If you have ever started to think about retirement you will find when it comes to retirement plans they come in an alphabetical soup of options; traditional IRAs, Roth IRAs, 401(k) plans, 403(b) Plans. If all the options and types make your head spin you are not alone. Many of us do not have a good understanding of what any of these terms mean in real life and if we have a retirement plan it is likely what work already had set up or what a family member or friend recommended. But you do not have to feel like all you can do is be swept away by others. There is an easy guide to many of the most common financial plans. With a greater understanding of each you will be able to pick the retirement plan which will best meet your needs or at least have better questions for a financial planner.
How Much Will You Need In Retirement?
First you should consider how much you will need in your retirement. Often something that financial planners recommend using is the 25x Rule which is a good place to start to estimate how much you should save for retirement. The 25x rule states we should estimate our annual expenses in retirement and multiply that figure by 25. So if you think your annual expenses will be $50,000, for example, the 25x rule suggests you’d need a total of $1.25 million saved. Once you have an idea about how much you should be saving you can turn to the numerous types of retirement savings accounts.
Roth IRA vs.Traditional IRA:
Individual retirement accounts (IRAs) are retirement accounts with various tax benefits. The two main types are: traditional and Roth both which require you to have earned income before you are able to contribute. With a traditional IRA, you get an upfront tax break being able to deduct your contributions, but you will end up paying taxes on withdrawals in retirement, whereas with an Roth IRA your contribution isn’t tax-deductible, but qualified distributions are free of taxes and penalties. It comes down to if you would rather pay taxes up front or at the end and which is the best fit will depend on what income bracket you imagine you will be at each point of time.
401(k) plans are similar to IRAs but are set up by your employer instead of by you. Such 401(k) plans are funded by employees making contributions through automatic payroll withholding. In addition many employers offer an employer match for 401(k) plans which means that they will contribute a certain amount into the account for you. For example, your employer might match your contribution to up to a certain percentage of your salary. If your employer offers a match take advantage since it’s essentially free money that is being put away for your retirement. You might also see 403(b) Plans, don’t let the different letters and numbers stress you, 403(b) plans are the non profit and educational sector equivalent to 401(k) which are used by for profit companies.
While saving for retirement is important if we want to be able to enjoy our final years traveling, following our passions, donating to causes we care about, or even spending time with family and friends the process can fill us with dread. It can feel like retirement and retirement accounts are in a forign language that we have no hope of ever learning. In reality while there are many terms each is pretty clear if you take a moment to ask good questions. Despite this you may have to reach out to a financial planner who can help you create a personalized retirement plan. No matter how confusing it may feel, believe in yourself and set yourself up for a wonderful retirement.