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Different Types Of Retirement Accounts
By Sarah Russell
Recently, we touched on the importance of investing early in your career. However, as you learn more about investing, you’ll notice that there are several different types of accounts – from 401K accounts to Keogh accounts, and from Roth IRAs to standard IRAs. Each type of account has different rules, regulations and tax implications. It’s important to learn more about each one to choose the best one for you.
401K Account
A 401K plan (named after a section of the 1978 U.S. Tax Code) is a plan offered by employers that allows you to automatically deduct a portion of your income before taxes are taken out and deposit it into a account. You’ll still have to pay taxes on the money when you withdraw it after retirement, but, in theory, you should be in a lower tax bracket after retirement, so you’ll save money on the taxes.
If your company offers a 401K plan (not all employers do), they may also offer a matching benefit for your contributions. This is the free money we talked about in the previous article and you should definitely take advantage of it if it’s offered. But be sure your 401K plan allows you to control how your money is invested. Some employers invest their 401K plan money heavily in their own company stock, which can be a problem if your company hits an unexpected financial crisis.
Keogh Accounts
Similar to a 401K, a Keogh account is a tax-deferred plan for self employed people. Some advantages to Keogh plans are that contributions are deducted from your gross income and your contribution limits may be higher than with other accounts. As with the 401K account, you can defer the tax from your contributions until the money is withdrawn after retirement.
Another option for self employed people is a SEP IRA which has less complex filing administrative paperwork and allows even higher contributions. If you’re running your own business, you’re probably already in contact with a tax attorney who can help you figure out the best way to invest for your retirement.
Individual Arrangement (IRA)
By definition, an IRA is "a personal savings plan that provides income tax advantages to individuals saving money for purposes." You may be eligible to set up an IRA through
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your employer or through a private financial institution. Like the 401K plan, IRAs operate on the principal that your tax bracket will be lower after retirement, saving you money on taxes in the long run. And you are in it for the long run, since most IRAs have penalties for withdrawing money before you’re 59 ½ years old.
When you contribute to an IRA, you’ll be eligible to deduct all or part of your contribution on your taxes, but you are bound by contribution limits. In 2006, the maximum amount you can contribute to a standard IRAs was $4,000. If you’re interested in setting up an IRA account, read the IRS’s Publication 590 “Individual Arrangements” for all the nitty-gritty details.
Roth IRAs
Roth IRAs are a relatively new creation with a few distinct benefits over standard IRAs. Although you can’t defer taxes on the money originally invested in a Roth IRA, all the income earned by the investments in a Roth account is tax free when it is withdrawn. Another benefit is that you are not required to take distributions beginning at age 70 1/2 as with other accounts, so if you don't need the money to live on, it can continue growing and earning for you tax free. Also, a Roth IRA makes it easier to take early withdrawals without penalties in some cases, compared to other accounts.
This article is intended to provide a very brief overview of some of the different types of accounts available. As you prepare to begin investing, you’ll obviously want to dig deeper and find out more about the types of accounts that interest you. The IRS website and a financial planner can be terrific assets in planning your investment strategy and helping you navigate the sometimes tricky set-up processes involved in investing.
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This article was published by Sarah Russell on Smart Young Money – a collection of money management resources for teens and young adults. For great information on using credit, managing debt and more for young people, visit www.smartyoungmoney.com.
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