403(b)

Which of These 9 Retirement Accounts Is Right for You?

Dr Penny Pincher — Wed, 24 Jan 2018 09:00:06 +0000

You might think that the simplest way to put away money for retirement would be to save or invest your money as you see fit — without reporting your contributions to anyone, and without following any special rules. The problem with following a freestyle retirement plan like this is taxes. You would pay full income taxes on the money that goes into your account, and you would pay capital gains taxes as your investment grows.

Fortunately, there are many retirement savings plans out there that can reduce your tax burden now and in the future, all while avoiding capital gains tax. And while there are many types of retirement accounts, you can — and should! — contribute to more than one. The 2018 contribution limit for traditional and Roth IRAs is $5,500 ($6,500 if you're age 50 or older). For 401(k) plans, the current contribution limit is $18,500 (plus an additional catch-up contribution of $6,000 if over age 50). (See also: Which Retirement Account Is Right for You?)

Here are some of the most popular tax-advantaged retirement plan options.

1. Traditional IRA

Contributions made to a traditional IRA are tax-deductible, which can reduce your current year income tax bill. However, you will have to pay income tax when you withdraw funds starting at age 59½. If your income is high now and you will be in a lower tax bracket after retirement, contributing to a traditional IRA may be a good move.

2. Roth IRA

Contributions to a Roth IRA are post-tax, so contributing to one of these accounts won't reduce your tax bill upfront. But when you withdraw the funds in the future, you won't have to pay income tax. A Roth IRA can be favorable if you are a young investor in a low tax bracket now. Also, if you are concerned that tax rates could go up in the future, contributing to a Roth IRA allows you to pay a known tax now versus a potentially higher tax in the future when you withdraw funds. (See also: 6 Reasons Every Millennial Needs a Roth IRA)

3. Traditional 401(k)

Employees can contribute wages to a 401(k) investment account as elective salary deferrals. The traditional 401(k) account works much like a traditional IRA where income can be contributed before taxes, but you will have to pay income tax on future withdrawals. Some employers provide matching contributions to 401(k) plans, and if you are not participating enough to obtain that match, you are leaving free money on the table. Keep in mind, however, that employer plans have fewer investment options than traditional IRAs, and that there may be limits on whether you can withdraw employer contributions early in, for example, a hardship distribution. (See also: 401K or IRA? You Need Both)

4. Roth 401(k)

The Roth 401(k) is an alternate 401(k) plan where employees can contribute after-tax funds. As with a Roth IRA, the Roth 401(k) allows you to pay a known tax today at your current tax bracket instead of an unknown tax rate in the future. A Roth 401(k) is also an attractive option to younger workers who are in a lower tax bracket now and who have a lot of time for funds to grow. If your employer offers matching funds, again, try to contribute at least the minimum required amount to receive the match. (See also: Things You Should Know About Your 401(k) Match)

5. SEP IRA

An SEP (Simplified Employee Pension) plan allows business owners — often the self-employed — to contribute to traditional IRAs on behalf of themselves and any employees they have. An SEP IRA has many of the same rules as a traditional IRA, but the employer is required to make all contributions to the SEP IRA, and employees can't make any.

An SEP IRA allows employers to adjust how much they contribute to an employee's account depending on the company's cash flow that year. Contributions cannot exceed the lesser of 25 percent of the employee's compensation, or $55,000, in 2018.

Money contributed to an SEP IRA is tax-deductible for the current year, and is subject to income tax when withdrawn in retirement. (See also: The SEP-IRA Is How the Self-Employed Do Retirement Like a BOSS)

6. SIMPLE IRA

A SIMPLE (Savings Incentive Match Plan for Employee) IRA is a retirement savings plan for businesses of any size, although it is still aimed at small businesses. A SIMPLE IRA allows employees to invest in their own accounts, in addition to receiving employer contributions of 1-3 percent of the employee's compensation. An employee may contribute up to $12,500 to a SIMPLE IRA in 2018.

Contributions made to a SIMPLE IRA (by both the employer and employee) are tax-deductible upfront and subject to income tax rates upon withdrawal.

7. 403(b) plans

A 403(b) plan, also known as a tax-sheltered annuity or TSA plan, is similar to a 401(k) — but is offered by public schools and 501(c)(3) tax-exempt organizations. Like 401(k) plans, 403(b) plans may be offered in either a traditional tax-advantaged or after-tax Roth version. (See also: 403(b) vs. 401(k): How Are They Different?)

