Tax-sheltered retirement vehicles should be part of any sound retirement plan. When making a choice of retirement savings plan, there are three factors to consider.
- Is there an available match or bonus to increase your contribution?
- Are there favorable tax consequences?
- Which option minimizes fees you will have to pay?
Generally, the first choice should be any plan for which you can get a match to your contribution. For most of us, this will be a 401(k) plan sponsored by an employer. Any match is essentially “free money”, or put another way, additional tax-deferred compensation. Any other plan that comes with an employer match should be next on the list. The next choice to consider after taking maximum advantage of the employer 401(k) is the various forms of Individual Retirement Accounts (IRA). For some people who are not covered by any sort of employer retirement plan, or for those in lower income tax brackets, a contribution to a Traditional IRA can be currently deducted from taxable income. Especially for those in a higher tax bracket, this can offer an opportunity to enhance the value of the contribution by getting a deduction now, which gives the opportunity to defer tax until after retirement, when you may be in a lower tax bracket. Of course the growth of the IRA is also tax free until distributions are made, so even for those who can’t deduct the IRA contribution, this is a valuable component of the plan. Contributions to a Roth IRA are also a consideration, especially if you can’t take a deduction for a contribution to a Traditional IRA. However, the rules of Roth IRA contribution and conversion can carry some adverse current tax consequences, so it’s best to consult a CPA or tax attorney prior to making a Roth IRA contribution. For those who are able to contribute to a Roth, the tax advantages can be significant since earnings in a Roth plan are never taxed, even on withdrawal. Self-employed persons have enhanced opportunities to use IRAs and should also consult an expert. For any of these plans, analysis of the fees charged by the administrator should be taken into account when making a choice.
One additional option to consider is an annuity investment, but usually only after maximizing the 401(k) and IRA options. Annuities can be a good retirement planning option, but they generally come with higher costs and more restrictions than other types of retirement plans. Annuities are frequently tied to an insurance component, and the rules surrounding access to the funds and vesting of the funds can be complex. However, annuities do offer a tax-deferred savings option, and especially for those who have maximized other types of tax-deferred plans, can be a sound option for retirement planning. The complexity of most annuity investments makes consulting with a financial expert such as a CPA or CFP critical.