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