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Everything to know about retirement accounts

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
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 401(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.

-- Updated: Jan. 1, 2007
 
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