Hopefully, in Part 1 of this series I convinced you to start saving NOW for retirement! If are convinced or if you were already doing so, read on. Part 2 discusses the different types of retirement vehicles available to us and explains why we want to maximize their use. Let me start with why you should maximize your 401Ks and IRAs for your retirement savings versus other types of accounts such as a savings account, online or traditional brokerage account. One word, TAXES. When you invest in retirement accounts your money grows tax free. The amount you will save in taxes as your retirement account grows tax almost always outweighs the benefit of taxable accounts.
Ideally you should maximize your retirement accounts before you begin after tax investing. What retirement vehicles are available in the marketplace? There are many, but the two major types are employer sponsored plans and IRAs. The ability to participate in them is based on your employer and income. I describe the most common vehicles below.
Employer Sponsored Plans:
401(k) – For profit companies offer 401(k) plans. These plans allow you to save up to $15,500 per year (for 2007), usually through payroll deductions. If you are 50 or older, you can put away $20,500 for 2007. Your employer’s plan may have lower limits. Your contributions to a 401(k) are excluded from your reported income and thus are generally free from income taxes. Your withdrawals at retirement are taxed at regular income tax rates. Some employers don’t allow you to contribute right away. Some employers match up to a certain percent; so in addition to saving on taxes, you get extra money.
403(b) – Not for profit companies offer 403(b) plans. These plans allow you to save 20% or $15,500 per year (for 2007), whichever is lower usually through payroll deductions. If you are 50 or older, you can put away $20,500 for 2007. Your contributions to a 403(b) are excluded from your reported income and thus are generally free from income taxes. Your withdrawals at retirement are taxed at regular income tax rates.
Standard IRA – Anyone with employment income can contribute to an IRA. For tax year 2007, you may contribute up to $4,000 per year, $5,000 if you’re age 50+.Your contributions to standard IRAs may or may not be tax deductible. If you are not covered by an employer sponsored retirement plan, you can take a full deduction regardless of salary. If you are covered by an employer sponsored retirement plan, for tax year 2007, if you’re single your tax deduction is phased out when your AGI is between $50,000 and $60,000 – for couples they are phased out between $80,000 and $100,000. Your withdrawals at retirement are taxed at regular income tax rates.
Roth IRA – Your contribution is not tax deductible but the money grows tax free and is withdrawn tax free. For tax year 2007, you may contribute up to $4,000 per year, $5,000 if you’re age 50+. However, there are income restrictions – Single: Up to $99,000 (full contribution); $99,000-$114,000 (partial contribution) Married: Up to $156,000 (full contribution); $156,000-$166,000 (partial contribution)
All individuals have at least one type of Retirement Account they can participate in, many have more than one. As you plan your retirement savings, utilize these tools to their fullest potential. In part 3 of this 5 part series “A Primer on Retirement Saving”, I will discuss the best use of these retirement investment vehicles to meet your retirement needs. Stay tuned!
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