Which Retirement Account Is Right for You?

By Andrea Cannon on 21 April 2016 0 comments

Saving for retirement is one of the most important things you can do for your future self. With so many options to choose from, how can you decide which type of account to invest your money in? There are a number of differences between an IRA, Roth IRA, and 401K. We've covered some of the most important factors below to get you started.

Roth IRA

Any contributions you make to your Roth IRA are with funds you've already paid taxes on, so your money can grow tax-free from then on. If you make more than $132,000, or $194,000 for married couples filing jointly, then you won't be eligible to contribute to a Roth IRA. There are no required minimum distributions and no age limit for contributions.

Maximum contribution amount: $5,500 per year, $6,500 if you're age 50 or older.

Tax advantages: Earnings grow tax-free with tax-free withdrawals in retirement.

Traditional IRA

Any contributions you make to your IRA are with funds you haven't been taxed on yet. You will be required to take a minimum distribution at age 70-½.

Maximum contribution amount: $5,500 per year, $6,500 if you're age 50 or older; cannot contribute after age 70-½.

Tax advantages: Contributing to your IRA can lower the amount of income you pay taxes on now. Once you retire, your withdrawals will be taxed at your ordinary income tax rate. If you make withdrawals before age 59-½, there will be an additional 10% early withdrawal penalty fee added. Certain approved purchases can be withdrawn penalty-free, such as a first home purchase and approved college expenses.

401K

A 401K is a retirement savings plan sponsored by an employer. Any contribution you make to your employer-sponsored deferred contribution retirement plan is made with funds you haven't been taxed on yet.

Maximum contribution amount: $18,000 per year, $24,000 if you're age 50 or older.

Tax advantages: Contributing to a 401K can lower the amount of income you pay taxes on now. Once you retire, your withdrawals will be taxed at your ordinary income tax rate. If you make withdrawals before age 59-½, there will be an additional 10% early withdrawal penalty fee added.

Which One Is Best?

If you can only open one account, or only have the funds to contribute to one retirement account, which is the one to go for? Suze Orman is a big proponent of the Roth IRA and calls it "the best retirement investment you can make." There are also a number of benefits to the Roth IRA.

For instance, you can withdraw your contributions (but not the earnings) in emergency situations, without worrying about taxes or penalties. While you don't want to ever withdraw from your retirement accounts, it can provide you with peace of mind knowing that the funds are available to you in an unexpected future emergency situation. (See also: 7 Surprising Facts About Roth IRAs)

If you believe you are in a lower tax bracket now than you will be in retirement (like you are just starting your career), a Roth IRA is usually the way to go. With a Roth IRA, you will be investing after-tax funds now, which means you won't be taxed later when you are in a higher tax bracket. On the other hand, if you are near your peak income now, then you will likely be at a lower tax rate in retirement, which favors a traditional IRA or 401K plan. (See also: Why Roth IRAs Are Ideal for Young Professionals)

If your employer offers contribution matching, definitely invest towards that account until you hit the company match limit so that you can benefit from the free money. With both an IRA and 401K, whatever you invest can be deducted from consideration this tax year. This means that you will be taxed on a lower amount, resulting in tax savings now.

Employer-Sponsored Plans

If your employer offers retirement benefits (such as contribution matching), then take advantage of this free money; your future self will thank you for it. You'll want to invest at least as much as the company match.

Ask about what sort of 401K, 403(b), 457, or pension plans your employer offers. This will allow you to take advantage of as much of the employer's contribution as possible. (See also: 8 Steps to Starting a Retirement Plan in Your 30s)

Self-Employed Options

Did you know that 28% of the nearly 15 million self-employed Americans are not saving for retirement at all? Sure, it can be difficult to set aside money for retirement when you can barely pay your business expenses as it is. However, it is imperative that you save what you can now to take advantage of compound interest and to ensure you are prepared for retirement.

Self-employed individuals have further retirement savings options, such as the SEP-IRA, SIMPLE IRA, and Individual or Solo 401K. These have higher contribution limits so that you can have a more sizable retirement savings. These accounts will allow you to save for retirement, while enjoying an up-front tax break and tax-deferred saving.

When in Doubt, Ask a Pro

If you aren't sure about which retirement account is right for you, it's time to speak with a financial adviser. They can help you make informed decisions based on your financial situation and retirement goals. (See also: Do You Need a Financial Planner?)

Do you have other tips for choosing the right retirement plan? Please share your thoughts in the comments!

0
No votes yet
Your rating: None
ShareThis

Disclaimer: The links and mentions on this site may be affiliate links. But they do not affect the actual opinions and recommendations of the authors.

Wise Bread is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to amazon.com.