Comfortable living in your twilight years requires decades of careful planning and saving. Within your planning, you must decide on your types of retirement accounts, percentage to contribute and how to invest your money. Retirement accounts fall into two categories: pre-tax and post-tax. As a general rule of thumb, choose pre-tax retirement accounts if you anticipate being in a lower tax bracket in retirement.
The most common retirement question is “How much do I save?” According to a February 2013 "Time" magazine article, you should save approximately 12 times your annual income for retirement. Now that you have a target, you must plan how much to save towards retirement. The Daily Finance website recommends saving a minimum of 10 percent of your monthly income into your retirement savings, while the "Time" article recommends saving 15 percent of your yearly income.
Why Pre-Tax Retirement?
Where you put your money determines the tax advantages you get. When you save with pre-tax income, you defer paying taxes on the income until retirement. You save money now and pay taxes in retirement when you are likely to be in a lower income tax bracket. Saving money on taxes now gives you extra money to put aside for retirement later.
The two most common pre-tax retirement accounts come with maximum contribution limits: the Traditional IRA and the 401(k). As of August 2013, you may contribute a maximum of $17,500 to a 401(k) for the calendar year -- $23,000 if you are age 50 or older. You may contribute a maximum of $5,500 to an IRA for the calendar year -- $6,500 if you are 50 or older. If possible, you want to contribute the maximum each year to get the full benefit of pre-tax savings. In addition, if your employer offers a 401(k) matching program, you want to fund to the maximum to take advantage of free money from your employer.
Pre-tax retirement savings is a recommended tool to prepare for retirement. Before socking all your money into pre-tax accounts, however, check your current income tax bracket. Compare your current bracket to the one you anticipate being in at retirement. If you are going to go up a bracket, you could get hit with higher taxes on your pre-tax withdrawals. Consider funding post-tax accounts as well so all your eggs are not in the same basket. The most common post-tax retirement account is a Roth IRA, which allows you to withdraw money in retirement, including earnings, tax-free.
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