Now that we’ve tried convincing you to start thinking about retirement, it might be time to take the next step and consider opening an account to begin saving for the day when you stop working.
Your first step is to consider which of the various types of retirement accounts is the best fit for you. This can seem overwhelming at first, with all of the jargon and acronyms like 401(k), IRA, SEP, and more that you encounter at first.
But the main differences generally relate to:
- whether your account is funded through your employer,
- what’s the maximum you can contribute each year, and
- how your contributions are taxed.
Here’s a handy comparison of the main types of retirement accounts:
| Retirement Account Type | How it works | Maximum annual contribution | Early withdrawal penalty | Need to know |
|---|---|---|---|---|
| 401(k) | Opened via your employer, account earnings aren’t taxed until withdrawal at retirement | $18,000 in 2016 | 10% if younger than 59 1/2 | Investment choices could be limited, but if your employer offers matching on your contributions, it’s free money |
| Roth 401(k) | A separate part of your 401(k), it must be accounted for individually | Roth contributions count toward $18,000 limit | 10% if younger than 59 1/2, must hold account for 5 years | Like a “reverse” 401(k), contributions are made with after-tax money, but distributions aren’t taxable |
| Roth 403(b) | Strictly limited to employees of schools and non-profits | $18,000 in 2016 | 10% if younger than 59 ½, but exceptions exist for some to start at 55 | This account has higher limits for matches than 401(k) |
| Traditional IRA | Small-business owners and self-employed can use this tax-deferred plan | $5,500 in 2016 | 10% if younger than 59 ½. Withdrawals at 70 1/2 are retirement are taxed | You may get more investment options and be able to use your current bank or brokerage as plan provider |
| Roth IRA | Contributions aren’t tax-deductible, but withdrawals at retirement don’t get taxed | $5,500 in 2016 | None if 59 ½; unlike traditional IRA, distributions at 70 ½ aren’t mandatory | Both traditional IRA and 401(k) accounts can be rolled over into Roth IRA plans |
| SEP IRA | This plan lets employers, including self-employed, make tax-deductible contributions to employee accounts | (By employers) the lesser of 25% of employee’s compensation or $53,000 in 2016. Employees don’t contribute | None if 59 ½ | Flexible contributions help if business has volatile cash flow |
| Simple IRA | Like a 401(k) for small business owners, employees can contribute and get matching get matching funds | (By employers) mandatory matching of 3% of compensation, or fixed contribution of 2% of compensation, up to $5,100 | None if 59 ½ | Contribution limits are lower than 401(k)s, but offers easy set-up and lower administrative costs |