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There is a range of different retirement accounts designed to help you save for your later years. Few people really understand the differences, making it hard to make the right decisions. How do you choose the best retirement account for you? How do you know you have chosen wisely? The answer to both these questions is education; learn all you can about your options and then make an educated decision. Seek professional help from a financial advisor; but at the end of the day, it’s your future so it you should go with what feels right for you.
This is an important point – decide what’s best for you. Everyone is different and each person’s circumstances are unique, so what’s best for you may not be right for your friends. This is why there are different types of retirement account.
Individual Retirement Accounts
Let’s look at Individual Retirement Accounts first, or IRAs. A traditional IRA allows you to put money in, up to an annual limit, currently $5,500. When you turn fifty, you’re allowed to save an extra $1,000 a year in your IRA. When you deposit money, it isn’t taxed, (unless you have another type of retirement account) but will be considered income when you withdraw it and taxed accordingly.
A Roth IRA is a type of IRA that operates in a similar way but has one key difference. When you deposit into a Roth IRA it is taxed, but isn’t when you withdraw it. Another useful difference is that you are allowed to access your money in a Roth IRA, from 59.5 years of age, without having to pay a penalty or taxes, provided you have held the account for at least 5 years.
IRAs are an easy option; the only restriction is you need to be earning an income. You can create an IRA from anywhere and you get to choose the type of investments your money goes into, because you are in control of the account. You can withdraw money without penalty or tax if you have a major life event to fund. Different accounts have varying rules so be sure to check these out before you set up your IRA.
The second most common retirement account is a 401k. Most employers offer a 401k program, with many matching your contributions up to a pre-set limit. This employer contribution is virtually free money, so why wouldn’t you take advantage of it? There are usually qualifying periods and various rules may apply. The funds you withdraw from a 401k are taxed.
This is a fairly painless way to save for retirement as your contributions are taken out before you get your pay check. You don’t see the money and so you tend not to miss it. Your retirement savings are not dependent on you transferring money into a savings account, something that is notoriously unreliable!
You are allowed to contribute more to a 401k than an IRA, so this is a good option for late-starters. Over-50s have the added advantage of being able to increase their contributions, to make up for lost time.
Because a 401k represents a large group, more money is available for investing. You can benefit from this through interest rates that are higher than you could get with just your own small investment. This means your money grows faster. The employer controls the account so you have limited input into how the funds are invested.
A 401k offers you more flexibility. You are allowed to retire at 55 and start to withdraw your account. If you choose to keep working for the same employer, you can continue making contributions. However, not all 401ks are created equal so it’s important that you learn how yours operates.
IRAs, Roth IRAs and 401ks are all protected by law in the case of bankruptcy or other financial hardship involving creditors. If your IRA comes under state law, as some do, check what the rules are.
Other Retirement Accounts
Smaller companies may offer a different type of IRA, called Savings Incentive Match Plan for Employees or SIMPLE IRA. This is also the popular option for self-employed workers. These accounts are managed similarly to the 401k, in that the employer takes the money before you are paid, your contributions are tax deductible and the employer matches some contributions. When you withdraw the funds at retirement, you are taxed.
Self employed workers may also choose to set up a Simplified Employer Pension or SEP-IRA. These are easy to set up and don’t require complicated reporting every year like some other plans. You are allowed to deposit up to twenty-five percent of your self-employment earnings. These accounts are especially suited to the individual or a partnership. A solo 401k is another option for the self-employed but these are more complicated to establish.
It is possible to have more than one type of retirement account and you can roll your funds between them if necessary. This can limit the effects of any disadvantages in one account and gives you the best of various options.
Learn as much as you can about the retirement plans that apply to you and your circumstances and keep up to date with the changes that invariably occur. You owe it to yourself to make the most of your retirement income.
Readers, which types of retirement accounts do you have and why?