Plan for Your Golden Years: Understand Key Retirement Accounts
Planning for retirement may sound daunting, but understanding what type of retirement accounts are available is key to developing a sound future. Such accounts ensure not only your after-retirement years are smooth but also have enough time to grow your savings. A Brief Primer on the Most Popular Retirement Accounts:
1. 401(k):
A 401(k) is a type of employer-sponsored retirement account to which you can contribute a portion of your pre-tax income, which lowers your taxable income for the year. The contributions grow tax-deferred, meaning you won’t have to pay taxes on those investment gains until retirement. Many employers offer matching contributions, meaning they will usually add to your retirement at no additional cost to you, up to a certain amount. Not all employers will offer a match, so check with your company’s plan details.
2. IRA stands for Individual Retirement Account.
IRAs allow anyone who has earned income to create one, thereby opening this option whether or not you have an employer-sponsored plan. There are two main types of IRAs:
Traditional IRA-Your contributions might be tax-deductible depending upon your income and whether you or your spouse have a retirement plan at work. Like a 401(k), money in the account grows tax-deferred, and you’ll pay taxes on withdrawals in retirement.
Roth IRA: Because you pay into this type of IRA with dollars that have already been taxed, qualified retirement withdrawals are tax-free. This account is good if you expect to be in a higher bracket later since you won’t owe a dime in withdrawals. The beauty of Roth IRAs lies in their flexibility-one can pull out his or her contributions at any time, tax- and penalty-free.
3. RMD-Required Minimum Distribution:
If you turn the required age, you must start taking distributions from Traditional IRAs and most 401(k) plans. Under current law, if you were born between 1951 and 1959, you’ll need to start RMDs by age 73; for those born in 1960 or later, the start age is 75. RMDs count as income, so plan your plan withdrawals accordingly to prevent a higher tax bill.
4. Pension:
A pension is a type of employer-sponsored retirement plan where-if you work for the employer long enough and earn a certain salary-you receive a fixed dollar amount each month upon your retirement until the end of your days. Traditional pensions are less common these days, but lots of employers still offer them. In fact, anyone who works for government agencies and most anyone who has a union job has a pension plan. Some pensions include a COLA, or cost-of-living adjustment, that inflates benefits for inflation. These can really add up over time.
How to Choose the Right Account for You
The type of retirement account chosen will depend on income, current and future tax bracket, and even long-term financial goals. If one expects his or her tax rate to be higher in retirement, a Roth IRA might be better. In that respect, a person who expects to fall into a lower tax bracket during his or her retirement may find more comfort in investing in a Traditional IRA or 401(k). Your financial advisor can help you with your specific situation and create a plan tailored to your future.
Pro Tip: The earlier you begin and the more regularly you contribute to a retirement account, the more saved, the more stable your future.
