Saving for retirement is an important goal for investors to follow, but sheer number of different types of retirement accounts keeps many investors from feeling comfortable getting started with a strategy for their retirement saving. Even though many people end up getting intimidated by the wide range of available options, smart savers understand that each choice has a potential role to play in an overall saving strategy. Let's take a closer look at several popular types of retirement accounts to figure out which ones make the most sense for you.
The big battle between IRAs and 401(k)s
One of the most controversial issues in retirement saving is whether to use an employer-sponsored retirement plan like a 401(k) or a self-managed retirement account like an IRA. Both accounts have their advantages and disadvantages, but in many cases, using both together can give you the best results.
401(k) plan accounts have the benefit of offering an easy way to divert money from your paycheck directly toward retirement savings, with tax benefits that allow you to use pre-tax money. In addition, many employers offer incentives to workers to participate in 401(k) plans, including profit-sharing contributions and employer matching of worker contributions. In essence, you might be able to get free money from your employer if you participate in your 401(k) plan, and contributing enough to take full advantage of any employer match is usually a smart move.
At the same time, though, some 401(k) plan participants have to deal with high expenses and a limited range of investment options that doesn't necessarily meet all of their needs. Because of this, an IRA can look a lot more attractive, as IRA investors can typically enjoy a full range of investment options that go beyond the typical mutual fund offerings in 401(k)s. IRAs let you invest in anything from individual stocks to exchange-traded funds, mutual funds, and even more exotic investments like real estate or precious metals under the right circumstances. By allowing you to choose your investments from the full range of those permitted by law, an IRA lets you make your investing as efficient as possible.
Both 401(k)s and IRAs offer generous amounts of savings. 401(k) maximum contributions set at $18,000 this year for those under age 50 and $24,000 for those 50 or older. IRAs have lower limits of $5,500 for those under 50 and $6,500 for those 50 or older, but even those amounts are generally enough to give you the flexibility to use either or both types of accounts to meet your needs.
Roth or regular?
The other major question with retirement accounts is whether to choose a traditional or Roth IRA or 401(k). Traditional retirement accounts use pre-tax money and grow on a tax-deferred basis until you withdraw the money in retirement, at which time the withdrawal gets included in your taxable income. Roth accounts, on the other hand, offer no upfront deduction, using post-tax money. Yet they also don't create a tax bill in retirement, as the account essentially grows tax-free as long as you use the money in an eligible manner.
Whether to use a Roth or regular retirement account depends on highly personalized factors, but the biggest has to do with your current tax bracket. If you're in a high tax bracket now, then using pre-tax money has a definite appeal, and it's more likely that you can reduce your tax rate by the time you retire and therefore make better use of a pre-tax traditional retirement account. If you're in a low bracket now, however, then a Roth retirement account makes more sense, as you can potentially avoid what might become a higher tax bracket by the time you retire.
Don't forget regular accounts for retirement saving
One thing that many savers never realize is that you don't have to use a special retirement account to save for your golden years. A regular taxable account doesn't give you all the tax advantages of IRAs and 401(k)s, but it also ensures that you can get access to your money at any time for any reason without any unnecessary complications. Having savings in an ordinary brokerage or fund account can help you save both for retirement and for nearer-term needs like a down payment on a home more effectively.
Overall, different types of retirement accounts can be extremely helpful in allowing you to prepare for your post-career life. By using the different benefits that each type of retirement account offers, you can take advantage of the incentives that the government has created to help you save for retirement and ensure your financial security for the rest of your life.
Dan Caplinger has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.