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Dr. Don Taylor, CFA, Bankrate.com advice columnistRetirement planning in your 50s

Dear Dr. Don,
I am starting all over again after a divorce and paying off all of my debt. The good news is that I am now 100 percent debt free and have accumulated a small emergency fund. The bad news is that I am 56 with no retirement funds. Also, I do not own, nor can I afford, a house.

My new employer offers a 401(k) in which he contributes one-quarter of 1 percent up to 6 percent, whatever that means. If I go this route, I am thinking of contributing the maximum of 25 percent (about $6,240/year). I am also considering a Roth IRA. I have not fixed a retirement date as yet, but I'm thinking age 62 or 66. My goal is to buy a nice, almost new, fifth wheel for cash, live in it and remain debt free. Which of these investments would you suggest?
-- Marc Mobilize

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Dear Marc,
Choosing between a Roth IRA and a 401(k) is a choice about which type of tax-advantaged retirement account to use, not what type of investments you can own. Although 401(k) plans often limit investment choices to a finite group of investment options, there's usually enough of a selection that an employee can find investments that meet his needs. If your employer is matching all or part of your 401(k) contributions, then it makes sense to contribute to a 401(k) account, at least up to the limit of the match.

What I think you mean in describing your employer's matching program is that your employer will contribute 25 percent, up to 6 percent of salary. That means your employer will contribute 25 cents for every dollar you contribute up to the point where you are contributing 6 percent of your salary to the account. If you earn $40,000 per year and contribute 6 percent of salary, or $2,400, to your 401(k) account, your employer will contribute $600 to the account. You contribute 6 percent, and your employer contributes 1.5 percent. With the match you've saved 7.5 percent of your salary toward retirement. It's free money, and it's why you want to participate in the plan.

Your contributions to the 401(k) aren't limited to the limit of the match -- that's just when the company stops contributing. The federal government's limit for the 2006 tax year is $15,000, with an additional $5,000 catch-up contribution available to you because you are more than 50 years old. Your company's 401(k) plan may limit your contribution to less than these federal maximums.

The ability to contribute to a Roth IRA is phased out for taxpayers with high modified adjusted gross incomes. Here's what IRS Publication 590, Individual Retirement Arrangements, has to say about the limits for the 2005 tax year:

Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:
  • $160,000 for married filing jointly or qualifying widow(er),
  • $10,000 for married filing separately and you lived with your spouse at any time during the year, and
  • $110,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year.

With the 401(k) plan you are contributing pretax dollars but qualified distributions in retirement will be taxed at ordinary income rates. With a Roth IRA you contribute after-tax dollars, but qualified distributions in retirement are free from federal income taxes.

A Roth IRA makes the most sense if you're in a lower tax bracket when funding the account than the tax bracket you expect to face in retirement taking distributions from the account. Often it makes sense for taxpayers just starting out versus someone like you that is fairly close to retirement. It would be a good idea to discuss this with a tax professional.

I don't think you should be planning on an early retirement at age 62. Starting to get serious about retirement savings at age 56 makes it pretty unrealistic that you'll have enough of a nest egg set aside by then.

Go talk to a fee-based financial planner about what you'll need in retirement and how you can use the next eight to 10 years to build that nest egg. An earlier Dr. Don column, "Picking a financial adviser," will help in the selection process. While you're at it, talk to him or her about the feasibility of owning your own home. You might be able to build some wealth that way as well.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: March 10, 2006
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