Ever worry that picking a retirement account is like choosing ice cream at a place with dozens of flavors? You never know if you’ve got the best flavor until it’s too late.

So how do you decide which account to use? Should you choose your work-based 401(k) or your own IRA? Or is another type of account a better choice? Take a look at the strengths and weaknesses of each.

Types of retirement accounts
  • Individual retirement accounts
  • 401(k)s
  • SIMPLE IRAs
  • Multiple retirement accounts
  • Comparison chart

Individual retirement accounts

A traditional IRA lets you put away money for retirement every year, up to $5,000 if you’re less than 50 years old. If you’re 50 or older, the limit is $6,000 in 2008. If you’re not covered under another retirement plan, such as a 401(k), you don’t pay income taxes on the money you contribute when you contribute it.

If you have another retirement plan, “You may or may not be able to take the deduction, depending on income,” says Barry Picker, CPA with Picker, Weinberg & Auerbach.

In any case, your money is taxed as income when you take it out.

The Roth IRA works much the same way with one major difference: You don’t get a tax break when you deposit the money, but the money is tax-free when you take it out. And, unlike a traditional IRA, you can tap the money you’ve contributed at any time without triggering taxes or penalties. You can start taking retirement income from the account as early as 59½, as long as the account has been open for at least five years.

With a Roth, “You’re trading a tax deduction today for free income tomorrow,” says Wayne Bogosian, co-author of “The Complete Idiot’s Guide to 401(k) Plans.”

If you have no retirement plan, “get a Roth,” he says. “And if you don’t know how to invest, just choose a balanced fund.”

The big plus of an IRA: It’s easy. The only requirement is earned income. You can set one up almost anywhere. Since you, not your employer, choose the custodian, you can select a plan that offers the types of investments you want.

IRAs also offer the best benefits to your beneficiaries. “It’s the best one to die with,” says Picker. The pension law enables nonspouse beneficiaries of 401(k) plans, effective in 2007, to extend their distributions over their lifetimes, but it remains to be seen how quickly 4 01(k) plans embrace the new provision. Meanwhile, many 401(k) plans require a lump-sum distribution after death, which can trigger tax problems for nonspousal heirs.

With an IRA, you must name a beneficiary. With a 401(k), your spouse, if you have one, is automatically your beneficiary unless you take steps to change that.

With most IRAs, you can pull money, such as contributions and earnings, out without taxes or penalties for certain life cycle events prior to retirement, but it depends on the rules of the account you have.

With most traditional IRAs, these events would include: reaching 59½, buying a first home ($10,000 limit), qualified college expenses, qualified medical expenses that exceed 7.5 percent of gross income, paying medical insurance premiums after a job loss and disability. If the account holder dies, a beneficiary can take out money without early distribution penalties.

With a Roth IRA, the account has to be at least 5 years old, and the events could include: reaching 59½, purchase of a first home (limit is $10,000 in earnings), disability and death. But with a Roth, you can also take out your contributions at any time for any reason, without taxes or penalties. It’s the earnings on those contributions that are restricted.

When it comes to IRAs, the Roth is king, says Bogosian. Roths are great for people who want to save but don’t know exactly what they are saving for. And since you can make withdrawals, “Roths are a good parking spot for your emergency money,” Bogosian says.

If you’re working past 70½, you don’t have to start taking money out and you can keep contributing, says Bogosian.

With a Roth there is also some financial security if you die or become disabled because you or your heirs can start taking disbursements without any penalties, says David Foster, CPA, CFP and principal with Foster & Motley Inc., in Cincinnati.

But once your income starts to climb, Roths are no longer an option. The cutoff range is $95,000 to $110,000 for individuals and approximately $150,000 to $160,000 for married couples, says Bogosian.

There are also limits on the amount you are allowed to contribute every year. If you’re starting your contributions later in life, it’s more difficult to play catch-up. If you need to put away more than the limit, “then the IRAs are off the table,” says Natalie Choate, author of “Life and Death Planning for Retirement Benefits.”

With a traditional IRA, you have to stop saving and start taking money out when you hit 70½ whether you’re working or not. And if you want to take your money out of a traditional IRA before you retire, you could be subject to taxes and penalties.

401(k)s

When it comes to investing for retirement, a company 401(k) plan can give you the advantage of group buying. “Because of the buying power inherent in these plans, you are able to get better rates; less expensive investments than you or I could on our own,” says Bogosian. “You get an institutional price on investments.”

If your employer offers a 401(k) program and matches your contributions, you can leverage your savings.

Since 401(k) money is taken out before you see your paycheck, “it’s painless,” says Picker. “You don’t even have to write a check like you do with the IRA.”

You can also contribute more, which makes it a great option for those who are starting late. If the individual plan doesn’t set limits, you could contribute up to $15,000 in 2006, or $20,000 if you’re 50 or older, says Picker.

The 401(k) gives you more flexibility in setting your retirement age. You can stop working (and start drawing on the account) as early as 55. Or you can keep working, continue adding to the account and hold off retirement as long as you want. But you have to keep working for the company that sponsors the plan.

