Retirement 101: Know Your Options
If you don't work in the career field of finance or business the word "retirement planning" can be intimidating. How do I start? What is the best way to do it? What is the risk involved? How much will it cost? How much will I need to retire? Your first step toward retirement is to educate yourself. You should never invest in something you don't understand. Below is a brief description of retirement options available to many employees.
- 401K This is a common retirement option at many workplaces. The money you invest in this option is tax deferred. You don't pay taxes on this investment until you withdraw the money. You can only contribute $16,500 per year. If you're 50 or over you can contribute $22,000. The 401 K can be rolled over if you change employment. There are penalties for withdrawing the funds before age 59 1/2. Some employers offer to "match" your contribution to a certain percentage (3%-6%). You need to invest enough to match because this is free money. You could call this a 100% return on your investment. If you are offered this option, you need to take advantage of it. You must begin withdrawing money from a 401K at age 70 1/2.
- Roth IRA A Roth differs from a 401K in a couple ways. Investments in a Roth IRA are "tax free." What this means is that you will not be taxed when you withdraw funds for retirement. You make your investment with after tax dollars. A Roth IRA has income limits. For single individuals your contributions begin to phase out once you reach an income of $105,000-$120,000. If you're married filing jointly the limits are $167,000-$177,000. You can also make withdrawals before 59 1/2 for 1) Buying a home; or 2) Financing your college education. You can also withdraw contributions (not earnings) anytime without any tax consequence. These funds are not taxed. You can also withdraw funds anytime (without taxes) after holding the investment for more than 5 years or reaching age 59 1/2, whichever happens first. While a Roth IRA should be a long-term investment, it can serve as an emergency fund if necessary. There is no age limit when you have to withdraw Roth IRA funds. You can also pass a Roth IRA on to a relative tax free upon your death. What makes this a great investment is all the options it offers an investor.
- Roth 401K - This investment has the same tax benefits as the 401K mentioned above. You also must begin making withdrawals at age 70 1/2. Just as the 401 K you can only contribute $16,500 per year. The Roth 401K differs from the Roth IRA in 2 significant ways: 1) The Roth 401 K has no income limits; 2) Contributions made by the employer are kept separate from the employee contributions.
- SEP/IRA - This investment is a good choice for self-employed individuals. A SEP allows business owners annual tax-deductible contributions equal to 25% of their compensation (if a corporation) or 20% of self-employment income (sole proprietor). For more information about retirement planning for small business owners check out Jeff's post at Good Financial Cents.
- IRA - The maximum amount you can invest is $5000. If you're 50 or older you can invest $6000. Unlike the Roth IRA, contributions to an IRA are tax deferred. This means your contributions are made before taxes are deducted from your paycheck. Like the 401K you will pay taxes on your investment when you withdraw the funds.
- Keogh - This is a full fledged pension plan for self-employed people in the U.S. It is a defined benefit plan. The maximum annual deduction amount is 20% of your gross self-employment income or $49,000 in 2009.
- 457 - This is a deferred compensation that happens on a pre-tax basis (patroll deduction). Your earnings accumulate tax deferred. You can dollar cost average your contributions. You can move your 457 if you change jobs. If you leave service early there is no penalty for withdrawals. You do have to pay taxes on the amount you withdraw. Withdrawals must be made April 1 of the year after you turn 70.
- Defined Benefit Plan. This is a common retirement option for employees of state government. Employees usually have a set percentage (5% or more) deducted from their check every pay period. Most defined benefit plans have a "vesting" period. Being vested means that you have achieved the minimum amount of years necessary to qualify for a paid benefit at your retirement. You need to designate a beneficiary on your account.
You need to make informed decisions about your retirement. Educated invesors are the best investors. If you haven't began educating yourself about funding your retirement I hope this post gets you started. Begin today learning all you can about your retirement options.
Other Notable Retirement Posts
Women and Retirement at Get Rich Slowly
GoToRetirement is a site devoted exclusively to retirement issues.
Frugal Dad has an excellent post on why you should start investing in a Roth IRA Now.
Very complete compilation of Retirement Options!
The only one I’m not familar is the one called 457! But it sounds like an older style of plan.
I have a 401k and my hubby and I each have Roth IRAs. My company still does match on the 401k, and I am very glad of that!
Looks like y’all are privileged to have plenty of options. Good to see that you’re getting a match. I read today that some companies are beginning to offer these again.
Nice well laid out article. There is just one point I would like to add. If you are over 55 and are severed from your company you can withdraw from a 401K penalty free. This can make a big difference to a relatively small group of people but if you are 55 to 59&1/2 you may want to exercise caution in rolling over your 401K to an IRA.
Thanks for sharing that detail…while it is not well known..it might just be the answer for someone needing income to carry them toward retirement without tax consequences…Thanks for adding to the conversation.