401k vs. IRA vs. Annuity
How do I know I'm funding my retirement correctly?
So you've started a new job. Congrats, but now they're asking you about how you want to setup your 401k. The thing is you don't know a thing about retirement, and you're left pondering the differences between a 401k, an IRA, Mutual Funds, and Annuities. Well it's easy to get lost in translation, and so I'm going to focus on 3 main areas; 401k, IRA, and Annuity products to help understand the pros and cons of your first step into retirement.
401k
A 401 k plan is a Defined Contribution plan, which means it is a retirement plan in which a certain amount or percentage of money is set aside each year by a company for the benefit of the employee. There are restrictions as to when and how you can withdraw these funds without penalties.
It is available to anyone who works for an employer that offers that plan. You can decide how much you wish to contribute each pay period, but there are a couple key factors in your decision. In 2015, 2016 the individual annual contribution limit under the age of 50 is $18,000, and over the age of 50 $2400 so make sure you know how much you should be putting in so you can max out your 401k.
*More information listed on Investopedia
But what if I don't have an employer, and I still want my personal income to go towards retirement?
Great question which brings us to our next point..
IRA
An individual retirement account (IRA) is an investing tool used by individuals to earn and put away funds for retirement. This is great for small business owners, and entrepreneurs like myself, as it allows us to fund our retirement with our own income, and also provides extra tax advantages with a Traditional IRA. Like the 401k there are limits placed on the plan. The current limit set for individuals under age 50 is $5,500 in 2015- 2016, and over the age of 50 is $6,500.
*More information listed on Investopedia.
There are 2 major points to pay attention to that are important to keep in mind!
The age in which you can start reaping the benefits of your retirement savings plan varies, and note these are long term based vehicles.
The plans I have mentioned are qualified plans that shelter them from taxes.
However the taxes apply once you start taking withdraws!
With a lump-sum payout, you can count on losing a huge chunk of your savings to taxes. If you are over 59 ½ and you choose to cash out the 401k, it will be taxed as current income. Your company will deduct 20% of your savings and hand it over to the IRS as a pre-payment on your income taxes. If you choose to reinvest you will have a lot less money to work. If you are under 59 ½, you may be forced to pay a 10% “early withdrawal” penalty, in addition to the 20% paid to the IRS. If you take the cash all at once, you will be required to report the entire amount on your income taxes for that year. This amount, in addition to your other annual earnings, can bump you into a higher tax bracket. In either case, cashing out your 401k is generally one of the worst decisions you can make when it comes to optimizing your retirement dollars.
Luckily there is hope... our 3rd item the annuity!
There are a couple different approaches an adviser, and yourself, have to keep in mind to make sure you've made the correct choice.
Immediate Annuity is in when you put away a single premium in order to start the payouts as you have guessed, immediately.
There are plenty of choices such as Fixed which focused on stability and guarantee, Variable which has the smallest guarantee but potential for higher yields, and Indexed which is the brain child of the other 2.
Events such as inheritance, settlements, and even the lottery all have adverse chances of increasing your tax brackets so annuities are excellent at providing tax shelter as well as many other benefits.
In summary Annuities are great for many reasons, and it's a great alternative to a CD which provides minimal interest growth.
I hope this article was helpful in answering any questions you had as well as guide to ask better questions. Please subscribe here to our newsletter to receive helpful information like this as well as future posts. Also make sure to share this article on social media to help inform others just like yourself.
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