5. Types of Accounts
c. Retirement accounts
Because planning financially for retirement is so important, there are several different types of investment tools available specifically to help you build your retirement fund. Many of these tools are tax-advantaged because the government hopes to urge you to plan financially for your retirement by allowing you to pay fewer taxes on the money you set aside.
Employer Sponsored Plans - The amount employees invest is withdrawn from their paychecks and sent directly to the investment plan. This allows the amount invested to be pre-tax, the equivalent of a tax-deduction for you before you file your taxes. The deposits and earnings of the investments will not be taxed until the money is withdrawn, hopefully when you retire. Your investments can potentially grow much larger because taxes are deferred for many years. In exchange for this benefit, the money must remain in the accounts until the investor is at least 59.5 years old or the government imposes a 10 percent penalty.
The reason this is desirable, in addition to having the money when you retire, is that you probably will be in a lower tax bracket at that time and you will pay less tax on that money because you are no longer earning a paycheck.
401k and 403b plans are common types of employer-sponsored retirement accounts. The main difference between the two types of accounts is that 401k plans are usually offered to employees of for-profit business, while 403b plans are for employees of non-profit businesses.
Some employer sponsored plans have provisions to allow Roth IRA contributions. Roth IRA contributions are subtracted from your take-home income after taxes. They then grow as an investment. When you retire, you can take out the money and earnings and not pay taxes on it.
Other types of retirement plans are available for self-employed and employees of self-employed business owners especially at smaller businesses.
IRA’s (Individual Retirement Accounts) - These are tax-advantaged accounts that individuals open without the help of an employer. You can open one even if your employer provides a retirement plan. The funds must come from the individual rather than being withheld from a paycheck. One of the biggest advantages of an IRA is that you can open an account at banks, credit unions, mutual fund companies or brokerage firms giving you many more choices of investments than you have with company sponsored plans.
On the next page you’ll find a chart comparing some of the common types of retirement accounts.