8. Payroll deduction IRAs

Payroll deduction IRAs allow employees or even self-employed workers to automatically contribute to a traditional or Roth IRA through payroll deductions. The employees set up the account and then let the employer know how much they'd like to contribute from each paycheck. This is perhaps the simplest retirement program that a business can establish for its employees.

9. HSA "IRA"

A HSA (health savings account) is available to those who are enrolled in a high-deductible health plan (HDHP). An HSA allows you to contribute pretax funds into a savings or investment account, and you can withdraw funds tax-free at any time for qualified health expenses. Once you reach age 65, money left in an HSA basically acts like a traditional IRA — there is no restriction that the funds must be spent on health expenses, but they will be subject to income tax upon withdrawal. (See also: How an HSA Could Help Your Retirement)

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This article is from Dr Penny Pincher of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

7 Signs Your 401(k) is Underperforming

Tim Lemke — Thu, 03 Sep 2015 15:00:12 +0000

You've been diligently putting money away through your company's retirement plan, and are hopeful that the mutual funds in your 401(k) will accumulate enough cash for you to retire comfortably some day. But how do you know if your account is performing as well as it could?

An underperforming 401(k) can cost you thousands of dollars in retirement income, so it's important to understand where it may be lacking.

Here are seven ways to tell if your 401(k) is not up to snuff.

1. The Underlying Indexes Are Performing Better

You may have your 401(k) invested in funds that are meant to mirror certain indexes, such as the S&P 500 or Russell 3000. In general, your overall investment returns should be in line with these indexes. If they aren't, then you may want to evaluate what you are paying in fees (see below), or consider switching to a fund that is better managed.

2. You've Never Rebalanced

You may think you have the ideal investment mix, but it's important to remember that your original investment choices may have shifted in proportion over time due to your portfolio's growth. For example, let's say you decided to place 60% of your money in domestic stocks, and 40% in international. But if domestic stocks grow more quickly, over time, that may turn into a 70/30 split. Reallocating your existing investments to reflect your investment choices will usually help you achieve greater growth.

3. You Pay a Lot in Fees

Many people don't realize that most 401(k) plans come with fees. There are fees to administer the plan, fees to manage the funds, fees for record keeping, and a variety of other things. Generally speaking, fees should not represent more than $1 for every $100 in your account, or a total of 1%. If you are primarily invested in index funds, anything more than .20% is high. Even the slightest fee can represent thousands of dollars in lost savings over the life of a plan.

4. Your Plan Administrator Uses Only Its Own Funds

If the company administering the 401(k) plan insists on offering only its own funds, that could be a problem. Those funds might be fine, but studies show they are often not the best funds available and administrators are less likely to dump those funds when they underperform.

5. You Aren't Getting the Maximum Match From Your Employer

If you're not certain what percentage of each paycheck to put into your 401(k), you should at least contribute the minimum required for your maximum company match. This amount varies, but it's often between 3% and 5% of your salary. If you don't take advantage of the company match, you're leaving free money on the table.

6. You're Trying to Time the Market

One of the best things about 401(k) plans is that money is usually deducted straight from your paycheck, so you can contribute a consistent amount into specific funds without much work. But if you decide to adjust your contributions according to market fluctuations, you might be messing with a good thing. Trying to time the market is rarely effective. The average 401(k) investor hangs on to investments for about three years, when they should be staying the course for at least five.

7. You Live in the South

If you live below the Mason-Dixon Line, you might find that your 401(k) is a little sluggish. According to BenefitsPro, six of the top 10 states with the most underperforming 401(k) plans are located in the south. This includes Alabama, Mississippi, Tennessee, South Carolina, Georgia, and Florida. In many of these states, more than 10% of all plans were considered low performing. Check with your HR department or plan administrator for a better understanding of your investment choices.

How is your 401(k) doing?

This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

The "one big lump" theory of your money

Philip Brewer — Sat, 03 Jan 2009 16:47:55 +0000

Don't get confused by the way your money's divided up. It might be split up into IRAs, 401(k)s, 403(b)s, 529 plans, and annuities. Separately from that, it might be invested in different things--stocks, bonds, real estate, and cash. You might even use separate accounts to segregate your funds by goal--emergency fund, retirement savings, car down payment, and sending the kids to college. Despite all that, it's really one big lump of money.

All those things--compartments, investments, accounts--are tools. And it makes no more sense to treat your money as different because of the compartment it's in than it would to divide up your garden produce based on whether the plants were weeded with a hoe or a trowel.

