Most financial experts agree: save for retirement sooner rather than later. It’s never too early to begin investing for retirement. If you don’t already have one, consider establishing a tax-favored retirement account, such as one of the following:
401(k) Plans. If your employer offers a 401(k) plan, it may be one of the best retirement savings vehicles available to you, particularly if the employer matches all or a portion of your contribution. With a 401(k) plan you may contribute up to a certain percentage of your gross income (i.e., total income before taxes). Typically, 401(k) plans offer numerous investment choices, but you will need to choose from those your employer offers.
Earnings in a 401(k) grow tax-deferred. Income tax is due when the money is withdrawn, usually after retirement. If you withdraw money before you turn 59 ½ you may be subject to a 10 percent tax penalty unless the withdrawal is made for a "qualified" reason (as defined by the IRS), such as medical emergencies or college tuition. You pay ordinary income tax on the amount withdrawn, and a 20 percent mandatory federal income tax withholding generally is required from the distribution amount. Some 401(k) plans may also permit loans against your account balance. There is typically a maximum loan amount, and the loan must be repaid, with interest, within a specified time period.
403(b) Plans. A 403(b) plan is similar to a 401(k), but is offered to employees of public and private school systems--K through college--and non-profit, tax-exempt organizations, such as churches, libraries, etc. Your plan administrator can explain how it works and how it differs from the 401(k).
Individual Retirement Accounts (IRAs). IRAs were established by Congress to encourage people to save for retirement by providing tax advantages. In 2008, qualifying individuals may contribute up to $5,000 annually to an IRA. If you are age 50 or over, you may make annual catch-up contributions of $1,000, for years you may not have participated fully or missed making contributions. Tax benefits will depend upon the type of IRA you select, your income level and whether you or your spouse are covered by another tax-advantage retirement plan (e.g., a 401(k) plan).
Traditional IRA: The earnings on your IRA are tax-deferred. Depending on how much money you earn, you may be eligible to deduct your IRA contribution from your gross income for tax purposes. But, there are penalties for withdrawing money from your traditional IRA before you reach the age of 59 1/2, and withdrawals of deductible contributions will be taxed as ordinary income.
Roth IRA: Eligibility is determined by the amount of your annual income. You may not deduct contributions to your Roth IRA from your taxable income, but growth in your Roth IRA is tax-free, assuming you meet plan requirements. Roth contributions can be withdrawn income and penalty tax free. You may incur a 10 percent penalty if you withdraw your earnings from a Roth IRA within the first five years after establishing a Roth IRA, and your earnings will also be subject to payment of ordinary income taxes. Assuming you meet the five-year test, the requirements for penalty-free withdrawals from a Roth IRA are essentially the same as those for making withdrawals from a Traditional IRA, that is, there will generally not be a penalty if you die, are disabled, or if you are older than 59 1⁄2.
You should consult with and rely on your own independent legal and tax advisers regarding your particular set of facts and circumstances
Keogh Plans. Keogh plans are tax-deferred retirement savings plans for people who are self-employed. Generally, a maximum of 25 percent of net income, up to a maximum amount per year, can be contributed on a tax-deferred basis. Keogh plans are more complicated than IRAs or 401(K) plans. To make sure your plan is properly implemented, be sure to get professional tax advice.
Annuities. Annuities are financial contracts issued by an insurance company. Annuities may be deferred or immediate.
With a deferred annuity, payout is deferred to some later date when you elect to receive income payments. A deferred annuity grows tax deferred; earnings are not taxed until you withdraw money. Ordinary income taxes are generally due on the taxable amounts of the withdrawal. Withdrawals of earnings prior to age 59 1/2 may be subject to a 10 percent tax penalty. There may also be surrender charges if you withdraw money from a annuity within a certain time frame, typically within the early years of the contract.
Immediate annuities are purchased with one lump sum payment, and payouts usually begin immediately. You receive payments on a regular basis, providing you with a steady stream of income. Generally, you can choose a payment option that guarantees payments by the issuer for as long as you live or choose from a number of other payment options. Annuities include a death benefit to a surviving spouse or other named beneficiary.
Annuities can be a complicated financial product. Before purchasing an annuity, discuss its specifics with a qualified financial professional to make sure you understand the annuity and your options.
