A retirement account is a savings option that allows you to put away your money for retirement with special tax benefits. Since retirement accounts have different options and benefits for growth – such as tax advantages – it is a good idea to know the difference between each type of account. This will help you choose the account that is best for you and your goals.
With this in mind, it is important to note that these accounts do not grow on their own. The account in and of itself holds no form of interest rate, however, the investments inside of the account have a rate of return which helps the deposited money to grow and be invested further.
Common Retirement Account Options
Traditional IRA: An Individual Retirement Account is an account that allows you to save money for retirement. IRAs are available to most people. The money you save grows tax deferred, meaning you will not have to pay taxes until you retire and withdraw money from the account. An IRA is a great way to save for retirement because of the flexibility in making contributions and the wide range of investments that are available. Just like most retirement accounts, what your money is invested in is determined by you.
Roth IRA: A Roth IRA is very similar to a traditional IRA; however the biggest difference is that the money you contribute is post tax dollars. This means that the income you are using to contribute has been taxed in the year that you make the contribution.
With Roth IRAs, your investments grow tax free; at retirement you won’t have to worry about what the tax rates are because you paid your taxes when you made the contributions.
SIMPLE IRA: SIMPLE stands for Savings Incentive Match Plans for Employees. This account is used by businesses with less than 100 employees. The employer can choose to make a contribution to the employee retirement account in order to incentivize saving among its employees.
SEP IRA: SEP IRA stands for Simplified Employee Pension. This type of account allows employers and self employed entrepreneurs to make contributions to a retirement plan. A SEP does not have the start-up or operating costs of a conventional retirement plan and allows for a contribution of up to 25% of each employee’s salary.
Traditional 401(k): A 401(k) is a retirement account set up by your employer and is one of the most common forms of saving for retirement. 401(k)s generally have limited investment options which vary depending on your employer. A 401(k) is built with pre-tax dollars, meaning you will pay taxes on your contributions and earnings at retirement. Some employers will match your contributions, which means you receive free money toward retirement.
Roth 401(k): A Roth 401(k) is very similar to the Traditional 401(k). The main difference is that your contributions will have been taxed before they are put in to the account. When you withdraw money from your Roth 401(k) at retirement, you will not pay any taxes.
403(b): This retirement plan is exclusive to some tax exempt organizations. Examples of these are public education organizations and other non-profit employers. Like the 401(k), employers that offer the 403(b) can match contributions to their employees’ accounts as an incentive, however, it is not required of them.
When you are making retirement account decisions, it is important to know which account is best for you and your needs. Financial advisors have the knowledge and the experience to help you put your money in investments and retirement accounts that can help meet your goals, risk tolerance, and desired tax benefits.
Retirement accounts are intended to save money for retirement, and the government wants to make sure that those funds are available when you are retiring. In order to ensure that the funds remain in the account and receive the preferred tax treatment, there are some regulations regarding early withdrawals. In most cases, if you wanted to withdraw funds from your retirement accounts before age 59 ½, there would be a penalty on the amount withdrawn and, in some cases, you would have to pay income tax on the balance withdrawn.