Come to think of it, groceries make a pretty good metaphor. You divide your food up into categories several different ways--whether it needs to be refrigerated or not, whether it's home-grown or not, where it fits into the food pyramid (or four food groups, if you're old). But your goal is a healthful diet for your family, and you meet that goal with the smaller goals of a series of good meals. Your entire pantry is at your disposal to serve those goals, and you'd never assume that you can only make breakfast with foods in the refrigerator, while making dinner with only canned food.

When it comes to their money, though, people start thinking like that. They assume that the money in their retirement account has to be invested for their retirement. They mentally allocate specific investments to specific goals--so if the stock market goes one way they get a great vacation but can't afford to repave the driveway (or vice versa).

Don't do that. Instead, treat your money as one big lump that supports all your goals. Then, use the various compartments and investments and accounts as tools to help you use your one big lump of money to satisfy all your needs--and as many of your important wants as possible.

Let me pause here for a moment to say that I certainly understand the temptation to target some funds--I used to do that. I'd figure, if I just put $x out of each paycheck into some account, after so many months I'd have enough money to buy some thing or another. I used to wish for a facility that didn't exist then, but actually does now: sub-accounts. At most of the internet banks and brokerage firms, you can divide your account into sub-accounts targeted for some specific goal. Then, when you make a deposit, you can allocate the money among any or all of those sub-accounts.

It's really all in one account; they're just keeping track of a variety of subtotals for you. And that's one clue as to why it's better to treat your money as one big lump--because it really is.

There are several wins if you treat your money as one big lump.

Double-counting

One advantage is that some of your money can serve several purposes at once. This is most obviously true for cash.

You need cash for several purposes. You need cash for liquidity--to smooth out the fact that the dates that your bills are due on are not synchronized with the dates you get paid. You need cash for emergencies--because a certain category of problem can only be solved with ready cash that you can spend today. You also want to have cash on hand to take advantage of opportunities--tomato paste going on sale is not an emergency, but there are huge investment returns (tax free!) if you stock up when you see a great deal. You also sometimes need to accumulate a large sum of cash for large transactions like a car purchase or a real estate closing.

To a considerable extent, you can use one pool of cash to support all these purposes. The money you keep on hand for liquidity is part of your emergency fund. You don't want to tie up a large fraction of your emergency fund in "opportunities," but you can invest several percent of it in household staples without putting your finances at risk (in fact, for a certain category of emergencies, such as a flood or a blizzard, a few jars of peanut butter and a big bag of rice is a lot more useful than cash in an internet savings account).

The same is true of all the other categories of investments in your portfolio. All your stock investments support all your long-term goals. All your bond investments support all your medium-term goals. And so on.

Clear thinking

Another big advantage to treating your money as one big lump is that it's a more accurate model of reality.

If you're one of the people who puts a few dollars every paycheck into several different accounts, each saving up for some particular goal, what happens if there's an emergency? You've got two choices: You either cover your emergency with credit (and pay interest), or else you raid your special purpose accounts for the cash (and feel bad).

You have the same two choices if you treat your money as one big lump--except that you can skip the feeling bad part, because you never pretended that the money was "allocated" to some goal or another. It was all part of your one big lump of money that supports all your goals--including dealing with an emergency.

Divided the money up by goal is one of those little tricks people use to fool themselves into doing the saving that they want to do, to keep themselves from just spending it on passing whims. Although I'm generally in favor of whatever tricks people find that seem to work for them, I think this one should be avoided.

See, what you're doing is lying to yourself. If you're only lying to yourself about the little things--pretending you only have the money in your checking account to get by until payday--that's fine. But your entire portfolio is too important for you to be managing it with one eye closed, pretending that it's something other than what it is.

Unified perspective

If you've got a plan for satisfying your wants, you've already got all the advantages of pre-allocating the money, without the disadvantages of lying to yourself.

Just like the person who puts money into a bunch of separate accounts, figure out how much you need to save to fund all your various goals--and then save that much. But instead of dividing the money into separate accounts based on goal, feed it all into your one big lump of money--and then manage that one big lump of money as a unified portfolio that supports all your goals.

Optimize compartment advantages

Finally, once you're managing your money as one big lump, you're in a much better position to take maximum advantage of things like tax-advantaged accounts such as IRAs and 401(k)s.

