Most employers offer their employees a 401(k) retirement plan, sometimes called a "salary-reduction" plan. Typically, the employer sets up the plan with an investment company, an insurance company or a bank trust department. You, the employee, agree to contribute part of your salary into a special savings and investment account. Most 401(k) plans offer a variety of investment vehicles, from individual stocks or mutual funds to money market accounts. Importantly, the money you invest isn't counted as income when you complete your annual tax return. For example, if you earn $45,000 but put $5,000 into a 401(k), your taxable income for the year would be only $40,000. Earnings that accumulate in the account are not taxed until you start making withdrawals, usually after you reach age 59 1/2. If you withdraw earlier, you'll have to pay taxes on the money and a stiff 10% penalty unless you qualify for an exception to the penalty. Many companies that offer 401(k) plans also match employee contributions. For example, the company might add 50 cents to the account for every dollar contributed by the employee. That makes a 401(k) plan a much better vehicle for retirement savings than an Individual Retirement Arrangement (IRA), which does not receive a matching contribution from your employer.

403(b)

If you work in a public school, or a tax-exempt organization then you should know about 403(b). 403(b) plan also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers. Individual accounts in a 403(b) plan can be any of the following types: -An annuity contract, which is a contract provided through an insurance company, -A custodial account, which is an account invested in mutual funds, or -A retirement income account set up for church employees. Generally, retirement income accounts can invest in either annuities or mutual funds. The features of the 403(b) plan are very similar to the 401(k) Plan. Employees may make salary deferral contributions that are usually limited by regulatory caps. Start Now It's never too early to begin saving for retirement, regardless of which savings vehicle you use. It's tempting to avoid saving for retirement, especially for people under 30. After all, they reason, they'll have 30 or 40 years to build a retirement nest egg. But one of the most powerful reasons to start saving early is that the earnings on your retirement funds will begin compounding sooner. Consider this example, provided by "Wealth Enhancement & Preservation" (The Institute Inc., Denver): Jo Anna, 28, deposits $2,000 to a tax-deferred retirement plan for 7 consecutive years and then at age 35 makes no additional contributions to the plan. Her friend, Ted, thinks saving for retirement at age 28 is ridiculous and waits until he is 35 before making retirement plan contributions. He then makes $2,000 annual contributions for the next 30 years. Jo Anna has made total contributions of $14,000, and Ted has contributed $60,000. If both earn an average of 10% on their investments, which one of them has the greater retirement fund? Through the magic of compound interest, Jo Anna's balance has grown to $331,000; Ted's is $329,000. By starting to save early, you will ultimately need to save less to have the retirement lifestyle you want.

Self-employed

Many Ghanaians in the US think that if you file your tax at the end of the year, it means you are contributing towards social security. That is a wrong assumption. If you are self-employed and you are not contributing towards social security or have not earned the necessary 40 credits, you will not get any monthly check from the government when you retire. So you have to take personal responsibility for your retirement. You need to buy real estate here in the US rather than build the big mansion in Ghana that you may never live in. You should own rather than rent here in the US. If you own your house or condominium, every time your property appreciates in value, your equity in that property also increases. There are many tax advantages you enjoy if you own your home in the US. The interest you pay each year to the mortgage company, the real estate tax you pay each year to your county or city or borough are both tax deductible. For example, if you made $40,000 a year and paid $6,000 interest on your mortgage and $2,000 in taxes to your city or county, your taxable income is now $32,000 and if you contributed another $5000 to your 401(k), this further reduces your taxable income to $27,000. While your friend who still rents an apartment also made $40,000, he will be paying taxes on the full $40,000 while you will pay tax on only $27,000. So it does not make sense to rent or not to contribute towards your 401(k).

In addition to this obvious tax advantage, the equity in your home can serve as your retirement fund. For example, you buy a house for $100,000 and live in that house for twenty years. Let's say the principal balance after 20 years is $15,000 and you sell it for $250,000, you will net $220,900 after paying the 6% agent's commission. This money is also free from capital gain tax. You can also tap the equity in your home and use it as seed money to buy a business. So next time you see a friend still living in apartment, show him this article and advise him to buy a house.

IRA

You can also set aside about $3,000 in tax deductible Individual Retirement Account each year. Because traditional IRA is tax deductible, you will incur penalties for early withdrawal and you will pay capital gain tax on your earnings when you receive distribution upon retirement.

There is also Roth IRA. The Roth IRA provides no deduction for contributions, but instead provides a benefit that isn't available for any other form of retirement savings: if you meet certain requirements, all earnings are tax free when you or your beneficiaries withdraw them. Other benefits include avoiding the early distribution penalty on certain withdrawals, and avoiding the need to take minimum distributions after age 70½. The chief advantage of the Roth IRA is obvious: the ability to have investment earnings completely escape taxation. The advantage comes at a price, though: you don't get a deduction when you contribute to the Roth IRA.

So which is more important? It depends on your personal situation, and also on what assumptions you want to make about the future. How long before you withdraw money from your IRA? What will your tax bracket be then? What earnings can you anticipate in the interim?

In conclusion, investing isn't as difficult or as expensive as most people think. Most of us just don't do it well. If you have not started, just go to your bank and talk to a broker there, especially if you are self-employed and you have no retirement portfolio.

Use these simple tools:

Don't rent, own!

Open an IRA

Stash money in stocks and mutual funds

Contribute to a 401(k) or 403(b)

Buy US savings bond, CDs

If you start right now, in ten years, your net worth will be in excess of $250,000.

So with the goals set appropriately low, this method for starting and managing a portfolio that requires very little money (just $200 monthly), even less effort, minimizes taxes and transaction fees, and is likely to outperform the Ghana real estate market over the long haul. Views expressed by the author(s) do not necessarily reflect those of GhanaHomePage. Baffour Ennin, Washington DC

Baffour Ennin
Baffour Ennin, © 2004

The author has 18 publications published on Modern Ghana. Column Page: BaffourEnnin

Disclaimer: "The views/contents expressed in this article are the sole responsibility of the author(s) and do not neccessarily reflect those of Modern Ghana. Modern Ghana will not be responsible or liable for any inaccurate or incorrect statements contained in this article."

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