Ways to Save for Retirement

This week’s Personal Finance Basics post takes a look at the various options available for U.S. residents to save for retirement.

With a variety of choices available, and the seemingly “detached reality” of saving for a goal 10, 20, even 50 years in the future, we are often paralyzed from taking any action at all.

While a savings account is always an alternative, these investment instruments are designed to give you a tax shelter for your money to grow in until retirement, and most also offer some degree of protection from bankruptcy:

  • Traditional IRA – A traditional IRA can be established by any individual with earned income, and allows you yearly contributions up to a certain limit, which are usually tax-deductible. Your money grows tax-free, but is then taxed when you take it out at retirement.
  • Roth IRA – A Roth IRA is similar to a traditional IRA, except that you cannot take a tax deduction for contributing. However, your money will grow tax-free and you will be able to withdraw without paying any taxes at retirement.¬†With both IRAs, certain life events (such as buying your first home or large medical expenses) allow you to pull money out penalty-free if you need it.
  • 401(k) – These company retirement plans give you the leverage of a large group of investors pooled together – you’re able to purchase investments not otherwise available to the public, and usually without any minimum limits. Contributions are also taken pre-tax, which has the same effect as a Traditional IRA.
  • SEP IRA – Simplified Employee Pension plans work in a similar fashion to other IRA plans, but are established by an employer. Contribution limits are also higher under this plan. Taxes are taken the same way as a Traditional IRA – tax-deductible but taxed at retirement.
  • SIMPLE IRA – This is another type of plan that can be offered by an employer, and is also contributed to pre-tax. Some employers prefer this type of plan because of its lower administrative fees, but it offers no other major advantages to the alternative plans discussed here.
  • 403(b) – Non-profits and educational institutions often use this alternative to a 401(k) plan for their employees, because of its lower administrative costs and other reasons.

While many of these account choices are employer-driven, you do have a choice when it comes to your contributions, investment choices, and IRA accounts. A well-balanced portfolio of retirement accounts can provide a nice level of diversification when it comes time to withdraw (they often have different age limits and tax treatments).

There are a number of other options and account types also available, but they are less common than the ones listed here.

Photo by bravenewtraveler

Disclaimer: Talk to your tax or financial professional before making any investment decisions based on this post, which is provided for informational purposes only.

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