Saving money is daunting. For many Americans, it is difficult to save for a rainy day, let alone retirement. Yet, proper saving for retirement is crucial in today’s age with life expectancy reaching 90 and beyond. With the retirement age being around 66 years of age, it is important to have the funds necessary to take care of our expenses when we are no longer able to work. Many experts suggest that we begin saving for retirement by the age of 30, but how? With information flooding the internet about retirement plans and saving, we would like to offer you a quick breakdown of several retirement accounts and how they operate so that you may select the option that best suits your needs.
Employer-Offered Retirement Accounts
A 401(k) is a retirement plan offered through employers in which the employer puts money into your retirement account through payroll deduction. The individual can choose what percentage is taken out of their pay and that amount will be deducted monthly. The benefit of a 401(k) is that the funds are taken out of your pay prior to taxes being deducted, essentially allowing you to pay less in taxes, currently. The money in a 401 (k) is not taxed until it is withdrawn.
Some companies match a percentage (up to 3% of the employees’ annual income) of the money that you put into your 401(k). It is highly beneficial to the employee if the employer matches their contributions because it is essentially “free money”. Without the company or employer matching contributions, the individual is responsible for the entirety of their retirement, which is still manageable. There are 401(k) plans that offer shares of the employer’s stock.
A 403(b) plan is a retirement plan offered to employees of government and tax-exempt groups, including schools, hospitals, and churches. A 403(b) works like a 401(k), the main difference is who it is offered to.
Individual Retirement Account (IRA)
A Traditional IRA is an individual retirement account that operates like a 401(k) without being provided through an employer. Earnings are tax-deferred, meaning, you do not pay taxes until you make withdrawals during retirement. If a retirement plan is not provided through your work, individuals can deduct the entire amount of their IRA contribution on their income tax return. There is no income cap, so individuals can invest in a traditional IRA no matter how much they earn. It is important to note that contributions can no longer be made after the age of 70. It is required to start withdrawing from a traditional IRA by the age of 70.
A Roth IRA is an individual retirement account where the money deducted from each check is taxed, but when it is withdrawn during retirement it is not taxed. If you’ve had your account for 5 years and you are over the age of 59, you can withdraw your retirement funds without owing federal taxes. There are no required minimum distributions (RMDs), meaning that you do not have to start withdrawing from the account at the age of 70. Also, you can continue to contribute to your Roth IRA after the age of 70. Roth IRAs are not tax-deductible.
Which retirement plan works best for you depends on your situation. If your employer offers a 401(k) and partially matches or 100% matches your contribution, great! Make sure that your deductions are being taken out and that your company is matching the agreed amount. For those without a 401(k) consider whether you want to pay the tax on your contributions now or later when you withdraw from your retirement fund. If you want to pay taxes on your retirement withdrawal, go with a traditional IRA. If you do not want to pay taxes on the money you withdraw during retirement, maybe a Roth IRA would be your best option. Regardless, it is best to start saving for retirement immediately, you will thank yourself later!