Retirement Savings Account

The term ‘retirement savings account’ is really a generic term that describes any type of account that is officially designated for retirement, such as a 401k or an IRA. This usually means that the federal government has designated that particular account type, with specific rules and regulations attached, to be solely designed for retirement savings.

In general terms there are almost always tax benefits attached to these accounts to make them particularly attractive to entice people to do the smart thing and save for their retirement. This is the government’s way to offer incentives to save for retirement during your earning years so you will be able to support yourself in retirement.

The major retirement savings account options are the 401k, which is an option available through your job, the traditional IRA, which is a self-directed tax deferred retirement savings option, and the Roth-IRA which is similar to the traditional IRA except for the fact that you are taxed upfront on your money and it will not be taxed again upon withdrawal.

The single most important thing you can do to make sure you’re ready for retirement is to start saving today. It is never too early to start putting money away for retirement, and it is also never too late to start. The worst thing you can do is to move through life blissfully unaware that you’re going to eventually retire some day off in the future and that somehow you’ll magically be financially ready for it.

You simply have to make it happen yourself, and through the powers of compound interest, you can save just a few thousand dollars a year, if you’re diligent about saving, and this can in many cases be enough to retire comfortably on (of course situations are different and it’s important that you do your own research or eventually consult your own financial advisor).

Most retirement savings accounts operate under the same theory which is you put money away in a government designated account and this money is basically untouchable until you reach the age of 59 1/2. For your sacrifice of effectively storing money away for decades without being able to spend it, the government offers you tax benefits of either allowing the money to grow and compound tax free for decades as in a 401k, or taxing the money one time in the present, where you have a 100% degree of certainty of the tax rate and then that money is never taxed again, even if the account is worth millions of dollars, as in the Roth-IRA.

The 2010 IRA and Roth-IRA contribution limits are $5,000 and the 2010 401k contribution limit is $16,500. There are provisions for people over 50 years old being allowed to put in additional amounts into their 401k; in 2010 that additional amount allowed is $5,500 for a total of $22,000.

It’s often difficult to determine which type of retirement plan to elect, so here are some simple strategies to remember.  The very first and most important is to determine if your company has what’s known as a “401k match”, and what that matching percentage is.  What this means is that if you personally contribute a certain percentage of your salary to your 401k, your company will reward you with free matching money that they will put in your 401k as well. 

So if your company offers a 4% 401k match, that means that they will put in up to 4% of your base salary into your own 401k if you meet certain guidelines (which usually means that if you put in 4% of your salary, they will put in 4% for a total of 8%.  If you put in only 2%, they will only match up to 2%).  This is literally free money, and what amounts to a 100% return on your investment, so you would be extremely foolish to not put in the minimum that qualifies you for the company match. 

After you’ve secured the full company match, you need to then take a hard look at your financial situation, your expected needs in retirement, and the total amount you are currently saving and then devise a plan to make certain you’re on the right track.  There is usually no incentive to save more in your 401k than what qualifies you for your company match, because the investment options are usually rather limited, and the plan is tied to your employer, which makes it more difficult to move with you. 

For that reason, you should look to open a no annual fee IRA or Roth-IRA with an investment firm such as Fidelity.  Fidelity allows you to open up an IRA for free, and they have hundreds of low expense mutual fund options that do not incur a trading fee if you purchase through Fidelity.  Your only real decision is how much of the $5,000 limitation can you save and whether you want a traditional IRA or a Roth-IRA. 

A strategy if you’re already saving in your 401k is to get some “tax diversification”, which means that since the 401k is taxed upon withdrawal, that you might want to open a Roth-IRA which is taxed today and then never again.   This lets you be certain what the tax rate is, since we are at historically low tax levels now and the rates will almost certainly rise in the future.