Stressing Over Retirement? Here’s What You Need to Do

Making the right choice of retirement saving arrangement could save you thousands on taxes and fees. This article describes the benefits and requirements of each type to help you choose the best option.

Why Save for Retirement

The money you save for retirement could very well be your primary source of support when age or illness force you to stop working. Considering there is a good chance you’ll be retired for over 30 years, you’ll need a significant amount of money. Most experts agree that to maintain a decent standard of living, you’ll need up to 80% of your current income (adjusted for inflation).  Currently, the average benefit amount paid monthly by the Social Security administration is a meager $1,177. Unless you’ll be eligible for a good pension from your employer, you need to take steps today to be ready for tomorrow.

What Should You Do?

To be prepared for retirement, there are two things you must do: (a) Save regularly and (b) Invest those savings well.

The sooner you start saving, the better off you will be. And the more you save, the better. A good rule of thumb is to save at least 10% of your monthly income. If you’re employer offers a retirement plan, such as a 401(k), you’d be doing yourself a disservice if you don’t take full advantage of it. If you’re self-employed, or your employer does not offer a 401(k) plan, make sure to open an IRA.

Contributing monthly to a retirement plan or IRA is the best way to ensure you will have a stress-free retirement. Besides putting you in a better financial position for the future, saving through a retirement plan and IRA offers the following advantages:

  • Contributions can be deducted from your taxable income, depending on the plan
  • Investment gains in the plan are not taxed until distributed.
  • Retirement assets can be carried from one employer to another.
  • Contributions can be made easily through payroll deductions.

There are two basic types of Retirement Savings Vehicles: Defined Benefits and Defined Contribution.

What is a 401(k) Plan?

A 401(k) plan is a workplace savings plan.  It is designed to encourage employees to save for retirement by giving them and their employers certain tax benefits. 

If your employer offers a 401(k) plan, you can participate by contributing part of your salary. Your contributions are deducted from your taxable income for the year, thus lowering your tax liability. Also, your employer may choose to match your salary contributions to the plan up to a certain percentage.

The money saved in your 401(k) is invested in a plan chosen by your employer according to your instructions. 

Types of 401(k)s Plans

Two common kinds of 401(k)s are traditional and Roth 401(k) plans. In many ways, these two plan types are similar. Unlike an IRA, they do not have an income limit to participate. Both are subject to the same annual contribution limit, which is much higher than the contribution limits placed on IRAs.

To boost contributions even further, you might consider catch-up contributions. If you’re 50 or older, you can make these so-called catch-up contributions for eligible 401(k) plans. These allow you to contribute more than the annual contribution limit to your plan. While they can help turbo-charge your savings as you near the retirement finish line, you don’t have to “be behind” in your savings to take advantage of catch-up contributions.

When it comes time to withdraw your money in retirement, traditional 401(k) plans have certain distribution requirements, which typically must begin the year you turn 70 1/2. Because Roth 401(k) contributions are made with after-tax dollars, the withdrawals are not subject to the same required minimum distributions.

How do 401(k)s differ?

Similarities aside, traditional and Roth 401(k) plans differ in how they are taxed. A traditional 401(k) plan is sometimes referred to as a pre-tax 401(k), meaning that you contribute to the plan with before-tax dollars.

But, because you didn’t pay taxes on the money you put into the plan, you will have to pay taxes (both federal and most state income taxes) when you withdraw the money.

With a Roth 401(k) plans, the opposite is true. You contribute a portion of your salary to your Roth 401(k) plan with after-tax dollars. Because you’ve already paid taxes, when you begin to make withdraws from the plan, that income will not be taxed – if it is what’s called a qualified distribution. A distribution (or withdrawal) is considered qualified if you have had the account for at least 5 years and you made the withdrawal due to disability or on or after you turn 59 ½ (the age at which you can start to withdraw money from the account without incurring an early-withdrawal penalty).

When to Withdraw

Aside from obvious tax implications and early-withdrawal penalties, there are other considerations when choosing a withdrawal strategy for your 401(k) plan.

While many people take all their money out of their savings plan when they retire and roll it into an IRA so they can manage it on their own or with an adviser, it may be beneficial to remain at least partially invested in the plan.

Many plans actually want you to stay in the plan, as they can negotiate lower fees with vendors when they have more assets. These lower fees may make it advantageous to stay in the plan.

401(k) plans can be a very useful tool in saving for retirement, particularly if you take advantage of features that your plan may offer to help maximize your savings.

There are many different ways to start saving for retirement. The trick is to find the right combination of savings plans and tools that work for you. For more on what to consider when selecting a plan, the IRS website offers valuable insight.

Individual Retirement Accounts (IRAs)

What is an IRA?

If you are self-employed or your employer does not offer a 401(k) plan, an individual retirement account (IRA) is a great option for you. An IRA is a broad category of retirement savings plans. In fact, there are several different types of IRAs to consider. These include ones that individuals can open for themselves (like traditional and Roth IRAs), as well as ones that employers can set up for the benefit of their employees (like simplified employee pension (SEP) IRAs and savings incentive match plan (SIMPLE) IRAs).

Regardless of type, however, there are a few similarities that all IRAs share. For example, an IRA cannot be jointly held (remember – the “I” stands for “individual”). But that’s not to say that you can’t necessarily contribute to your spouse’s IRA if you have an income and your spouse doesn’t.