See, income earned in those accounts accumulates tax-free, but any money that you take out of those accounts is taxed as income--including capital gains that would otherwise have been taxed at a favored rate. So, the key to take advantage is to use those compartments to hold income-earning securities. Don't fund your IRA or 401(k) with long-term investments for your retirement! Fund your IRA or 401(k) with things that earn interest. (I wrote about this in more detail in Your 401(k) is not an investment.)

If you think that your 401(k) or IRA needs to have a balanced retirement portfolio, you're going to miss out on some of the juicy tax advantages that the plans offer. The key to avoiding that misstep is to understand that your whole portfolio is one big lump of your money. No individual account or compartment needs to be balanced on its own--it's only your entire portfolio that needs to be balanced.

And the way to keep that perspective is to treat your money as one big lump that supports all your goals.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Intimidated by Retirement Investing? Get Professional Help!

Sarah Winfrey — Wed, 11 Apr 2007 19:09:19 +0000

It might seem like something of a no-brainer to ask for professional investment advice, particularly about retirement. That said, there's still an astonishing number of people I know who don't. They either go it alone, wading through jargon that they don't understand and desperately trying to make numbers that don't mean anything to them mean something, or the guess and hope they get lucky, or they avoid the topic altogether.

I'm lucky. I work for a company that offers a very generous matching program for funds invested in a retirement account. It's a non-profit organization, so I have a 403(b) instead of a 401(k). There are some salient differences there and I'm not sure which I would choose if I could choose anything, but the 403(b) is my only option so I knew I was going with that. It seemed like it would be easy to figure out, given the amount of colorful brocheures full of smiling people that I was handed on my day of hire.

And the fact that I successfully avoided those brocheures for almost a year? Well, let's chalk that up to planning a wedding and the fact that the generous matching program doesn't start until I've worked here for a year, and not to fear or...yeah. Please?

Recently, though, the day came when I actually looked at the packets of information. Lo and behold, I felt intimidated. This in spite of the fact that I'm knowledgeable about personal finance, I have other investments, and I'm comfortable with the basics (diversify (but not too much!), look into growth when you're young, etc.). A big part of the intimidation came from the fact that the choices I make in this situation determine so much of my future. I felt so intimidated that I avoided it for a week. Then I called my dad. Then I actually read all of the material. Finally, I gave up. I realized that I couldn't do it myself, got the name of our rep from HR, and called him. Once again, I'm lucky. He was coming out today and still had appointments available.

I met with him this morning and it was wonderful. He was professional and friendly, and comfortable with eye contact (a must for me!). He was able to explain the funds and even recommend some. He gave me an outside source that I could check for other reviews and to corroborate his claims. He even brought a calculator so we could determine how much, exactly, I want to put into the account every paycheck. I feel so relieved. My money is in good hands, and he will be keeping track of the funds to make sure they continue to perform well.

I've heard the horror stories about shoddy or bad financial advisors. You've heard the stories. We've all heard the stories. So, in light of my experience today, here are some things to think about when you're choosing someone to meet with.

Make sure your financial advisor comes recommended. The man I met with today represents a major company. He graduated from the university I work at and also advises some close friends of mine. Their accounts have made money, and they like this man.
Get external support for what he says. A good financial advisor will tell you where you can see the funds he recommends tracked. If the source he gives you is his own company, ask for another one. You can find it yourself, but he should be willing to direct you there without a problem.
Ask questions that are important to you. Today, I confirmed with him that I can reallocate assets later, if fund performance changes or my investing goals change. I also found out that my 403(b) is easy to rollover to another company, to a 401(k) if I ever get a job in the public sector, and even to and IRA and a Roth IRA. Since I don't plan to work this job forever, that was important to me.
Get a feel for how truly prepared your advisor is for your meeting. Professionalism can cover a multitude of sins, but not ineptitude, ignorance, or dishonesty, especially in the world of finanicial advising. Look beyond what he wears and how he talks to you to other details. Is he familiar with any forms you fill out (mine was--he saw immediately that the ones HR had given me last year were out of date)? Does he know your company well? Does he have the tools he needs to do his job well (like a calculator, and an extra pen)?
Make sure he listens to you. An advisor can know all there is in the world to know about investing and still not be the person you want to deal with. Does he make time during his spiel to answer your questions? Is he willing to be interrupted when you have a question? Does he respond to how much you know about investing, or does he just go through his pitch? All of these are important when you're trying to find someone you may be working with for quite a while!

Happy investing!

This article is from Sarah Winfrey of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: