Investing Step #5: Retirement Accounts

Photo by: rutlo

This post is step 5 in our Investing Template.

Retirement accounts are probably the type of tax-deferred vehicle with which people are the most familiar.  The number of people invested in the stock market has skyrocketed in the past two decades, much of which is owed to tax-deferred retirement accounts.  Some examples of these types of plans are:

401(k) – The most common type of plan.  They are generally offered through for-profit companies and often include matching.

403(b) – 403(b) plans are similar to 401(k) plans, but are offered by public schools and some non-profit organizations.  There are other differences, but that is the most obvious one.

Traditional IRA – IRAs are also tax-deferred accounts, but are not implemented through an employer.  You are able to deduct the amount contributed and it grows tax-free.  You pay taxes on the funds when you withdraw them. 

Roth IRA – A Roth IRA is different from a traditional IRA in that you do not get to deduct your contributions from your income from this year.  However, like an IRA the money grows tax free and you can withdraw it without paying taxes when you withdraw.  Additionally, there are a few exemptions available to withdraw from a Roth IRA before retirement that are not available with other vehicles.

Self Employed IRAs – There are several other types of IRAs, such as a SEP-IRA and SIMPLE IRA,  available to people who are self-employed, which can allow them significant deductions as well.

All of these programs have different income limits and contribution limits, and a wide variety of details.  Make sure to do considerable research and consult with a tax professional before deciding which one is appropriate for you.

Your Strategy

Which of these accounts make the most sense for you can be complicated, but keep these things in mind:

If your company matches your contribution, it is almost always wise to maximize your contribution to the point at which they match.  Even if they only match 33% or 50%, you are still making an amazing return immediately. Many companies match up 100%!  Imagine a guaranteed return of 100% instantly.  It’s an incomparable investment.  This should usually be your number one investment destination after you’ve established your emergency fund. 

With the exception of the Roth IRA, these are funds you should be setting aside for retirement.  That means that this is the longest window in your time horizon.  These are essentially your funds for when you don’t want to work anymore.  Thus, you should only tie money up in these funds that you will not need for a long time.  There can be severe penalties for withdrawing this money before you reach retirement.

By the same token, if you are setting money aside for retirement, there is no reason not to get it into some kind of tax-deferred vehicle.  Once you are comfortable that you can afford to deisgnate this money for retirement, at a bare minimum you want it to be able to grow tax-free.

Leave a Reply

Your email address will not be published. Required fields are marked *