What Types of Retirement Accounts Are the Best for You?
There are a lot of recommendations out there about where to put your money, both for the short term and the long term If you’ve got questions or concerns about the best retirement savings vehicle, keep things simple. For those with a 401(k) at work, start there. Put enough in the fund to get the full match from your employer, then keep looking for other retirement saving options.
Which Accounts Are the Best For You Right Now?
While you’re earning, it’s a good idea to have a retirement account that reduces your current taxable income. This generally means a 401(k) through your employer or a traditional IRA with a broker. A tax-deferred retirement account means
- the dollars that go into your retirement fund are not counted in your income
- the monies that build up in your account are not taxed as they grow
- you don’t have to pay any taxes on these dollars until you take them out, which you can do on a monthly basis as a supplement to your social security or pension
Because most people make less in retirement than they do during their working days, the ability to save in a pre-tax account will save you in taxes paid over the course of your life.
If you’ve already got a 401(k) through your employer but are also working on a small business or other income source, a Roth IRA may be a good choice. Roth IRAs are funded with post-tax dollars. These can grow untaxed, just like a traditional IRA, and when you take the money out, it stays untaxed!
Both of these IRAs will have a contribution limit over the course of a year, but it goes up as you get closer to retirement. Talk to your broker about your next age bracket bump and try to max your contributions as possible. You can have multiple IRAs.
Why Not Just Use a Savings Account?
The abysmal returns of most savings accounts mean that your retirement money won’t even beat inflation as it grow. You will have to pay taxes on that money in the year you deposit it, rather than after you leave the working world and your income is presumably lower.
It’s also important to note that retirement funds come with restrictions. Any money that you put into a retirement vehicle to be managed at a better rate of return than a savings account will cost you if you try to take out the money before you turn 59 and a half. Not only will you have to pay income taxes on it, but there’s also a penalty of 10% unless it’s a hardship withdrawal.
It’s important to have some money in savings for emergencies. However, your retirement funds will grow faster over time in an account that gets a better rate of return than a standard savings account. Finally, knowing that you may have to pay a penalty means that you will probably leave the money in the account unless you absolutely have to have it due to hardship.
Why Not Use Social Security?
Social security can supplement your retirement income, but relying on it can lead to a very limited lifestyle once Medicare is taken out of your check. Additionally, as of September 2020, experts suggest that retirees relying on social security may face cuts as early as 2031.
Of course, the political fallout from this event would be catastrophic. Likely as not, the fund will be rescued. However, if you have a retirement account in place, a restriction or delay of your social security wouldn’t be catastrophic.
Why Do You Need a Retirement Account?
You may do perfectly well with just a 401(k) through your employer and have no need to set up any of the types of IRAs available in the markets today. However, if you have a stay at home spouse, there’s a nifty trick you can use to put money in their retirement, even if they technically have no income.
The spousal IRA contribution is an ideal way to put money away today for bigger returns tomorrow. If your spouse goes back to work, you can create a standard IRA and make contributions to that. Many stay at home spouses fall behind in their retirement investments in the years they’re home and never catch up. With a spousal IRA, a single-income family can reduce that loss.
How Accessible Is Your Money?
As noted above, it’s important that you leave your money in the retirement account so you have it available for withdrawals in retirement. If you need to make a hardship withdrawal, make sure you qualify before you take the money out.
You can also borrow from some retirement accounts. For example, there are 401(k) accounts that allow you to
- borrow from retirement to make a down payment on a house
- pay the principal and interest back to yourself
- get a lower interest rate on the loan
The key with borrowing from your retirement is to start early. The more you have in there, the more you can borrow. The sooner you start, the faster it will grow.
What If You’re Self-Employed?
Self-employed people need a retirement account even more than folks who work for someone else. Often, the self-employed are putting nearly all of their time and a lot of their income into building up the business. The power of investing in retirement comes from compound interest, and that takes time to build up.
Simply put, compound interest allows you to earn both on your initial investment and on the interest you’ve already earned. A simple $100 investment turns into $110 if you earn 10%, so you get $10 free. The next round of interest will earn you $11, because you get 10% on $110, which means you have $21 dollars that cost you nothing, plus you get your $100 back. The greatest retirement regrets are often tied to not saving enough and to going into retirement with too much debt. Start saving early. As you get closer to retirement, either double up on your mortgage payments or consider downsizing to keep your retirement money as free and clear as possible.