In addition, IRAs are often referred to as “tax-advantaged investment vehicles.” But it’s important to note that “tax-advantaged” can mean a couple of different things, depending on the type of IRA. Some allow tax deductible contributions (the money you put into your IRA on an annual basis). Others allow tax-free distributions (the money you get out of the IRA).

Understanding these differences, and even the limits on these tax advantages, can help you decide which type of IRA might be the best fit for you.

How do individual retirement accounts work?

Traditional IRA

If you received taxable compensation during the year, you may be eligible to make contributions to a traditional IRA. A traditional IRA is a retirement account in which individuals can typically make pre-tax contributions up to a specified maximum dollar amount (not including any catch-up contributions).

You can begin to withdraw the funds, without incurring a 10% early withdrawal fee, when you turn 59 ½, and you must begin taking distributions from your IRA when you turn 70 ½.

Three advantages to remember:

1. Making a contribution can potentially lower your annual taxable income. When you contribute to your traditional IRA, that money is contributed pre-tax, meaning it doesn’t count toward the income taxes you have to pay for the year.

2. Your investments grow tax-deferred. Let’s say your IRA, which has underlying investments in stocks, bonds, and other assets, has a really good year. You still don’t pay capital gains on it that year. And similarly, there’s no tax in the current year for any dividend income.

3. You pay taxes only when you begin to receive distributions. Which, if you play your cards right, should be after you’re retired when your income is lower and, therefore, the tax rate on your IRA payouts may also be lower. Note that we don’t know what tax rates will be in the future.

Roth IRAs

Like a traditional IRA, a Roth IRA also provides tax-free growth on investments. However, unlike a traditional IRA, you can only contribute to a Roth IRA with after-tax dollars. In addition, your contribution amount might be limited based on your filing status and/or income.

But, because you’ve paid taxes on your contribution to the IRA up-front, generally you don’t pay taxes on the payouts you receive from your Roth IRA.

IRAs for small businesses and the self-employed

SEP Plan

A simplified employee pension (SEP) plan is a kind of IRA that allows business owners to make tax-deductible contributions for their own and their employees’ retirement. If you have an SEP IRA through your employer, you own and control the plan, but only the employer contributes to it. As such, you don’t pay taxes on the contributions that your employer makes. But, you will pay taxes on the distributions you receive from the account, plus any earnings made.


A savings incentive match plan for employees (SIMPLE) IRA is a retirement plan that small employers (think: fewer than 100 employees), including self-employed individuals, can set up. SIMPLE IRAs allow employees to contribute pre-tax dollars to the plan while requiring the employer to make either matching contributions (up to 3% of compensation) or nonelective contributions.

The difference between the two is simple: Matching contributions are based on what the employee puts in, while nonelective contributions are consistently paid to employees regardless of whether or not they contributed anything.

IRA Withdrawals

You are required to take the Required Minimum Distribution (RMD) from a traditional IRA beginning the year you turn 70 ½. For beneficiaries of a deceased IRA owner, whether or not the original IRA owner had begun their RMDs determines their options for taking distributions from an inherited IRA.

An owner is never required to take RMDs from a Roth IRA. However, if you are the non-spouse beneficiary of a Roth IRA, you must either take the entire balance by the end of the fifth year after the original owner’s death or take distributions starting in the year after the original owner’s death in minimum amounts based on your own life expectancy.

If you inherit a traditional IRA, when you must take money out of it depends on whether the original IRA owner died before his or her required beginning date, the April 1 of the year following the year the original IRA owner turned or would have turned 70 ½. If the owner died before his or her required beginning date, you may either take the entire balance by the end of the fifth year after the original owner’s death or take distributions starting in the year after the original owner’s death in minimum amounts based on your own life expectancy.

If the IRA owner dies on or after his or her required beginning date, you generally must take distributions in minimum amounts based on the longer of your own or the original owner’s life expectancy.

Someone Will Inherit Your IRA

That’s why you should name a beneficiary of your IRA. Here are some things to consider ahead of time:

When leaving your IRA to your spouse. This can be very straightforward. Your spouse can take control of the assets as his or her own and follow the regular rules for making IRA withdrawals. But if your spouse is younger than 59 ½ years old, the age at which IRA early-withdrawal penalties subside, he or she may want to leave the inherited IRA intact and use the rules other beneficiaries must follow.

When leaving your IRA to anyone other than your spouse. Withdrawal rules get more complicated in this case, but the basic thing to remember is that withdrawals are required every year. Think of an inherited IRA as a frozen account. As such, it can’t be rolled over into another IRA and no additional contributions can be made. In addition, no matter how old the beneficiary is, he or she must make a withdrawal every year.

There is, however, one noteable exception: If the IRA was inherited before the original owner reached age 70 ½, the beneficiary can choose to withdraw all the money within five years. However, the beneficiary would still owe any income tax due on the withdrawal.

Otherwise, the beneficiary can choose to stretch out the payouts by taking smaller annual distributions, called required minimum distributions (RMDs). The dollar amount of these RMDs are based on the beneficiary’s own life expectancy. In addition to the control-factor, a trusteed IRA may offer a cost-advantage over establishing and maintaining a traditional trust and is also protected from creditors.

If you are the beneficiary of a Roth IRA, you may either take the entire balance by the end of the fifth year after the original owner’s death or take distributions starting in the year after the original owner’s death in minimum amounts based on your own life expectancy.

Keep in mind that a spouse can treat an IRA inherited from his or her spouse as her own IRA and that different rules apply if the owner of the inherited IRA is not an individual. For more information about when you must take money out of an inherited IRA, consult IRA Publication 590B, or consult a tax advisor.

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