The Ins and Outs of Retirement Savings Vehicles

Someday. That is how many people think of retirement: that it will happen to them someday. Indicative of the distant future, someday often gives us a far-off connotation– something that may actually never find its way into the present, until it does.

Whether you are near retirement or it lives in the someday realm, thinking through avenues that can help you save money for its impending arrival is beneficial. It isn’t as simple as stashing some money in a coffee can or tucked away on a high shelf when you need it most. There are so many investment funds and retirement accounts that you should explore until you find the right option. Today, I am going to break down 4 of the most common retirement accounts: 401(k), Pension, IRA, and SEP IRA. Each of these categories have specific subcategories which hold both their benefits and detractors. Let’s take a closer look to understand each account more deeply.

Workplace Retirement Plans: 401(k) vs. Pension

Retirement savings channels in the workplace are constantly evolving. Pension plans are spearheaded by the company and offer a defined plan where the employer supplies money to a fund that will act as your retirement income. These plans are often quite expensive which have led many employers to adopt a new model: 401(k) or 403(b).

A 401(k) is a retirement plan that relies on an employer and employee contribution. It establishes that the employee must contribute to the account before the employer will put in any money. Most companies will offer a 100% match up to 3% of the employee’s salary and an additional 50% match up to 6% of your salary. In this scenario, it’s best for the employee to contribute 6% of their paycheck to the 401(k) account in order for the company to contribute their maximum amount. By contributing the full amount, you never leave money on the table.

Unlike a pension plan where the employee does not have much of a say in how their money is invested, a 401(k) puts the employee in charge of their investment portfolio. The account owner has to decide how the funds should be invested and what type of investment strategy will work best for them. It can be empowering to have control over your investments and take on the responsibility of managing your money, but that can also be overwhelming. This investment strategy is dependent upon the risk tolerance of the individual. Your risk tolerance is determined by your goals and can be adjusted over time. The flexibility of investments is one of the main benefits of a 401(k) or 403(b) plan.

Individual Retirement Accounts

Individual Retirement Accounts or IRAs are put in place for an individual to open and contribute to it as they see fit. These accounts are not sponsored by a company or employer and are not added to by other people other than the account owner.

IRAs are important because of the tax benefits they offer. However, not all IRAs are created equal. There are two types of IRAs: Traditional IRA and Roth IRA. Both of these accounts aid the account owner in saving for retirement while offering tax incentives. But they do differ in the type of tax benefits you are eligible to receive and the account’s withdrawal terms. Let’s take a closer look at each to see the differences.

Traditional IRA

  •       If you have not yet reached age 70 ½ and you are producing income, then you can contribute to a traditional IRA. Your contribution to this account could be taxable based on your (and your spousal) income as well as the use of an active 401(k) account. Check with the current IRS rules and regulations for such tax instructions.
  •       Any money that you put into the account is not taxed.
  •       Your account grows on a tax-free basis.
  •       You must adhere to the required minimum distributions (RMD) once you reach age 70 ½. These withdrawals will be taxed as income.
  •       Contributing to a traditional IRA could lower your taxable income in the contribution year, leaving you available to receive other tax breaks you might not otherwise get.

Roth IRA

        A Roth IRA is quite similar to the traditional IRA but has distinct tax benefits.

  •       There are no age restrictions with Roth IRAs
  •       Income eligibility restrictions exist. For example, in 2018 those who filed single had to have a modified adjusted gross income of less than $135,000 to contribute to the account.
  •       Tax benefits are not granted for contributions to these accounts.
  •       Most Roth IRA accounts allow the owner to withdraw the money tax-free.
  •       The money grows tax-free in the account.
  •       After you begin contributions, you cannot withdraw any funds for 5 years. If you do, the money may be severely taxed.

The main difference between these two accounts are the tax parameters. It can be difficult to decide how to choose between them. That is where a professional comes in! Get professional advice on which plan would fit best in your retirement savings strategy.

Self-Employed Retirement

If you own your own business or a majority of your income comes from freelance efforts, how can you best save for retirement? One account to look into is the simplified employee pension individual retirement account or SEP-IRA. This account is meant for people who are self-employed entrepreneurs.

Any business owner or someone with freelance income can open a SEP-IRA. Any contributions made to the account are tax deductible. Also similar to a traditional IRA, the money cannot be taxed until it is withdrawn. One of the big benefits of this type of account and what differentiates it from a traditional or Roth IRA is the contribution limit. In 2018, business owners are able to contribute 25% of their income or $55,000 whichever is less. These numbers are subject to change by contribution year, so be sure to check with the IRS standards.

Saving for retirement is a long process. The overview of these accounts should help you know that you have options. Most plans will fit your lifestyle and needs. If you aren’t feeling secure in your retirement investing strategy, give us a call. We would love to help you save for the life you want in retirement.