The first step toward retirement planning is setting up your retirement investment account. For many Americans, Social Security is still the main source of income after they stop working. They just don’t give much thought to planning for their future financial stability. The government offers many plans to encourage people to save for the future while they are still productive and earning an active income.
Retirement investment accounts
Individual Retirement Accounts (IRAs), 401k plans, SEP IRAs are some of the options to choose from. The advantage of these sort of accounts is that they offer you different types of tax benefits.
- Traditional IRA
IRAs are special accounts you can create for your retirement investment. There is a limit to how much money you can deposit each year, and this is redefined annually.
In traditional IRAs, the amount you deposit each year is tax deductible. The money in your IRA can be invested in stocks, bonds, and mutual funds. Once you are over 59 1/2 years in age, you can start withdrawing the funds from this account, but you will need to pay taxes on your withdrawals. Mostly, you will be in a lower tax bracket when you retire, so this might be an advantage.
If you withdraw money before you are 59 1/2, you will incur a penalty of 10% apart from the taxes to be paid.
These work just like IRAs, but 401(k) plans are employer-sponsored retirement investment accounts where you contribute a fixed amount monthly. Many employers make a matching contribution to the plan. These may be an attractive option as you get an extra contribution from your employer.
In the 401(k) plans, the employer has an upper hand in deciding where the money should be invested, but you also have a say in it.
- Roth IRA
Roth IRA is a different form of IRA, where yearly contributions are made from your after-tax income. You can then invest the funds and let them grow. In a Roth IRA, your withdrawals are tax-free, which makes this investment suitable if you expect to be in a higher tax bracket after retirement or wish to avoid paying tax on your IRA funds after retirement. Note that there are some income-related restrictions on Roth IRA.
- Solo 401(k) or Roth Solo 401(k)
Solo 401(k) plans are ideal for a self-employed person with no employees with the exception of a spouse. Here, you can contribute both as an employee and as an employer. As an employee, you can save up to $19,000, and also contribute an additional amount as an employer. The money you contribute as an employee is tax-deferred in the Solo 401(k) account. In this account, you use after-tax dollars, but the eventual withdrawal is tax-free.
- SIMPLE IRA and SEP IRA
These are for small business owners. In SIMPLE IRA, employers contribute up to 2% of each employee’s pay.
In the SEP IRA, only employers make the contribution. They contribute the same percentage of each employee’s pay into their respective SEP IRA accounts.
There are more options in retirement accounts, and in some cases, you can have more than one. As they provide benefits in the form of either tax-deferral or tax-free withdrawals, they are ideal as retirement investment options.