Like IRAs (and other types of retirement plans), 401(k)s are protected from creditors in bankruptcy court. Since they are governed by federal law, they also enjoy a bit more protection from creditors if you don’t file bankruptcy. IRAs fall under state law, and each state has slightly different rules governing how or when creditors can access your retirement funds, says Choate.

Since your employer sets up the plan, you’re limited to whatever vehicles the company selects. “Its weakness is the lack of the right asset classes,” says Paul Merriman, author of “Live It Up without Outliving Your Money!” His solution: Balance it with the investments in your IRA.

Employer matching often depends on a vesting schedule, so if you don’t stay for a certain number of years, you can’t keep all the money your employer put in your account, says Foster.

Another drawback of an employer-sponsored plan: The company sets the rules. So not all 401(k) plans are created equal. While 401(k)s can be very flexible, individual companies can make them more restrictive, especially when it comes to borrowing money or making payments to heirs.

Once you put money into a 401(k), it’s difficult to get it out prior to retirement. Some company plans will allow you to borrow from yourself. But should you borrow and then lose your job, you’ve got a short amount of time to repay the debt.

When you retire and start taking out money, it’s taxed as income.

If you’re married, federal law mandates your spouse must be your beneficiary. If you want to leave this money to children or another family member, you have to get spousal consent.

SIMPLE IRAs

If you work for a smaller company, it might offer what is known as a SIMPLE, or Savings Incentive Match Plan for Employees, IRA. A SIMPLE IRA also can be a good option for self-employed individuals, says Foster.

With a SIMPLE, the employer will match some of your contributions following one of several formulas. Like a 401(k), you set up contributions to come out of your income before you see the check and receive an annual tax deduction. The money is taxed as income when you take it out of the account at retirement.

Unlike a 401(k), there is no vesting schedule for employer matching. Any employer contribution “is yours immediately,” says Foster. “You could literally quit the next day and get it all.”

With a SIMPLE, an employee can contribute up to $10,000 in 2006 ($10,500 in 2007) annually in addition to any employer matching, says Foster. An additional $2,500 catch-up contribution is allowed for those over 50.

Unlike a Roth IRA, you can’t pull your contributions out any time you want. SIMPLEs carry the same penalties for early withdrawals as traditional IRAs, unless the money is for a qualifying event. And if you need to tap the account in the first two years, the penalty is 25 percent.

As with a company-sponsored 401(k), you’re limited to the investment vehicles that come with the plan your employer selects.

Since employers can use one of several matching strategies, you need to understand exactly which formula your company is using. And remember: Employers can change formulas annually if they wish.

Self-employment options

If you have self-employment income, you can set up a Simplified Employer Pension or SEP-IRA. They are easy to establish and don’t have the annual reporting requirements of other self-established retirement plans, says Picker.

“SEPs are just IRAs once funded,” says Choate.

They are especially attractive to one-person businesses because they allow a self-employed person to contribute up to 25 percent of annual self-employment income, up to $44,000 in 2006 ($45,000 in 2007).

For the one-person company or partnership, “There is no real downside,” except for the limitations you have with regular IRAs, says Picker.

But if you go the SEP route, be careful of hiring new employees. “They will be eligible for those IRAs as well,” says Bogosian. “You’re now going to contribute on their behalf.”

As with IRAs, “creditor protection is a wild card,” says Choate.

If you’re earning income on your own, you can also set up what’s known as a solo 401(k). A little more complicated to establish than a SEP, it will give you some of the advantages of a work-sponsored plan. “It’s good for the solo practitioner,” says Bogosian. An employee can contribute up to $15,000, or $20,000, if you’re 50-plus. In addition to the elective deferral, an employee could make the employer contribution — up to a limit of $49,000.

And since you control where the account is housed, you can pick an option that will give you all the investment vehicles you need.

“The main thing is that you can put away more money,” says Picker. What to watch out for: If you hire an employee, you may be limited to his or her contribution levels, he says. Plus you’ll have a lot more paperwork.

“The term ‘profit-sharing’ is actually a misnomer,” says Picker. It’s really a contribution to the employee’s retirement plan made at the employer’s discretion. Since the employee and employer are one and the same, it’s a vehicle for saving more money for retirement.

The power of multiple accounts

Trying to decide between a company 401(k) and an IRA ? Your best bet might be both.

You can avoid some shortcomings by staying in both and rolling the money from one type to another, says Choate.

For instance, with an IRA you must start taking money out of the account once you hit 70 ½. But if you also have a 401(k) and intend to continue working, you can roll your IRA into your 401(k) and put off those withdrawals as long as you work.

If you are married and die first and your company plan mandates a lump-sum payment, your spouse could roll the 401(k) into an IRA or the spouse’s own 401(k) and take payments out over time based on life expectancy.

It also helps to check out the tax laws in your state, says Choate. “Certain states have tax exemptions for all retirement plans or some retirement plan distributions,” she says.

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