Few of us have hefty pensions in the wings that will support us in very comfortable retirements. For most of us, it's up to us to save and invest for our futures -- and it can be hard to know what the best retirement plans are for each of us. So here's a quick guide to which plans are best, on different measures.
Want to sock away a lot?
Looking at the annual contribution limits for IRAs of $5,500 for most of us (in 2015 and 2016) and $6,500 for those 50 and older, it can seem like that's not the way to go, if you want to save a lot. So look into your 401(k) or 403(b) instead. The annual contribution limit there, for 2015 and 2016, is a much heftier $18,000 -- plus an additional $6,000 for those 50 and older.
Don't just favor the 401(k) because of the bigger limit, though. IRAs have some advantages, such as how they let you park your money in a wider range of investments -- almost any stock and perhaps any of hundreds of mutual funds. So you might consider maxing out your IRA contribution -- as well as contributing as much as you can to a 401(k). Be sure to contribute enough to the 401(k) to grab all the matching funds you can, as that's free money.
If you're self employed, you may be able to sock away even more. You can fund an IRA, of course, but though you have no workplace 401(k) to participate in, you can make use of other retirement plans, such as an SEP IRA, which has a contribution limit for 2015 and 2016 of the lesser of 25% of your income or $53,000 . The best retirement plans for self-employed folks also include the SIMPLE IRA and the Solo 401(k).
Want the biggest tax savings?
If you want to realize the biggest tax savings, consider the Roth IRA. (More and more workers also have the ability to fund a Roth version of the company 401(k).) Here's the main difference between Roth and traditional IRAs (and Roth and traditional 401(k)s): With a traditional IRA, you contribute pre-tax money, reducing your taxable income for the year, and thereby reducing your taxes, too. (Taxable income of $60,000 and a $5,000 contribution? Presto -- you now have just $55,000 in taxable income for the year.) The money grows in your account and is taxed at your ordinary income tax rate when you withdraw it in retirement.
With a Roth IRA, you contribute post-tax money that doesn't reduce your taxable income at all in the contribution year. (Taxable income of $60,000 and a $5,000 contribution? Your taxable income remains $60,000 for the year.) Here's the selling point of the Roth, though: Your money grows in the account until you withdraw it in retirement -- tax free.
Here's how powerful this can be: Imagine socking away just $5,000 each year for 20 years in a Roth IRA, where it could grow by an annual average of 10%. In 20 years, it would become about $315,000 . You will have contributed a total of just $100,000 -- so $215,000 of your account is earnings. If you faced a 15% or 25% tax hit on that $215,000 gain, you'd be looking at a tax bill of $32,250 or $53,750 -- considerable sums. But with a Roth account, you can withdraw all that money in retirement tax free! This is one of the best retirement plans for maximum tax savings.
Want income that grows?
If you want income that grows -- from a principal that grows, too -- then consider one of the best retirement plans -- generating some or much of your retirement income from dividend-paying stocks. You can do that by choosing strong individual stocks -- Chevron, for example, recently yielded 4.8%, while IBM and Ford Motor Company respectively yielded 3.8% and 4.3% -- or by opting for a simpler dividend-focused exchange-traded fund (ETF), such as the First Trust Morningstar Dividend Leaders Index ETF, which recently yielded 3.5%. The iShares Dow Jones International Select Dividend, yielding 4.7%, adds global exposure, focusing on large international companies.
With healthy, growing companies, dividend payouts tend to be increased over time -- and the company stock is likely to rise in value, too. Chevron's payout, for example, has risen by an annual average of 8% over the past five years. That's well above the inflation rate. A downside, though, is that dividends (and stock appreciation) are not guaranteed.
Want to most guaranteed income?
Another kind of income that can grow is income from an annuity. By paying more (or accepting less), you can often get terms that include adjustments to payments to account for inflation. Annuities offer another benefit, in that their payouts can be quite predictable as they're guaranteed by the insurer you buy them from (as long as the insurer stays in business). There's a lot to learn about annuities, though.
For starters, variable and indexed annuities can be problematic, as many sport steep fees or restrictive terms, but immediate annuities or deferred annuities with fixed payouts (or inflation-adjusted ones) are generally a much better deal, offering monthly payouts that can last for the rest of your life. As an example, in our current interest rate-environment, a 70-year-old man who lives in Colorado might pay $100,000 to an insurance company for monthly checks of about $640 -- or $6,700 per year. (That might not seem like much, but if he can spend $100,000, he'll collect $23,000 annually, a lot more than the average Social Security income.)
Want to be creative?
You might also think outside the box a little for some great retirement-plan strategies. For example, if you're a light user of healthcare services (such as if you're young and healthy), you might opt for a high-deductible health insurance plan. That can qualify you to take advantage of a Health Savings Account (HSA). With an HSA, you sock away pre-tax dollars that you can spend on qualified healthcare expenses, without having to use-it-or-lose-it by the end of the year. Your contributions can sit and accumulate in the account, and can often be invested in a range of mutual funds. When you turn age 65, though, any money left in the account can be spent on anything (though such withdrawals for non-medical expenses will be taxable) -- it will have turned into a retirement account!
The more you learn, the more likely it is that you'll figure out which retirement plans are the best retirement plans for you and your needs.