Are you planning your retirement and feeling uneasy about what would be the best action to take to get there?
Most of the retirement plans today are of the “defined contribution” kind wherein you and your employer contribute a specific amount each month, quarter or year. But the payout you eventually receive upon retirement will be mainly based on the market value of the account. There are very few people who have access to “defined benefit” plans these days, such as pensions that could guarantee your grandparent’s life savings insurance from their retirement payout. The limited access is quite problematic for retired adults and senior citizens.
The most common among these said defined contribution plans would be IRAs and 401(k)s. The great thing about these two is that you won’t be pressured to choose one over the other as they both equally offer tax-advantaged retirement savings. If you’re planning for a well-thought-out retirement, you may as well include both a funded IRA and 401(k) to your plan.
Although there are indeed some differences between these two types of plans, it might still be a good idea for you to be well-informed of the differences, so they can help you make the right decisions for your future.
401(k), 403(b) and even 457 are qualified employer-sponsored retirement plans. The best time to start on your retirement would be if you already have complete access to an employer plan, especially one where your employer would offer matching contributions to your plan. But in the case that your employer does not offer you a 401(k) or any other sponsored plan, it best that you begin saving in a Roth IRA or traditional IRA.
Say for example your employer decides to match up your 401(k) contributions for about 6 percent of your salary. If that turns out to be the case, the best action would be constantly contributing at least 6% or if possible, almost the same amount as your employer contributed. That way, you have the chance to receive a little extra to your savings or plan. Or else if you don’t, you will be letting go of your free pass to additional payout upon retirement and that would be a waste, don’t you agree?
If you are still uneasy about how 401(k) works, rest assured as all the money that you have contributed to your 401(k) accounts are in fact, pre-tax money. Although you would still have to pay taxes when you withdraw it during retirement, but the good thing is that you won’t be taxed on it during the year you earned that money. So, in the year of 2015, all employees were allowed to contribute up to $18,000 of pre-tax income to their 401(k) accounts, and for those above the age of 50 are allowed to contribute an additional contribution of $6,000.
Since contributing to 401(k) plans is limited to people working for a company, what about everyone else? Compared to 401(k), a Traditional IRA or Individual Retirement Account is open for anyone to contribute so long as they are beneath the age of 70½ years old. There’s a chance that they can also offer tax-deductible contributions for those who aren’t participating in an employer-sponsored plan yet.
The two are the same in the fact that just like 401(k), traditional IRAs also offer tax-deferred growth on your investments so that the assets in your IRA will not be taxed until withdrawn. While a Roth IRA, on the other hand, would offer the opposite tax advantages than a traditional one. It is that you will have to pay the tax of your income before making contributions to your Roth IRA, but instead, you won’t have to pay tax on the earnings you had when making withdrawals upon retirement. Not everyone is qualified for a Roth IRA plan though. To qualify for it, you need to have an adjusted gross income that should either be less than $116,000 or $183,000 for married couples that plan on a joint filing.
By 2015, there is a limit for annual contributions made to an IRA, $5,500 for those below the age of 50 and $6,500 for those above. The same limit applies for both traditional and Roth IRA’s so there is not much difference between the two, except for their tax advantages.
There may be some pros or cons between IRA and 401(k) contribution plans, but it is up to you to decide as to which you deem a good plan for your future retirement. The most important thing is to settle on at least one. You should prepare your contribution plan ahead of time so that you can secure a stable and reliable financial insurance for your future.