As you begin planning for your retirement, one of the most important decisions you’ll make is selecting the right type of retirement account. With so many options available, it can be overwhelming to decide which account is best suited for your needs. This article will outline the various types of retirement accounts available, and help you determine which one is right for you.
A Traditional Individual Retirement Account (IRA) is a tax-deferred account that allows you to save for retirement while reducing your current taxable income. With a Traditional IRA, you can contribute up to $6,000 per year, or $7,000 if you are 50 or older. The funds in your account grow tax-free until you withdraw them, at which point they will be taxed as ordinary income. A Traditional IRA is a good choice for those who expect to be in a lower tax bracket in retirement than they are currently.
A Roth IRA is another type of Individual Retirement Account, but with different tax advantages. With a Roth IRA, you make contributions with after-tax dollars, meaning you won’t get a tax deduction for your contributions. However, the funds in your account grow tax-free, and withdrawals are tax-free as well. Unlike a Traditional IRA, there is no required minimum distribution at age 72. A Roth IRA is a good choice for those who expect to be in a higher tax bracket in retirement than they are currently.
A 401(k) is an employer-sponsored retirement plan that allows employees to save for retirement through automatic payroll deductions. Contributions to a 401(k) are made on a pre-tax basis, meaning they reduce your taxable income for the year. Many employers also offer a matching contribution, meaning they will contribute a certain percentage of your contributions up to a certain limit. A 401(k) typically offers a variety of investment options, such as mutual funds, and there is no income limit on contributions. However, there are penalties for early withdrawals before age 59 ½.
A 403(b) is similar to a 401(k), but is designed for employees of non-profit organizations, such as schools, hospitals, and charities. Contributions to a 403(b) are also made on a pre-tax basis, and employers may offer a matching contribution. The investment options in a 403(b) are often limited to annuities and mutual funds.
A Simplified Employee Pension (SEP) IRA is a retirement account designed for small business owners and self-employed individuals. Contributions to a SEP IRA are made by the employer, and are tax-deductible. The contribution limit for a SEP IRA is higher than that of a Traditional or Roth IRA, at up to 25% of an employee’s compensation or $58,000 (whichever is less).
Choosing the Right Retirement Account
With so many options available, it’s important to choose the retirement account that best fits your individual needs. Factors to consider include your current tax bracket, your expected tax bracket in retirement, your age, and your employment status. A financial advisor can help you weigh these factors and make an informed decision.
In general, if you are eligible to contribute to a 401(k) or 403(b) with an employer match, it is wise to take advantage of that first, as it’s essentially free money. If you are self-employed, a SEP IRA may be a good option. If you expect to be in a lower tax bracket in retirement than you are currently, a Traditional IRA may be the right choice. On the other hand, if you expect to be in a higher tax bracket in retirement than you are currently, a Roth IRA may be a better fit.
It’s never too early to start planning for retirement, and selecting the right retirement account is critical