Retirement Accounts...
Which is Best For Me?
So, what are the differences between the various retirement accounts, especially a 401(k), an IRA, and a Roth IRA?
I don’t claim to be an investment advisor, so I won’t even attempt to give you investing advice here. But if you need help finding a competent investment advisor, I will be happy to help you find one.
Furthermore, I personally don’t have a whole lot of faith in the Social Security System being able to provide me with a secure retirement, so I believe investing in some type of retirement account is essential.
Now, I know this can be somewhat unnerving, especially right now with the current state of the economy and the stock market, but I believe everything is cyclical, and the stock market will eventually recover.
If that’s the case, and you are planning to hold your investments long term, then there are many great buys in the investment world right now...stocks and mutual funds that are currently at record lows, or, looked at it in another way, “on sale!”
Even though I’m not here to give you specific investment advice, I do think, however, it is important for you to understand the difference between these retirement vehicles, as well as the tax benefits of each.
401(k) Plan
A regular 401(k) plan is a wage reduction employee benefit available to many employees through their employer, allowing an employee to save for retirement, have the savings invested, with income taxes being deferred on the saved money until it is withdrawn.
Essentially, in a nutshell, an employee may elect to contribute a portion of his or her wages into his or her 401(k) account through payroll deductions. These deductions are made on a “pre-tax” basis, meaning that the amount of contributions is not included in the employee’s wages for the year.
In addition, the 401(k) account is permitted to grow tax free, until the funds are withdrawn. Furthermore, some employers may be willing to match a certain amount of the employee’s contributions, paying extra money into the employee’s account as an incentive for the employee to save more money for retirement.
Usually, the employee can select from a number of investment options, commonly an assortment of stocks, bonds, mutual funds, money market accounts, and even the company’s stock.
Typically, if funds are withdrawn from a 401(k) (before an individual reaches retirement age), and the funds are not rolled over into another similar type of account, not only are the funds taxed, but they are also hit with a 10% early withdrawal penalty.
In some cases, since the enactment of the Roth IRA, employees participating in 401(k) plans may be permitted to allocate some or all of their contributions to a separate designated Roth 401(k) account.
Qualified distributions from a Roth 401(k) account are tax free, and the Roth 401(k) is permitted to grow tax free, while contributions to them are on an “after-tax basis”, meaning income taxes must be paid or withheld on these contributions in the year they are made.
Individual Retirement Account
An Individual Retirement Account, or IRA, is another type of account that typically provides tax deductions for retirement savings.
The most common form of IRA, is a Traditional IRA. In this case, contributions to an IRA are tax deductible, the IRA account is permitted to grow tax free, and withdrawals at retirement are taxed as regular income.
Similar to a 401(k), a person can usually select from a number of investment options, commonly an assortment of stocks, bonds, mutual funds, and money market accounts.
Typically, if funds are withdrawn from an IRA (before an individual reaches retirement age), and the funds are not rolled over into another similar account, not only are the funds taxed, but they are also hit with a 10% early withdrawal penalty.
There are annual limits as to how much money a person can contribute to an IRA, and traditional IRAs are not provided by or monitored by the employer.
Roth IRA
A Roth Individual Retirement Account, or Roth IRA, is similar to a Traditional IRA in that the Roth IRA account is permitted to grow tax free.
Different than a Traditional IRA, contributions to a Roth IRA are not tax deductible, but withdrawals at retirement age are not usually taxed.
Similar to a Traditional IRA, a person can usually select from a number of investment options, commonly an assortment of stocks, bonds, mutual funds, and money market accounts.
Typically, if funds are withdrawn from a Roth IRA (before an individual reaches retirement age), and the funds are not rolled over into another similar retirement account, the funds are NOT typically taxed, but they are hit with a 10% early withdrawal penalty.
There are annual limits as to how much money a person can contribute to a Roth IRA, and Roth IRAs are not provided by or monitored by the employer.
Please note that several other less popular types of retirement accounts do exist, which I will not elaborate on here.
As mentioned previously, I am not an investment advisor, so I don’t want to go too in depth in the world of investing in retirement accounts, but if you need help finding a competent investment advisor, I will be more than happy to help you find one.
To Your Success...
David Jesse, Your Fellow Average Joe