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Being frugal and paying attention to your finances is obviously important, but sometimes it can be hard to look beyond the day-to-day. Planning and thinking ahead is crucial in order to ensure financial stability in the future. Planning for retirement and taking steps to put money aside for when you’re working is one component of healthy finances, but it can be overwhelming if you’re unfamiliar with your different options. This guide to retirement accounts will help you decide which option is best for you.
Want a great eye opener on just how much you’ll need for retirement? One of the best retirement calculators is the Vanguard Retirement Income Calculator. Plug in what you already have saved and and it will show you just how close (or how really far away) you are right now!
Also, not to get into politics, but most retirement specialists will tell you that if you are 50 or younger, you should not include Social Security in your planning. Plan for what you can save and if it’s there that’s a bonus…
Guide to Retirement Accounts
The two main questions when it comes to retirement accounts are What kind of account should I get? and Where should I get it? I’ll seek to answer both questions as well as I can!
Different Kinds of Retirement Accounts
There are four types of retirement accounts that are the most common: traditional IRA, Roth IRA, employer 401(k), and SEP (simplified employee pension).
A traditional IRA is a retirement account in which contributions are tax-deductible. You can contribute up to $6,000 a year if you are under 50 years old, and you must stop contributing at age 70 1/2. At that point, you must begin to withdraw the money. The withdrawals will be included in your gross income for tax purposes.
You can choose to withdraw the money without penalty at age 59 1/2 or greater. If you withdraw early, then in almost every case, you will have to pay a 10% penalty and also pay taxes on the withdrawal amount. You cannot take a loan from a traditional IRA and pay it back later.
It makes sense to get a traditional IRA if you think you may be in a lower tax bracket when you retire (a majority of tax payers). You get to reap the tax benefits now, and if your income at retirement puts you in a lower tax bracket than you’re in now, you’ll pay less taxes on it overall. Traditional IRAs take advantage of compound interest!
Savings Tip: You can withdraw early without penalty for higher education. If your children have jobs, this could be a great place to put their earnings. It will count as a tax deduction for them this year and allow their money to grow faster than a normal savings account. Unlike college 529 plans, if they decide to not go to college or get tons of scholarships, then they can keep the money in their IRA and have an incredible start towards retirement! The only rule that might apply for kids is that they cannot contribute more than they earned (in other words, parents can’t add to their earnings).
A Roth IRA is kind of the opposite of a traditional IRA, you’ll pay taxes when you contribute, so when you retire and withdraw the money, all the contributions and earnings will be tax free. There are certain upper income limits; if you make more than that, you can’t open a Roth IRA.
Like the traditional IRA, you can contribute up to $6,000 year, but unlike the traditional, you can leave the money as long as you want. You cannot take out a loan from the Roth IRA and pay it back.
A Roth IRA makes sense if you think you’ll be in a higher tax bracket when you retire. You pay the taxes now, but then you’ll be tax-free in retirement. This can also be a great option for new college graduates if your employer doesn’t offer a 401k. The money you put in will have a long time to grow and all those earnings tax free is a big savings.
An employer 401(k) is a retirement account that is set up by your employer. Like a traditional IRA, the money is tax deductible on the front end, and you pay income taxes when you begin to withdraw (after age 59 1/2). You can contribute up to $19,500/year.
If you withdraw before age 59 1/2, you will have to pay a 10% penalty and income tax on the withdrawal. Unlike other IRAs, you may be able to take a loan from an employer 401(k), as long as you pay it back within 5 years.
The best thing about employer 401(k)s is that employers can opt to match your contributions up to a certain percentage of your income or dollar amount. If your employer does this and you choose not to contribute anything to your 401(k), you are losing out on free money!
When you leave a job that has a 401k you can take that money with you. Roll it over into a new 401k or put it in a traditional IRA with no penalties. The best option is to roll it into another 401k, if that is available, because of an IRS rule of 55.
An SEP or simplified employee pension can be established either by an employer for employees or by a self-employed individual, who can contribute up to $57,000 annually.
Like traditional IRAs, withdrawals after age 59 1/2 are taxed and you must begin to withdraw money by age 70 1/2.
These are appealing to those who are self-employed because start-up and operating costs are lower than other options for retirement accounts and the huge difference in annual contribution limits.
Where to Get a Retirement Account
The places I’m going to list are not the only options to get a retirement account, but they are the most well known and best recommended. If you have an employer 401(k), you will not have any say in the company but you should still take that option.
How are you planning for retirement? Let us know in the comments!