Though an alarming number of working Americans have yet to start saving for retirement, those who do realize the importance of establishing a nest egg are certainly on the right track. Since the average American can't live off of Social Security alone in retirement, it's critical that we all do our part to save independently.
Now when it comes to saving for the future, you have several options. You could stick your money in a savings account, a traditional brokerage account, or a dedicated retirement account, like an IRA or 401(k). And while some people might go with one of the former options, here's why you'll come out ahead for choosing the latter.
1. Retirement accounts come with tax benefits, either up front or in the future
When you stick money into a regular savings or brokerage account, you don't get any sort of tax break on that cash. On the other hand, if you contribute to a traditional IRA or 401(k), you get an immediate tax break on the money you put in. In the case of a traditional 401(k), your employer will deduct the amount you wish to contribute from your paychecks before taxes are applied. With a traditional IRA, you'll need to front your entire contribution, but you'll get to deduct that amount when you file your tax return.
Roth IRAs and 401(k)s work differently in that they don't offer an initial tax break for contributions. But whereas traditional IRA and 401(k) withdrawals are taxed in retirement, Roth distributions are taken tax-free. Whether your goal is to reduce your taxes now or in the future, you can achieve that objective while saving for your golden years by funding a retirement account.
2. Retirement accounts offer tax-advantaged growth
When you earn money in a savings or traditional brokerage account, you're required to pay taxes on those interest payments or gains right away. So if, for example, you invest in a traditional brokerage account this year and realize a $2,000 gain, you'll be required to report and pay taxes on that $2,000 when you file your 2017 return.
Retirement accounts, on the other hand, offer tax-advantaged growth, which means the IRS won't come after its share of your earnings until retirement, if at all. With a traditional IRA or 401(k), your money gets to grow tax-deferred, so you won't pay taxes on your gains until you actually start withdrawing from your account in retirement. Roth IRAs offer an even greater benefit: You'll never pay taxes on your investment gains at all. To really see the difference between taxable versus tax-advantaged savings, you can check out this helpful calculator.
3. Some retirement accounts give you free money
Though you may not get any help funding your IRA, if your company offers a 401(k) and you choose to participate in its plan, you might snag some free retirement cash in the form of an employer match. Not every company offers a 401(k), but of those that do, an estimated 92% are willing to match employee contributions to a certain degree. And as long as you put in enough of your own money to capitalize on that match, you'll give your savings an instant boost with no strings attached.
Not only might you score some free cash via a 401(k) match, but you'll also get an opportunity to invest that money and grow it even more. Imagine your company is willing to match up to 3% of your $50,000 salary each year. If you contribute $1,500 of your own money and get an additional $1,500 each year from your employer for 20 years, you won't just be $30,000 richer come retirement. Rather, you'll have an extra $61,000 to your name when you factor an average annual 7% return on investment into the equation (which is more than doable with a stock-heavy strategy). And that's something you just won't get from a traditional savings or brokerage account.
Given the costs you'll most likely face in retirement, it's critical to build as large a nest egg as you can. Opening a retirement account is an efficient way to grow your savings and set yourself up for a financially secure future.