While living in the moment can be fun, it’s never too soon to start thinking about retirement. There are multiple retirement plans to choose from. Two common plans are a 401k and an Individual Retirement Account (IRA). Which plan is the best fit for you?
When finding the right retirement plan, you have many options, but you may only qualify for some. A 401k is a plan that is offered to you by your employer, and they may even match your contributions. If you are contributing a consistent percentage each paycheck, some employers will match or double it. When you and your employer are putting money into your account, it is being invested into stocks or bonds to help your funds grow over time. Now that you have created a retirement plan for yourself, when are you able to start taking money out of it? You can withdraw from your 401k at any time, but there may be a 10% penalty plus taxes that you will have to pay. In order to avoid this penalty, you need to be 59 ½ years or older or meet specified qualifications. If you become disabled, are purchasing your first home or need to pay for your education, money may be withdrawn with no penalty, but taxes may still apply.
Individual Retirement Account (IRA)
Another retirement plan option is an Individual Retirement Account (IRA). There are two main types of IRA, a Traditional and Roth. The benefits of each type vary, but there are a few similarities.
Contributions to a Traditional IRA are pre-tax. This means that the money you contribute has not been taxed and can be tax-deductible for your annual taxes. When you get ready to take money out of this account, you will pay taxes. Withdrawals must begin at age 70 ½, and the IRS will require you to stop adding money to the account. Just like the 401k, you can take money out of your account early, but you may have to pay a penalty on it. Penalty-free withdrawals can be made at age 59 ½ or if the same qualifications listed for 401k withdrawals are met.
Unlike the Traditional IRA, you pay taxes on your money prior to contributing. Since you will be paying taxes on your contributions, you may have to pay taxes on eligible withdrawals. The Roth IRA has slightly different requirements when it comes to being able to withdraw money. In order to make qualified withdrawals, you also have to be at least 59 ½ and your account has to be open for at least five years. This plan tends to be more appealing to younger people because you tend to pay a lower tax rate as it’s likely your income is less than it will be later in life. Another popular reason younger people have this account is because the 5-year qualified withdrawals allow them help with a first time home purchase and higher education.