Saving for retirement is a complicated process, largely because there are so many places you can put your money. You can always set aside money for retirement the same way you do any other purchase, simply by putting it in a regular account and earmarking it yourself for your retirement nest egg. Yet there are also many tax-advantaged retirement accounts to choose from, including your 401(k) plan account at work, IRAs, Roth IRAs, and some other specialized retirement vehicles available to some. With all those choices, it can be hard to decide how to pick. Below, you'll find some things to think about to help you make the right decision for your situation.
1. Be sure to grab free 401(k) money.
The most important consideration when considering where to save for retirement is figuring out whether you can get any outside help to boost your account balance. With many 401(k) plans, your employer will provide some support in the form of profit-sharing contributions or an employer matching contribution. With an employer match, you'll get extra money in your 401(k) up to a certain amount, but only if you make contributions of your own to your retirement plan account. If you decide not to participate or if you don't put in enough money to take full advantage of what your employer would be willing to match, then you'll end up missing out on what essentially would have been free money.
A typical employer plan with matching will give you a match of half of your contribution, maxing out when you save 6% of your own salary in the 401(k) each year. That's a fairly modest amount, but it can make a big difference in the size of your retirement savings by the time you reach the end of your career. Talk with your HR department to get more details on any profit-sharing or employer matching provisions in your 401(k) and make sure you understand what you have to do to take full advantage of them.
2. Use IRAs for their flexibility.
401(k) plans can be great, but they almost always come with limitations. The vast majority of 401(k)s have fixed investment menus, and if you don't like the choices available to you, then you're just out of luck. By contrast, IRAs are free to invest in a much wider array of assets, ranging from the mutual funds you'll most often find within 401(k)s to individual stocks, exchange-traded funds, and even more exotic assets like gold and silver bullion. If your 401(k) investment choices don't excite you, then once you've saved enough to max out an employer match, diverting any extra savings to an IRA gives you the best of both worlds.
3. Consider the tax-free advantages of a Roth IRA.
In addition to the flexibility IRAs provide, access to a Roth IRA gives you tax advantages that a traditional IRA or 401(k) won't always provide. A Roth IRA doesn't give you an up-front tax break on your contribution, but unlike traditional IRAs and 401(k)s, Roth IRA withdrawals are generally tax-free in retirement.
Some 401(k) plans have taken advantage of recent legislation allowing what are called Roth 401(k) provisions, which essentially gives plan participants the same advantages of a Roth IRA within their 401(k) account. For those whose plans don't have such provisions, though, a Roth IRA can be the only vehicle that gives you long-term tax-free growth for retirement.
4. Think about keeping some retirement money outside a 401(k) or IRA.
As useful as IRAs and 401(k)s are, it can be useful to keep some of your money outside tax-favored retirement accounts. Especially with long-term buy-and-hold stocks, holding some investments in a taxable account can actually be a tax saver in the long run, as preferential tax rates on dividend income and long-term capital gains are available in taxable accounts. Moreover, by keeping things outside a retirement account, you'll never have to worry about early withdrawal penalties or special tax consequences if you end up needing the money before you retire.
You should never let indecision about where to save for retirement become an obstacle that prevents you from saving for retirement at all. By understanding your options and their pros and cons better, you'll be more likely to make a smart choice that works out best for you and your situation.