No matter what you do for a living, or how much money you make, there are plenty of tax-advantage ways to save for your retirement. Ideally, you should pay 12% of your total earnings before taxes (gross earnings) into some sort of retirement account and leave it there until it’s time for you to actually retire. Ensure yourself a great retirement later by paying yourself first – put that money directly into the account so you aren’t tempted to spend it or attribute it to other bills.
There are two kinds of pre-tax retirement accounts: the kind your company provides for you and the kind you provide for yourself. It is vital that you have one or the other, whether you are self-employed or on a company’s payroll. Below are a list of retirement accounts and the benefits of each:
401(k) plan This is the most popular retirement program companies provide for employees. You can typically contribute 15% of your gross annual earnings to your plan, up to a maximum amount that changes every year. For 2009, the most you can contribute is $16,500. Whatever the maximum allowable contribution is the amount you should be putting in to your plan. This is called “maxing out” your retirement plan and it is the single most important thing you can do to secure your financial future, especially if your employer will match a percentage of your contributions.
Traditional IRA A traditional IRA is primarily for people who work for companies that do not offer retirement plans. This year, the maximum you can contribute to a traditional IRA is $5,000, and, depending on how much you earn, your contributions may be fully tax-deductible. As long as the money stays in your account, it will grow tax-deferred, which means you won’t pay any taxes on interest you’ve earned or capital gains.
Roth IRA The single most important difference between a Roth IRA and a Traditional IRA is that you’re savings grow tax-deferred witha Roth and you don’t pay any additional taxes on them once you draw from the account (as long as you are over 59 1/2 years of age when you make a withdrawl.) The maximum allowable contributions for this year is $5,000 as well. If you are having a difficult time deciding which IRA is best for you and your financial situation, remember this rule of thumb: if you are more than ten years away from retirement, you’ll come out ahead with a Roth IRA because the benefits of the tax-free distribution later will most likely outweigh the benefits of the tax deduction now.
Determining the best plan for you depends on your income, your age and your goals. Company-sponsored plans are typically the best way to go, however, if your company doesn’t offer a plan or, if you want to put away more money for retirement, you can always supplement with an IRA. Talk to a financial adviser and determine the best option for your personal and financial situation.
