Long ago, in the days of our parents and grandparents, it was possible to work for a single company for the duration of your working career. Along the way, the company saved money for you in the form of a pension that would provide you with a stable flow of income throughout your retirement years. Well, things have certainly changed. Over the decades we have been told that increased business competition for market share, shrinking profits, and the increased costs of doing business have slowly eroded and, in many high profile cases, have eliminated many pension plans. The result—many of us are left to plan for our own retirement.
The Individual Retirement Account (IRA) was originally established in 1974 to provide individuals who were not covered by company pension plans with a tax-sheltered means of accumulating savings for retirement. Over the years, the basic IRA has remained and has been joined by a host of other retirement plan mutations, each offering particular advantages depending upon an individual's needs. The basic idea behind all plans is the same—make regular contributions to a plan, (tax free and often generating an income tax deduction), allow the money to earn interest throughout your working years, and then have a nest egg to assist you financially in your retirement years (at which time the funds are taxed as you withdraw them).
It's scary to think of taking a portion of your hard-earned income each payday and setting it aside for your eventual needs some 30 or 40 years down the road. It's even more confusing when you attempt to decipher the letters, numbers, and parameters that designate the variety of individual retirement plan options that exist today. For now, we'll concentrate on the basics. According to the Internal Revenue Service, there are four basic types of IRA-based plans:
Traditional IRA— This is a personal savings plan that yields tax advantages for saving for retirement. Contributions to a traditional IRA may be tax deductible in whole or in part. The earnings on the amounts in your IRA are not taxed until they are distributed. The portion of the contribution that was tax deductible also does not get taxed until it is distributed. You can establish a traditional IRA at many different financial institutions including banks, brokerage firms, and insurance companies.
Roth IRA— A Roth IRA is also a personal savings plan, but it works in reverse when compared to a traditional IRA. Contributions to a Roth IRA are not tax deductible while those to a traditional IRA may be deductible. However, while distributions (including earnings) from a traditional IRA may be considered taxable income, the distributions (including earnings) from a Roth IRA are not taxable income. More simply, contributions to a Roth IRA are made after taxes but the growth or earnings on the contributions are tax-free. Once you make a contribution to a Roth IRA, you never pay taxes on that money again. Since withdrawals are not reported as income, your adjusted gross income is not affected during retirement. One downside to a Roth IRA is that you pay taxes on the contribution while you're working instead of when you 're retired, when your tax rate is likely to be lower.
If your employer offers a tax-sheltered savings plan, such as a 401(k), sign up and contribute all you can. Your taxes will be lower, your company may match your contribution up to a certain percentage of your salary, and automatic deductions from your pay make contributions easy. If your employer doesn't offer a retirement plan, suggest that one be started. Even a simple plan is better than no plan at all. Almost every financial institution's website will include information or a calculator that will provide you with an estimate to show how earnings accumulate over decades of contributions. The longer your contributions have to earn interest, the greater your fund at retirement so start one today!
Choosing the proper plan is an important decision that should meet the needs of your unique financial situation. Perform your research beforehand and consult with a certified financial planner to help determine the right plan and best course of action for your money.
Articles are provided for the general interest of our readers. Gerber Life Insurance is not responsible for any content and recommends that you consult the appropriate professional with any questions or concerns you may have concerning any financial or health related issues.
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