401(k) plans are retirement plans administered by employers that allow for employees to contribute a portion of their paychecks towards the account.
There are many benefits to using a 401(k) account for your retirement savings. These benefits include the ease of contributing funds, certain tax benefits and in many cases, employer-matching contributions. Although there are many benefits, there are some downsides as well. Some people do not like that 401(k) plans have specific contribution limits and that 401(k) accounts may require more management than other plans.
Because of this, a 401(k) account is not the right option for everyone. Therefore, it is good to know that there are alternative retirement savings plans available that have different structures and benefits. Also, some people find it beneficial to have more than one account for retirement savings and opt to have both a 401(k) plan and a different retirement plan as well. If you are interested in learning more about the various retirement account options available for you, read the information provided below.
An individual retirement account (IRA) is an option most frequently used by self-employed workers and/or small business owners, although anyone can reap the benefits of an IRA account. Just like a 401(k), an IRA is an investing tool that you can use to earn and save for retirement.
The United States government offers two different type of IRA’s – traditional and Roth. Both options are retirement accounts that include certain tax advantages. They also both offer options for the funds deposited into the account to be invested into a variety of different investment opportunities. These include stocks, bonds, mutual funds, certificate of deposits (CDs) and other investments.
While both traditional and Roth IRA’s operate on the same principle and share many similarities including having the same contribution limits and withdraw regulations, they do differ in some ways and offer different tax benefits. To learn more about these differences and to determine which IRA may be a better fit for you, read the sections below.
The biggest difference between traditional and Roth IRA’s is the way that the money is taxed. When using a traditional IRA, in most situations the funds that you contribute are tax-deductible or considered pre-tax dollars. This means that if you contribute a certain sum of money into your IRA you can then claim that amount as a tax-deduction on your income-tax return, and the Internal Revenue Service (IRS) will not apply income tax to those specific earnings. It is important to note that tax-deductible contributions are only available to certain individuals depending on their income, other retirement accounts and tax filing status.
If you do receive a tax-deduction you will still need to pay taxes on that money, but the taxes will only be applied once you withdraw money from the account when you are retired. This makes a traditional IRA a good option for you if you believe that you will be in a lower tax bracket when you retire; therefore, allowing you to pay less in taxes than you would if you paid them before retiring.
You should also note that contribution limits do apply to traditional IRAs, and in 2018 the annual individual contribution limit is $5,500 in most situations. If you are 50 years of age or older, you may contribute up to $6,500 annually.
A Roth IRA is very similar to a traditional IRA except for how the taxes are handled. When you contribute to a Roth IRA, the contributions are not tax-deductible. However, certain eligible withdrawals from the Roth IRA are completely tax-free. This means that when you contribute to the Roth IRA, the funds you provide are taxed, but after the account grows and you decide to retire, you will be able to withdraw your money from the account without incurring any income taxes on your distributions.
The biggest factor to consider when determining which type of IRA to obtain and invest into is your current and future tax situation. For most people, once they reach retirement age they fall into a lower tax bracket because they are not making the same level of income that they were previously. If you predict that you will be in a lower tax bracket, you may consider using a traditional IRA because that type of account has its funds taxed once they are withdrawn during retirement.
Alternatively, if you would rather pay the taxes when you deposit the money into your retirement savings, and not face taxation once you withdraw the money later on, you may want to consider a Roth IRA. If you opt to use an IRA account it is important to carefully consider the different options before you decide on one or the other. Conferring with a financial planner or investor can help you decide which plan is right for you.
If you would rather have more control over your retirement savings with no contribution limits and limited regulation, you may want to consider opening a regular investment account. An investment account has the benefit of allowing you to contribute exactly how much you want, when you want. You can either manage the account on your own and choose where you want your money invested, or you can enlist the assistance of a broker. Either way, the investment account is your responsibility, and it may require more effort than you would need to provide when using a 401(k) account or an IRA. Additionally, with the added freedom you gain, you do lose out on the tax incentives included with a 401(k) or IRA, and you may end up paying for the capital gains on your income growth.
There are many different types of retirement investment accounts, and many pros and cons to each as well. Before you completely decide on which plan will work best for you, it is important to do your research because the type of plan you choose and the way that you manage it can have a big impact on the retirement funds you will have in the future.