Straight Talk About Retirement Accounts

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Posted August 19, 2013 by Kelley Long in Life After Five
retirement

 

Hopefully you’ve figured out that saving for retirement is a key to your financial security, regardless of your age. Now that you’ve decided to start saving, the next step is determining what type of account to utilize for this purpose. This is where many Career Girls get hung up because there are so many confusing options available. The bottom line is that any retirement account is basically a savings account with a few more rules. Don’t be intimidated by that.

bottom line

Let’s define the most common options 

Traditional 401k plan: If you are employed full-time, chances are that your employer offers you the opportunity to participate in their 401k plan. Different employers have different rules – some don’t allow you to participate until after you’ve been there a year; some will put money into your account as long as you do, called the “employer match;” all of them will give you the chance to save money through payroll deductions for retirement.

Key characteristics:

  • Contributions are pre-tax
  • Your investment choices are dictated by the plan sponsor (such as Fidelity, Charles Schwab, Putnam, etc.)
  • There is a penalty if you withdraw money before retirement age (59 ½)
  • Some plans will allow participants to take loans out, although that is not something I recommend
  • Once you leave your employer, you may keep your savings in that account or you may roll the money over into a Rollover IRA
  • When you reach retirement age and begin distributions, the money is taxed the same as if it was paid to you by an employer (called “ordinary income”)

Traditional or Rollover IRA: Anyone may open an IRA, regardless of age, income or employment status. In order to contribute money to the account, you must have earned income (such as from a job) and the amount you can put in is subject to an annual limit.

IRAs may be opened with any financial services company that offers investment accounts such as Vanguard, Fidelity, Morgan Stanley, PNC Investments, etc. Where you open your account depends on how much help you want in selecting the investments. Discount brokerages like Vanguard will not offer you advice, full-service brokerage firms like Morgan Stanley or PNC will have a financial advisor that will collect a commission in return for giving you guidance. Once your account reaches a certain dollar amount, you may decide to hire a portfolio manager who will take charge of investing the money on your behalf for a fee based on the total value of your account.

Key characteristics:

  • Contributions CAN be pre-tax, but aren’t always if you have an employer-sponsored plan available to you (such as a 401k)
  • The amount you can contribute is limited to $5,500 for 2013 ($6,500 if you’re over age 50)
  • You have more investment options – you aren’t restricted to the mutual funds offered in your 401k
  • Investments grow tax free, so you won’t have to claim any interest, dividends or capital gains on your tax return
  • There is a penalty if you withdraw money before retirement age (59 ½)
  • When you reach retirement age and begin distributions, the money is taxed the same as if it was paid to you by an employer (called “ordinary income”)
  • Once you reach age 70 ½, you will be required to begin taking money out of the account, based on the value of the account and IRS age tables

Roth IRA: This type of account is very similar to a traditional IRA account except that you pay income tax on the money before you put it in instead of when you withdraw it like a traditional IRA. There are also limitations on who can contribute to this type of account based on income, but if you do qualify you can open the account anywhere that will allow you to open a traditional IRA.

Key characteristics:

  • Contributions are AFTER tax
  • Same limits as a traditional IRA ($5,500/$6,500)
  • If you make more than $112,000 ($178,000 if you’re married), your contributions may be limited or not allowed at all
  • You have more investment options – you aren’t restricted just to the mutual funds offered in your 401k
  • Investments grow tax free, so you won’t have to claim any interest, dividends or capital gains on your tax return
  • You can withdraw up to the amount you contributed at any time, penalty-free
  • Once you reach age 59 ½ you may begin taking distributions, but you will never HAVE to take distributions
  • Distributions are tax-free – you already paid the taxes when you put the money in

One thing that all three of these accounts have in common is the need for a beneficiary designation. The beneficiary designation says who should receive the account upon your death. It’s important to have this form filled out and kept current – if you’re married, you must put your spouse down unless he/she signs a consent form acknowledging the designation of someone else.

I can’t emphasize enough the importance of socking away money, even just $25 per paycheck, for retirement.

You can thank me when you’re ready to retire and able to do so without worrying about money.


About the Author

Kelley Long

Kelley Long is a CPA/PFS and CFP® who believes that the true meaning of financial security means having choices in life. Formerly the head of her own practice, KCL Financial Coaching, Kelley parlayed the knowledge and experience gained from starting her own business into her dream job as the Director of Communications and Marketing for the Chicago-based CPA firm Shepard Schwartz & Harris. She’s also a volunteer and media ambassador for Feed the Pig and 360 Degrees of Financial Literacy. In Kelley’s perfect world, everyone would feel great talking about their money concerns, fears, questions and problems, because then everyone would see that we ALL have those concerns, fears, questions and problems. Kelley lives in Chicago where she also teaches BODYPUMP group fitness classes at the Chicago Athletic Clubs.

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