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Types of Retirement and How They Work

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With the massive amount of financial information available to us at any given time, it can be difficult to sift through and make the best choices. One of our main goals in financial planning is funding our retirement.  We know that we “should” be contributing to a retirement account, but which one is the best?  Thinking of which one is the best is not the ideal way to look at it.  You should just look at each type as different with advantages and disadvantages.  With this in mind, I’ll discuss six important types of retirement accounts and their benefits.
Individual Retirement Account (IRA)
IRAs are Individual Retirement Accounts. The benefits and funding methods vary according to the type:  Traditional, Roth, Simple and SEP.
Traditional – Your investments are tax deferred, meaning you won’t pay income tax until you retire and withdraw funds. Because these are pre-tax contributions, your are able to deduct them on your yearly income taxes. There are, however, penalties if you try to withdraw funds before age 59 1/2.  Contributing to a traditional IRA could be used as a strategy if you need to reduce your income now.  Just be aware that your money will be tied up for a long time.
Roth – Your contributions to a Roth IRA are with after-tax money. This means that whatever you contribute will grow tax free and when it’s time to withdraw, you can do so tax free. You can also take money out of a Roth before you retire and without paying fines, up to the amount that you contributed.
Simple – This Roth is a savings incentive match (SIM) program administered by your employer. The contributions are from your pretax paycheck and then taxed at withdrawal time. This plan also comes with heavy fines if you withdraw before retirement age.
SEP – A SEP IRA is for self-employed individuals with no employees. You gain tax benefits by investing a part of your income and then deducting it on your income taxes.
401(k) Plans
This type of plan is usually offered as an employee benefit, allowing you to invest pretax money which will grow until retirement. If your employer offers a 401(k) match, definitely contribute enough to fully take advantage of the match.  401(k) plans also come with penalties if you withdraw early, but some companies offer a 401(k) loan if you need to access your money immediately.
Roth 401(k) plans combine the best features of both the 401(k) and Roth IRA plans. You fund this account with after-tax dollars, but the entire account is tax-free when withdrawn after retirement.  There’s also an added benefit if your employer matches your contributions to a Roth 401(k) account!
If you’d like to learn more email or call me and we can talk more about the tax implication of these options.


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