Retirement planning is a necessary component of our lives and one that you focus on as early as possible. The sooner you start investing in a retirement plan, the more money you can accumulate before you reach retirement age. Here is a basic rundown of two common retirement plans, the 401(k) and the IRA.
401(k)
401(k) plans are typically started by a business for their employees. Employees who buy into the 401(k) plan enjoy several benefits. These plans allow for tax deferred growth as well as up-front tax deductions. This is far superior to the tax shelter of retirement accounts you can open independent of your employer.
You cannot open a 401(k) plan on your own. They are strictly company-based. Your employer will typically match your contribution to a 401(k) savings plan, and therefore sometimes restrict the amount you can contribute to the plan each year.
Another benefit of a 401(k) plan is that no matter how high your income, your savings is still tax deductible. This differs from other types of retirement plans that limit allowable tax deductions based on income.
IRA
IRA stands for individual retirement account. You can open an IRA at a bank, a brokerage firm, or a mutual fund company. IRAs offer several tax breaks that make them especially appealing. Opening an IRA is a convenient savings choice if you’re self-employed, switching jobs, or want to supplement your company retirement account.
IRAs allow for a maximum contribution of $5,000 per year for those under 50 and $6,000 per year for those over 50. This might not seem like a lot, but this maximum increases every few years to cover inflation and, over time, can really add up. If you start an IRA at 22 and deposit the full amount each year, you could retire at 65 with well over $200,000 in the account. This is in addition to social security benefits and any other retirement plans that you invest in over the years.
IRAs provide most of the same tax deductions as 401(k)s. There are exceptions for those who make over a certain amount each year and for those who have an additional pension plan such as a 401(k).
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