Nest Eggs For Late Starters

Retirement-funding shortfalls lurk everywhere. Sure, the magic of tax-free compounding is great if you begin building your 401(k) plan at age 25, but what if you don't start until 40 or 50? What if you switch jobs so many times you never get fully vested in any pension program? What if you take off for seven years to raise your kids? No longer can you count on a cushy pension or Social Security. Still, you can find options that help you catch up.

The first step, of course, is fully funding company 401(k)s and any of your individual retirement accounts, even if you can't defer taxes on the entire contribution. If you work for a nonprofit group or a government agency, says Houston financial planner Lorraine Decker, you may be surprised to learn that you can make up for a lack of past contributions with a 403(b) plan--the public sector's version of a 401(k). If you're a school teacher, for example, you can shelter huge amounts of pretax salary according to an Internal Revenue Service formula, if your school district has a 403(b) or will set one up.

YOUR OWN BOSS. If you are self-employed in any manner, even as a silent partner in a small business, if you give lectures, or sell batik scarves on weekends, you have some options that may be even better than a 401(k). You can contribute up to 25%, to a maximum of $30,000 a year, of your self-employment earnings to a Keogh plan, and it's all tax-deferred. There are two types of Keoghs: profit sharing and money purchase.

With a profit-sharing Keogh, you can vary the amount you contribute each year. But you pay for it with a lower cap on contributions: 15% of your income. With a money-purchase Keogh, you can put away up to 25% of your earnings. But you must contribute a fixed amount each year. You can have both plans as long as your combined contributions don't exceed 20% of your net income. Use a money-purchase Keogh to contribute a fixed amount you can handle each year, say 6%, and a profit-sharing plan so you can add up to 14% more if you have a good year.

FEE TRAP. A similar kind of savings plan available to the self-employed is a simplified employee pension (SEP). Since there is less paperwork involved, a SEP is even easier to set up and administer than a Keogh. A SEP lets you defer 15% of earnings up to $30,000 each year, and there are no restrictions on how much you have to put in the plan during a given year.

Even if you have maxed out your 401(k), IRAs, and a SEP or Keogh, you can buy an annuity to help fund your retirement. Avoid fixed annuities "because they don't keep up with inflation," says financial planner Ron Roge. If you're playing catch-up, you'll do better with a variable annuity that can be invested in a variety of equity funds for higher returns that will compound tax-free. But beware of steep fees. Shop for annuities with low expense ratios, such as American Skandia Life's LifeVest Personal Security Annuity or Equitable's Equi-Vest. Annuities sold by mutual funds such as Vanguard, Scudder, Stevens & Clark, and Fidelity Investments tend to be cheaper also. Or call Independent Advantage Financial Services (800 829-2887), an annuity shopping service.

MORTGAGE ATTACK. There's no place like home for a source of retirement savings. Prepaying your mortgage even in tiny increments each month can translate into huge savings on interest payments over the life of the loan. If a couple in their 40s who just bought a house with a 30-year, $100,000 mortgage at 10% interest started paying $31 extra a month immediately, they would cut back their interest payments by $43,300, according to Kiplinger's 12 Steps to a Worry-free Retirement ($14.95, Kiplinger Books). The money that would have gone for interest is then freed up--and the couple will be building more equity in their house. The Banker's Secret book and software (800 255-0899) can help you customize a prepayment plan for your budget.

Later on, if you still need retirement funds, you can sell your house and move to a smaller, less expensive residence. Keep in mind that if you wait until age 55, up to $125,000 in profit is free of capital gains tax.

A much more drastic way to catch up at the last minute would be to pack up and move to a cheaper country. If you work abroad, you can exempt up to $70,000 annually of earned income from U.S. taxes, even though you still have to file returns. And if you're forced into early retirement, you can live more comfortably on less. Guadalajara, Mexico, has a popular U.S. retirement colony, for example. But, of course, that's an extreme solution: You can find most of the answers to retirement savings much closer to home.