One critical component of saving for retirement is choosing which savings vehicles best suit your needs. Traditional savings accounts are not the best bet for retirement savings. Not only is temptation to tap into them high, but they also yield little interest, and anything you do earn could be taxable.
Understanding the options, from employer-sponsored to individual accounts, will help narrow down your choices. Each offers a tax-advantaged way to save for retirement. Keep in mind that just because you start with one type of account doesn't mean it will remain your sole source of savings. You'll likely add, convert and roll over various streams throughout your savings lifetime.
Employer-offered retirement savings plans may include 401(k), 403(b) and 457 plans, Thrift Savings Plans (TSPs), pensions or other options, including the military retirement system. Employee contributions generally are directly deducted from paychecks, and employers may contribute toward the plan or match employee contributions. These plans don't provide a predetermined benefit at retirement; total benefit depends on contributions and investment performance over time. Contributions are typically made pre-tax, and earnings are tax-deferred; any money in the plan remains untaxed until distributions begin at retirement. In the case of Roth options, contributions are made after taxes, and earnings are not taxed each year. Instead, distributions at retirement can be free of federal income taxes if certain requirements are met.
Take advantage of employer-sponsored retirement plans—they make saving for retirement seamless. If your employer offers matching contributions, you'll be even better off.
Individual Retirement Accounts (IRAs)
Individual Retirement Accounts provide an excellent vehicle for tax-advantaged savings beyond what your employer may offer. While there are different variations of both, the two primary types of IRAs are Traditional and Roth.
Traditional IRA: These potentially tax-deferred retirement plans allow you to avoid paying taxes on contributions and earnings until you withdraw the funds. Both deductible contributions and earnings are then taxed at your regular income tax rate when the money is withdrawn. Contributions can be made as long as you have earned income and you are below age 70½.
Roth IRAs: Roth IRAs allow for tax-free growth over your lifetime. While contributions are not tax-deductible in the year they are made, withdrawals that are classified as "qualified distributions" are tax-free. Contributions can be made beyond age 70½ with earned income. No required minimum distributions allow you to choose when to withdraw funds.
Another type of retirement plan is the Simplified Employee Pension (SEP), which provides business owners and self-employed individuals with a simplified method to contribute toward their employees' retirement as well as their own retirement savings.
Regardless if you have an employer-sponsored plan, an IRA can help you work toward your savings goals and is a helpful way to consolidate or manage accounts if you move jobs.
Assembling a portfolio of mixed assets like stocks, bonds, and certificates is another way to add to your retirement savings. Work with a financial advisor to create a strategic asset allocation that will allow you to meet your retirement savings goals and other financial objectives.