Retirement Savings Accounts
Tomorrow I’ll be finishing off the Money 101 series with a post on retirement, but before I did I wanted to talk a little bit about the different retirement savings accounts that are out there.
There is a lot of misinformation about the different kinds of accounts, and while not a fully thorough entry, this post is a great starting point for you to know the differences.
Is this where you put your retirement money? (credit: Kevin Collins)
What Is A Retirement Savings Account?
A retirement savings account (RSA) is a place you put money you agree not to touch until you retire. Mostly, the money goes int mutual funds, stocks, and bonds but it can go into just about anything.
They rules are simple: You can’t withdraw the money until you are 59 ½ years old and there is a limit to how much money you can put into an account each year.
There are several types, but the three most popular are the 401k, the Traditional IRA, and the Roth IRA. I’ll go into some detail about each.
401k
A 401k is a retirement account that you can only get through your employer.
The good:
- You can pull money from your check before taxes are taken out.
- Most employers match the money you put into the account up to a certain percent of your paycheck. This is basically free money!
- The money grows tax free until you pull it out at retirement.
- You can put up to $16,500 dollars into a 401k every year.
The bad:
- Your employer controls where you can invest your money.
- You get hit with a big tax bill when you start withdrawing.
- Some employers don’t match.
Traditional IRA
The traditional IRA is very similar to a 401k except it is an Individual Retirement Account (IRA) and not associated with your job.
The good:
- Like a 401k, contributions are pre-tax (for most people) which means you have a lower tax bill at the end of the year.
- You have complete control of where your money is invested.
- You can use it no matter how much money you make.
The bad:
- You can only contribute $5,000 a year ($6,000 if you’re 50 or older).
- You get hit with a big tax bill when you start withdrawing.
- You must start withdrawing at age 70 ½ or you will be penalized.
Roth IRA
Roth IRAs are the crowd favorite right now. Like the other two, you can’t touch the money until you are 59 ½ but unlike the other two, the investment is money that has been taxed.
The good:
- Contributions can be withdrawn tax free at any time (though before 59 ½ there is a penalty).
- You can wait as long as you want to start withdrawing.
- All interest earned is tax-free. No matter what it’s worth when you start withdrawing, every penny is yours.
The bad:
- You can only contribute $5,000 a year ($6,000 if you’re 50 or older).
- Contributions are not tax-deductible (so you have the same tax bill).
- If you make too much a year, they won’t let you contribute to a Roth IRA.
You decide
I barely scratched the surface of the three most popular retirement accounts. In truth, you need to spend time looking at each one yourself and deciding which situations works best for you.
How do you do that? Come back tomorrow and I’ll show you.
Are you putting money into a retirement savings account? Why or why not?
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I LOVE talking about 401k vs IRA, especially when a ROTH is available. The idea of a ROTH being tax free at retirement is incredible, especially with the volatility in the market today. Yes, I said ESPECIALLY with today’s volatility. Check this out:
I have an old 401k that I haven’t touched in over 5 years (haven’t added or withdrawn, it just sits there). In 2005 it was $34k. Today it is at $42K. Did you get that? I haven’t done anything with it and it grew by at least $8K (or 25% for you people playing at home) in 6 years — during the GREAT RECESSION (it dropped 50%) and August’s crazy “Debt Ceiling” week. I won’t tell you what my wife’s 401k (consistently funding and getting a match) has done since 2005, you wouldn’t believe me.
Also, I started a ROTH IRA in April 2009. I’ve put a total of $5,925 into it and today (yes, August 15th, 2011) it is worth $9,024.
Mind you, I am an old guy (in AlexSpeaks terms) and don’t have as much time as some of you kids. If you can scrape some money together and start today I am convinced y’all will be millionaires by the time you are 60. I think Alex is going to show you how that is possible, and I hope my experience has been a positive example of how to stick to the market even when the cable news and financial radio stations are screaming about how bad things are.
The market in 2040 or 2050 will be better than it was in 2008 or even 2011. And you can take that to the bank!
Wow Steve, those numbers are amazing! You are proving what everyone says (and then some!). It is amazing to see money grow in these accounts…but more on that tomorrow.
Roth all the way! The income limits are pretty generous (I think north of 90,000 a year) and my understanding is that that’s not your actual income but merely your taxable income. So kids, charitable deductions, etc. can bring that down.
Married couples can also donate $5,000 EACH, and $10,000 is a pretty sizable amount to invest in a retirement account (at least for me).
My wife and I try to contribute as much as possible, but this is balanced between college accounts for two children, a health savings account, short term savings, and paying off our mortgage.
I agree! Especially when you consider the national average is only $60,000 dollars! The overwhelming majority of my readers should be able to contribute to a Roth IRA with no problems.
Thanks for the great comment, Loren!
We’re ROTH folks. Best advice: start early!
Very true. My wife and I are currently looking into which accounts to invest into. We’re both excited about doing it through a Roth
My company is all kinds of awesome, where it contributes 3% of my salary into a 401k regardless of what I contribute, and I have complete control over where and what it is invested in. Talk about FREE money!
Once we get our last debt paid, we’ll start contributing towards that, or possibly a ROTH. We’ll see…
Wow, that’s awesome!
If they increase their contribution you may want to put a bit of your money into the 401k if they don’t you should probably look more deeply into a Roth.
Whatever you decide, your company is amazing! I have never heard an investment plan that awesome.
It should be noted that the cup with small change in it is making as much as any savings account right now.
My only concern with the Roth IRA is that we get some crazy Congress in there that decides to change the tax law so that “those evil millionaires” hiding their money away in a retirement tax shelter can “pay their fair share.” Don’t think it can’t happen; I’ve already read a news editorial suggesting that Roth IRAs be ended. (http://articles.latimes.com/2011/apr/10/opinion/la-oe-scorse-roth-iras-20110410)
Despite what a good idea the Roth IRA is if one thinks about it for more than 5 seconds, i don’t imagine it is still very popular or even well-known, even amongst people that have a 401(k). Hopefully that will change.
I can’t wait for the last in the Money One Oh One series!
Just read the article. I understand their “point” but it ignores a few basic facts:
1) Roth IRAs are taxed, they are just taxed at the beginning instead of the end. And eventually they are taxed again when a person withdraws the money and spends it on ANYTHING. lol.
2) Even as a tax shelter for the rich, you can only put in $5,000 per person. Technically that means you can add 10,000 if you’re married but only if your spouse is working. In most “ultra rich” homes one spouse stays home thus they can only “shelter” $5,000 per year (which isn’t really sheltered since the money has already been taxed).
Like you said, there’s always a chance of some congress ruining it for everyone. However, I like that both parties are interested in keeping Roth’s around. Ruining Roth IRAs wouldn’t hurt the rich or increase the economy, it would just end the best way for poor and middle-class folks to have a great retirement.
Great comment, Tim!
PS — I’m not terribly surprised that it was the L.A. Times that wrote that piece. Leave it to California to think that my already taxed money needs to be taxed again before I can spend it on something that’s taxed…