Retirement planning is more important than ever with the current downturn in the economy. There are many ways to plan for retirement and sifting thought all the option can be confusing. However, the way to financial freedom and a successful retirement isn’t really that complicated. The main thing to remember is that you should start saving and investing as much money as you can and as early in your life as you can, to give your money the time to grow over time. Time and sound money management are the keys to create wealth for your golden years to come.
This article aims to explain the differences between a 401(k) plan and an IRA (Individual Retirement Account). These are two of the most popular retirement savings plans available that makes retirement planning easy, even for people without any financial sense.
What exactly is a 401 (k) plan? A 401k plan is an employee-funded and company-sponsored retirement plan. Some companies also offer to match the employees’ annual contribution.
A 401(k) plan is an excellent retirement planning option because taxes on the contribution and any return on investment are deferred until you start to take money out from the plan when you reach the permissible age to do so without penalties. Taking part in a 401 (k) plan saves you money on income taxes and gives your money the power to make more money tax deferred. Over time, the return on that extra money invested can produce thousands of more dollars toward your retirement fund.
To take full advantage of this retirement plan, you should consider contributing the maximum allowed by law, if your situation allows it. The current maximum contribution you can make to your 401 (k) is limited to 10% of your salary. If you can’t afford to contribute the maximum 10%, try to contribute at least up to the amount that your employer will match. Any matching contributions made by your employer are not counted toward the 10% limit.
It should be noted that there are penalties, in addition to paying the regular taxes on that money, for taking money out of the plan before the allowed age, so be sure that the money you put aside is money that you can do without for the foreseeable future.
The tax-deferred 401 (k) plan should be a part of everyone’s retirement planning portfolio.
IRA (Individual Retirement Account)
An IRA, or an Individual Retirement Account, also provides either a tax-deferred, though a traditional IRA, or tax-free, though a Roth IRA, way of saving for retirement.
A traditional IRA allows you a maximum tax-deductible contribution of up to $4,000 a year, or 100% of your annual income, whichever is greater until the age of 49. If you are over 49, you are allowed to contribute an extra $1,000. A Roth IRA allows a non tax-deductible contribution but offers greater flexibility than a traditional IRA. For the first five years, money contributed into a Roth IRA can be withdrawn without being subjected to a penalty or tax, which has already been paid, but the money earned in the account will be taxed as original income. After five years, both contributions and earnings in the account can be withdrawn without penalty or taxation.
There are limitations to a Roth IRA, however. The amount you can contribute to the retirement plan may be limited or not allowed depending on you income.
You are not limited to picking either the 401 (k) or the IRA. You can have both as long as you work for a company that offers a 401(k) plan and you earn an income.
Regardless of whether you choose a 401 (k) plan, a traditional IRA or Roth IRA, or both as your financial planning for retirement, the key to successfully meeting your retirement needs is to plan for you retirement as early as possible and save as much money as you can afford and as quickly as you can to let time work to your advantage and to grow from your investments. By the time you retire, you will need to be able to cover the cost of living, in addition to any expected medical expenses. This is especially important in today’s age because our life expectancy is going to continue to increase, so you want as much money as possible available when the time comes for your retirement.
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