After you make the commitment to save for retirement, your next step is to find a place to store your savings. Here are a few options.
•Check with your employer first. Your place of employment may offer a retirement plan, and a contribution match — an incentive your employer contributes to encourage you to save — along with it. This is a good place to start, because along with the incentive, it’s convenient. Retirement contributions will be automatically deducted from your paycheck, so that you don’t have to transfer the funds yourself every month.
The 401(k) plan, one of the most common defined contribution plans offered by employers, also comes with tax benefits. Your income taxes on contributions and earnings are deferred until you take a distribution in retirement. This allows you to pay less in taxes during the year you make the contribution, and to build earnings tax-free until the time comes for withdrawal.
•Search for an IRA. An IRA is a great option if you don’t have a plan at work or need to roll over your 401(k) plan from an old job.
A Roth IRA in particular can be a great place to begin, especially if you are new to retirement savings. If you have an emergency and you wipe out your emergency fund, your Roth IRA can function as a backup emergency fund. You can withdraw your contributions before age 59 without penalty, unlike other retirement plans. That option, and the extra peace of mind it provides, can be very important in your early working life.
You fund a Roth IRA with after-tax dollars. You don’t get a tax benefit up front, as you do with the traditional IRA and the 401(k).
But with a Roth IRA, your earnings are tax-free when you withdraw them from your account in retirement. In comparison, traditional IRA and 401(k) contributions and earnings are generally taxed when withdrawn.
Some financial institutions require a $1,000 minimum or more to open an investment Roth IRA. If you want to start saving with smaller, regular amounts, you have some options. You can search for an account that doesn’t require the minimum, save up for the minimum on your own, or open a savings Roth IRA, which typically has low or no minimums. You can earn savings interest and then do a direct rollover into an investment IRA when you have enough to invest.
There are limits to what you can contribute to the Roth IRA every year. The 2012 annual limit is $5,000 for those under 50, and $6,000 for those age 50 and older, but that shouldn’t be a problem if you plan to contribute less than $400 each month. There also are income limitations. As long as your modified adjusted gross income for 2012 is less than $110,000 for those filing single, or $173,000 for those married filing jointly, you can contribute the full amount.
A traditional IRA may allow you to take a tax deduction in the year you contribute, depending on your income. If you think your total annual withdrawals in retirement will be substantially less than your current annual salary now, you could save on taxes.
You can look into these options on your own, or talk to a financial professional for personalized advice.
Michael Camacho is president and chief executive officer of Personal Finance Center. He has more than 19 years experience in retail banking and with financial institutions in Guam and Hawaii. If there is a topic you’d like Michael to cover, please email him at firstname.lastname@example.org