Maybe it’s because I am consistently involved in the finance world, but no matter who I talk to, “retirement savings” seems to be a consistent topic of discussion. Employees are thinking about their 401(k) benefits, banks are marketing IRAs and insurance companies are promoting annuities. Even investment companies seem to be regularly advertising the benefits of target retirement funds. With all this information and marketing many become frozen with indecision asking, “Where is the best place for me to save for retirement?
First things, first. There is no “perfect” or more advantageous spot to park your retirement savings. Everyone has different life circumstances that will dictate what types of retirement accounts are best for their retirement savings. The most important part of this conversation is that you are saving for retirement in some form or fashion.
Let’s look at several options.
Contrary to popular belief, an IRA is not an Individual Retirement Account. The IRS code actually identifies IRA as an Individual Retirement Arrangement. This is because an IRA is an arrangement between you and the IRS about where you save your money. There are a specific tax breaks – depending on the type of IRA you choose.
The Traditional IRA is designed to give you a tax break NOW for your efforts to save for retirement. You can put up to $5,500 in your Traditional IRA ($6,500 if you’re over 50) and deduct the amount saved in your Traditional IRA off your Adjusted Gross Income (AGI) at tax time. You will pay the taxes on this money when you withdraw it in retirement.
The Roth IRA is designed to give you a tax break LATER for your efforts to save for retirement. Roth IRA contributions are subject to the same contribution rules as the Traditional IRA. However, Roth IRA contributions are considered “after tax” money and there is no deduction on your income taxes. HOWEVER, Roth IRA funds grow tax-free and are distributed tax-free. Why? Because you already paid the taxes on the money in your Roth IRA.
401(k), TSP, 403(b)
The terms 401(k) or 403(b) actually refer to their specific location in the IRS code. The Thrift Savings Plan (TSP) is almost exactly like the 401(k) – except it is available only to government employees. In all cases, employers sponsor these types of retirement savings plans for the benefit of their employees. They are not available to non-employees. Generally, the amount you can contribute each year to these types of retirement savings plans is significantly greater than an IRA. You can save up to $18,000 a year with these retirement plans and, if you’re over 50, you can save an additional $6,000. These plans are especially beneficial because an employee can potentially save more than three times the amount allowed by an IRA.
In the simplest terms, an annuity is a contract between you and the insurance company. You give them money now and they agree to pay you a set amount money, through regular payments, beginning at an agreed upon age in the future. Annuities come in many different forms because each insurance company writes their “contracts” differently. Therefore, there is a wide range of options for using annuities as part of your retirement savings plan.
A retirement target fund is where a mutual fund company builds a portfolio – as if they were investing for a single person expecting to retire at a specified target time (2020, 2030, etc…). Target funds operate like any other mutual fund in that the fund is a pooled amount of money, managed by a single source, and focused on a specific objective. Target funds are not retirement accounts. They can be used inside an IRA, 401(k), or annuity like any available mutual fund in a specific retirement plan, but the target funds themselves are not specifically tax-advantaged accounts designated by the IRS.
WHICH ONE IS RIGHT FOR YOU?
There are many “vehicles” to save for retirement. There are advantages and personal reasons to use each type of account. For example, married couples who make more than $191,000,are not eligible for a Traditional or Roth IRA and they must rely on their employer-sponsored 401(k) or TSP to save for retirement. Others may not have an employer pension plan and may choose to use an annuity to create a consistent income stream in retirement.
Certainly, step one is to save money for retirement. Step two would be to sit down and look at your own personal financial situation to identify what account you can use, what you will need income for in retirement, and how which type of retirement savings account best suits your needs.
Wow, do I really need to try and plan the rest of my financial life?
Yes, BUT remember that discussing your personal financial plan is NEVER a one-time conversation. You will consistently review your plan (at least annually) and revise your plan to fit your current situation. Generally, most people end up with several types of retirement accounts and this is a good thing! Having various types of accounts leaves you options for both contributions and distributions.
Diligently continue to save, review your plan, make adjustments, and seek advice when necessary. Remember that being an informed consumer is a significant step in the personal financial planning process. Understanding the general types of retirement savings accounts and their options puts you in a great position to put together an effective retirement savings plan.
Jonathon Rowles Captain, USMC (Ret.)
Disclaimer: (have to do it) – This blog should not be considered financial, investment, legal or tax advice. Consult your licensed financial professional, tax advisor or legal counsel. This blog is for educational purposes only.