You have to consider dozens of factors when planning your retirement. How much should you save? How old should you be retiring? How much will you receive from social security benefits? One of the factors that probably is not one of your major concerns, however, is where to put your money.
Not all retirement accounts are created equal, and choosing the right one could help you save more and spend less on fees and other expenses. Traditional IRA, Roth IRA and 401 (k) accounts are among the most common types of retirement accounts. Although they are similar in many respects, they present some essential differences. And understanding these differences can help you choose the right account for your needs.
Similar but not the same: Understanding the options of a retirement account
According to the US Bureau of Labor Statistics, about 60% of workers have access to a defined contribution plan such as a 401 (k) work-based scheme. With a 401 (k), you can contribute in tax deductible dollars, let your money grow over time, and then pay income tax on withdrawals made at retirement.
The main advantage of a 401 (k), however, is the contribution of the potential employer. If your employer offers them, your organization will pay a contribution matching your 401 (k) contributions up to a certain percentage of your salary. So, for example, if you make $ 50,000 a year and your employer contributes 3% of your salary, that means you could get $ 1,500 a year in essentially free money.
Another advantage of the 401 (k) s is that they have high contribution limits. In 2019, you can pay up to $ 19,000 on your 401 (k), versus $ 6,000 for a traditional IRA or Roth. And if you are 50 or older, you can contribute $ 6,000 more per year to a 401 (k), or just $ 1,000 more to an IRA.
A disadvantage of 401 (k) plans, however, lies in the limited investment options. In general, you are limited to a few predetermined choices by your plan administrator. You may also be subject to high fees. Since you have no control over these factors, you may just end up with less than stellar investment options and high fees if you want to invest your money in your 401 (k).
With a traditional IRA or Roth, you have a lot more control over where to invest your money. These types of accounts are highly customizable to meet your individual needs and you can search for the least expensive accounts – so you can keep your savings as much as possible.
IRAs also offer flexibility in the way you prefer to be taxed. With a traditional IRA, your money is deductible initially, but you will have to pay income tax when you withdraw. Roth IRA contributions, on the other hand, are taxed initially, but are tax free when you withdraw your money. Because you are not taxed on Roth IRA withdrawals, you can keep your money in your account for the rest of your life. Unlike traditional IRAs and 401 (k) s, you need to start receiving the required minimum distributions at 70-1 / 2 or face tax penalties (because the IRS wants its money eventually, after all) .
The age at which you are allowed to make withdrawals without incurring a penalty also differs from one account to the other. With traditional IRAs and 401 (k), you are subject to a 10% penalty plus income tax of any withdrawal made before 59-1 / 2 years. With a Roth IRA, you can withdraw the amounts you have paid at any time. However, if you are under 59 and a half years old, you may have to pay a penalty to withdraw your earnings from these contributions.
Choose the type of account that's right for you
Each type of retirement account has many nuances and it can be difficult to choose which one to choose. There is, however, a simple way to make a decision. If your employer offers a 401 (k) with matching contributions, contribute at least enough to this account to get the full match. Even if your plan offers not very attractive investment options and high fees, the money you receive for free largely offsets this disadvantage.
If you do not have access to a 401 (k) account or an employer account (or if you have contributed enough to your 401 (k) account to win the full match and wish to place the rest of your savings in another account), There are a few key considerations to consider when choosing between different accounts.
First, take a look at what you pay in fees. Each account carries a fee (even though 37% of Americans mistakenly think they're not paying fees, according to a TD Ameritrade survey), and choosing a retirement account with lower fees can save you money. thousands of dollars. According to a study by the Center for American Progress, a person paying an average of 1% annual fees will spend about $ 138,000 in their lifetime, while a fee of 1.3% will increase this figure to about $ 166,000. The Center for American Progress also found that average retirement account fees represented 1% of total assets under management. Therefore, if your 401 (k) has above average fees, it may be a good idea to look for other options.
If you decide between a traditional and Roth IRA, one thing to consider is the age that you plan to retire. If you want to retire before the age of 59 and a half, it may be better to choose a Roth IRA because you will not be penalized by penalties by withdrawing your contributions. On the other side of the coin, a Roth IRA can also be a good choice if you plan to work up to age 70 and you do not want to start taking the required minimum distributions at the age of 70 years and a half.
Your tax situation may be another determining factor. If you are earning high income now, the tax deduction with a traditional IRA can work in your favor if you find yourself in a lower tax bracket at the time of retirement. This is because you will end up paying less tax on your withdrawals than if you are taxed initially with a Roth IRA.
There is a lot of information to consider when choosing a retirement account, but it all comes down to a few factors.
If your employer offers a 401 (k) with matching contributions, make this account your top priority. Once you reach the employer equivalent, you can stick to your 401 (k) if you pay a reasonable fee or if you plan to save more than the $ 6,000 a year that you are allocated with an IRA.
If you do not have access to a 401 (k) account or if you choose to invest some of your savings in another account, a Roth IRA is a good choice if you plan to retire early or very late. -1 / 2 or after 70-1 / 2). Finally, a traditional IRA can be a solid option if you expect to be in a lower tax bracket than you are now once you start making withdrawals.
Choosing the right retirement account may seem like a difficult and confusing decision, but the most important thing to do is just get started. Whatever type of account you choose, the sooner you start saving, the easier your retirement will be.