Pros & Cons on the Types of Retirement Investments
You can choose from a variety of retirement investments as you make your retirement plans. Each type of investment offers you advantages that range from current taxes to retirement taxes, flexibility about what you invest in and a variety of limits on how much you can contribute. You only get one retirement, so understand your options for setting up your retirement savings.
Individual Retirement Accounts
If you choose a traditional individual retirement account, all of your contributions are tax-free. That means the amounts you put into your IRA come from your income before you calculate your taxes. For example, if you earn $40,000, but you contribute $2,000 to your IRA, you only pay tax on $38,000 worth of income. However, when you retire, you pay tax on the money you withdraw from your IRA. The advantage of this type of account is that you get the tax break now, while your earnings, and therefore your taxes, are higher than they may be during retirement. By the time you retire, though, tax rates could change and you could face difficulty paying higher-than-anticipated taxes on your withholdings.
You pay taxes on your contributions to a Roth IRA. For example, if you earn $40,000 and contribute $2,000 to a Roth IRA, you still pay tax on the full $40,000 worth of income. However, you do not pay taxes on the money you withdraw from a Roth IRA during retirement. This offers you the advantage of living tax-free in retirement. You have the disadvantage of paying taxes now on money you don’t get the full benefit of for your current lifestyle.
Many employers offer a 401k plan with matching contributions from the employer. For example, if you put $5,000 a year in the plan, the employer puts a matching $5,000 into your account. This offers the advantage of growing your retirement funds more quickly than if you depended on your contributions alone. However, a 401k usually limits your investment options to a small number of investments. These investment choices may charge fees that are higher than you would pay if you had the opportunity to shop around.
You can purchase an annuity by placing your retirement funds in an annuity account with an insurance company. You receive a guaranteed payment amount each month during retirement. This offers the advantage of knowing what your retirement income will be. However, a steady amount does not compensate you for inflation. In addition, when you die, your spouse may receive a reduced payment. Although annuities exist that offer the surviving spouse full payment, you must check the spousal payment terms of any annuity carefully before purchasing.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.