Retirement planning: Three things to consider when choosing a plan
聽It鈥檚 the most basic question many people have about saving for retirement: 鈥淲here should I put my money?鈥�
Because of their tax advantages, government-approved retirement accounts should be a core part of any retirement savings plan. The most common of these聽include 401(k)s and individual retirement accounts, or IRAs.
The wisdom of maximizing tax advantages is clear, but figuring out which type of account will provide the most benefit聽isn鈥檛 as obvious. And once you鈥檝e chosen a plan, such as an IRA, you might still have choices to make. For instance, you can invest in a聽聽or a. Here鈥檚 the main difference:聽You pay taxes on Roth IRA contributions upfront,聽but not when you take your distributions; conversely, your contributions to a traditional IRA are tax deductible, and then聽distributions are taxed.
Consider these three factors聽when deciding whether to use an聽IRA and聽.
IRAs vs. employer-sponsored plans
In聽2015 and 2016, IRA聽savers are allowed an聽聽of up to $5,500 in earned income per person, per year. People 50 and older can聽make聽an additional $1,000 in 鈥渃atch-up鈥� contributions. In contrast, employer-sponsored plans allow up to $18,000 in annual contributions, with a $6,000 catch-up provision for older investors.
In addition to contribution limits, consider whether your聽聽offers an employer match, and research its聽investment options and fees to see whether it鈥檚 a better deal than an IRA.
Under most circumstances, you can聽contribute to both an employer plan and an IRA. However, there are income ceilings for Roth IRA eligibility. You can find more information on these limits at the聽. And if either you or your spouse are covered by an employer-sponsored retirement plan, there are limits on the amount you can make and still聽.
Tax now or tax later
The tax treatments of traditional and Roth IRAs make them adequate for different retirement savers.
If you聽expect to be in a lower tax bracket when you retire, you might be better off contributing to a traditional IRA and taking a tax deduction now. If you expect to be in a higher tax bracket in retirement, consider聽putting your after-tax money in a Roth and taking tax-free distributions later.
To estimate聽your taxable retirement income, take into account your expected Social Security benefits and required minimum distributions. Traditional IRA owners must take minimum distributions starting at age 70陆, while Roth owners need not take distributions.
Retirement income vs. leaving a legacy
Some people 鈥渙verinvest鈥� and have more money in retirement than they need. When they reach the age of 70陆, RMDs from 401(k)s and traditional IRAs聽create an additional tax burden. If you think you might find yourself in this situation, you can avoid paying taxes on money you don鈥檛 need and more easily leave an inheritance for your heirs聽with a Roth IRA.
A Roth IRA can be an effective estate-planning tool for two reasons. First, there are no RMDs, so the balance can grow tax-free for life without loss of principal. Second, since Roth IRAs are funded with after-tax money, the proceeds can be withdrawn tax-free by you or your heirs.
Note that IRAs, whether traditional or Roth, also let聽the account holder establish a beneficiary. After death, this allows for a much quicker transfer of assets than going through probate. If your family is suddenly faced with bills after you pass, being able to access the money in an IRA could make a big difference.
There are many other variables that can affect聽how you plan for your retirement, but the process involves聽much more than thinking about money 鈥� it鈥檚 about figuring out what your聽needs and goals will be when you stop working. If you鈥檙e still overwhelmed by the options, schedule an appointment to talk with a local fee-only financial planner. Working with a professional helps ensure that you鈥檙e making聽the best possible decisions about your retirement funds.
聽is a fee-only financial planner and the principal of聽.听Learn more about Forrest on NerdWallet鈥檚聽.
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