What are my Choices!!!
401K (Retirement savings account) - offered by Employer
You can participate in this program ONLY if offered by your employer.
- Reduce your taxable income - You defer paying taxes on your contribution to this account there by reducing your taxable income (contribution are deducted from your salary)
- Matching contribution from your employer - Free money as most employers would match your contribution upto 4-6% (e.g. if you contribute $500 then your employer would also add $500 to your 401K account if they are matching $1 to $1). If your company does not provide any matching contribution then choose Traditional IRA account as it provides better investment choices.
- Money you contribute to this account benefits from tax-deferred growth compounded over years
- Maximum contribution limits imposed by government per year
- Any withdrawals before the age of 59-1/2 must pay income taxes on that portion plus a 10% penalty
- Forced required minimum distributions after the age of 70-1/2
- Account allows employees to take loan from their 401K account but is not recommended
When not to use this choice!
- Employer does not offer retirement savings plan
- If your employer does not match any % of your contribution then this is not the best choice, as you will learn other better choices are available
- But why is this not the best choice if my employer offers it but does not match any contributions?
2. Restrictions of holding period are imposed on fund transactions
3. Traditional IRA is the best alternative as brokerage accounts offer various fund choices, no trading restrictions,
you can trade Funds, Bonds, Stocks or even invest in CDs, etc.
Traditional IRA (Individual Retirement Account)
Anyone can contribute to this type of account, usually offered by many brokerages (Fidelity, TD Ameritrade, Schwab, etc.)
- Contributions may be deductible from your gross income on your federal income tax return for the year in which the contributions are made
- Earnings grow on a tax-deferred basis
- You're not limited in your investment choices, you put funds from IRA in variety of investment instruments including CDs, ETF, Mutual Funds, Bonds, etc.
- Anyone with earned income is eligible to open a traditional IRA, but there are some restrictions as to who can deduct the contributions
- If you withdraw the funds before age 59 1/2, then in most cases you'll have to pay both income tax and a 10% penalty on whatever earnings have accrued, however exceptions apply
- Forced distributions based on age. Withdrawals must begin by age 70½. Even if you don’t need the money, if you do not take at least the required minimum distribution (RMD) each year, you are subject to stiff penalties
More information about Traditional IRA:
Roth IRA (Individual Retirement Account)
Anyone can contribute to this type of account, usually offered by many brokerages (Fidelity, TD Ameritrade, Schwab, etc.). You pay income tax on your earned income, and then make your contribution with post-tax dollars. Ideal choice for young adults (age group of 18-35).
- Your principal grows tax-free
- Direct contributions to a Roth IRA may be withdrawn tax free at any time. Eligible (tax and penalty free) distributions of earnings must fulfill two requirements. First, the seasoning period of five years must have elapsed, and secondly a justification must exist such as retirement or disability.
- Contributions may be made to a Roth IRA even if the owner participates in a qualified retirement plan such as a 401(k)
- Assets in the Roth IRA can be passed on to heirs
- NO required minimum distributions as in a traditional IRA or 401(k)
- Eligibility to contribute to a Roth IRA phases out at certain income limits. By contrast, contributions to most tax deductible employer sponsored retirement plans have no income limit
- Eligible (tax and penalty free) distributions of earnings must fulfill two requirements. First, the seasoning period of five years must have elapsed, and secondly a justification must exist such as retirement or disability
- There is a 10% early withdrawal fee if you withdraw money before 59 1/2 without a qualified reason
More information about Roth IRA: