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.
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Types of retirement accounts: | |
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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.
