We all want to retire eventually, and retirement funds can help us strategize our finances to make this a reality. Planning for retirement includes strategizing how we save our money, how we invest it, and ultimately how we distribute this money to sustain our lifestyles when we're no longer working.
Let's talk about these three commonly used retirement funds: 401(k)s, Traditional IRAs and Roth IRAs. All of these models are designed for long term investing.
A 401(k) plan is a company-sponsored retirement account that employees can contribute to through automatic payroll withholding. Employers have the option to match all or some of these contributions.
Employee contributions reduce their income taxes for the year they are made. The money that accrues in a 401(k) is not taxed until the money is withdrawn, typically after retirement.
In recent decades, 401(k) plans have become more popular as employers have shifted the responsibility and risk of saving for retirement to their employees.
An individual retirement account (IRA) is an investment account that allows you to save for retirement in a tax-advantaged way. With a Traditional IRA you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59 and a half.
If you take money out before your 59 and a half birthday, you may have to pay a penalty (with some exceptions).
The main benefits of having a traditional IRA are the tax deduction for contributions, the tax-deferred investment compounding (compounding is your friend when investing!), and the ability to invest in virtually any stock, bond, or mutual fund you want.
Traditional IRAs are especially good if a 401(k) or pension may not provide enough retirement income.
A Roth IRA is an individual retirement account where you pay taxes on money going into your account, and then all future withdrawals are tax-free.
Roth IRAs are best when you think your taxes will be higher in retirement than they are right now.
Almost all brokerage firms, both physical and online, offer a Roth IRA.
Note: The biggest difference between a Roth IRA and a Traditional IRA is how and when you get a tax break. This applies to when you put money into your account or when you take money out.
Learn more from our sources: