Where to Put Your Retirement Money

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You may have questions about how to get the most from your retirement savings: Which retirement plans should I contribute to first? What's the most I can contribute? How do I choose my investments? We've got the answers.

Where to Put Your Retirement Money

You can save for retirement using several tax-deferred accounts, but sorting through them all can feel overwhelming. Here's how to prioritize where to invest your money.

1. Employee plans. If your employer has a 401(k) or similar retirement plan and matches your contributions, participating in that plan should be your top priority. That match from your employer is essentially free money, so always contribute at least enough to earn the full amount.

Another benefit: Traditional 401(k) plans allow you to put aside money on a pretax basis. Because your contributions aren't included as income when you file income taxes, they reduce the amount you pay to the IRS today.

In recent years, many employers have begun to offer Roth 401(k) plans. With a Roth 401(k), your contributions are taxed as income, but those contributions and their earnings will be available tax-free when you retire. Many employers who offer a matching amount allow you to direct the match to a Roth 401(k), which can magnify the tax advantages for you.

Depending on your situation, one or both of these 401(k) options may make sense.

Review the material provided by your employer so you understand the vesting schedule for your plan. That's the timetable that determines when you can take full ownership of the money your employer has contributed. For example, a company may give you 100% ownership of its contributions after you've worked for the company for three years, or it may take a more gradual approach in which you own a progressively higher amount of the money over, say, six years.

When making career decisions, be sure to keep the vesting schedule in mind. If you're thinking of changing jobs, it may pay to linger until you reach the next vesting milestone. Otherwise, you could lose some or all of the money your employer has added to your 401(k) plan.

2. Roth IRAs. These individual retirement accounts are a do-it-yourself option that allows tax-free withdrawals during retirement, as long as your account has been open five years and you're at least 59½ years old when you start tapping it. Because of that generous treatment later, your contributions aren't deductible now. Also, you can only contribute to a Roth if your income falls below certain limits. If you withdraw your earnings before you’re 59½, you'll face a 10% penalty and ordinary income taxes. But you can withdraw your contributions whenever you like.

Consider a Roth IRA if:

  • Your employer doesn't offer a Roth 401(k) and doesn't match your contributions, and "tax-free" appeals to you.
  • You've reached the maximum contribution limit in your employer plan.
  • You don't qualify for a traditional IRA.
  • You think you'll be in a higher tax bracket when you retire.
  • You like the ability to tap your contributions for other financial goals without paying taxes or penalties.
  • Your spouse doesn't have earned income. You can make a contribution to a Roth on his or her behalf under the spousal IRA rules.

3. Traditional IRAs. A traditional IRA may be your next-best investing strategy. Like Roth IRAs, they let you take retirement planning into your own hands. Depending on your income and whether you're covered by an employer retirement plan, you may be able to take an income tax deduction for the money you contribute.

You then delay paying taxes on your contributions and any gains until you withdraw the money. Don't tap it before you reach 59½, though, because you'll owe a 10% penalty on top of whatever taxes you incur.

Consider a traditional IRA if:

  • Your employer doesn't match your contributions.
  • You've reached the maximum contribution limit in your employer plan.
  • You (or your spouse) aren't covered by a retirement plan, but you can't contribute to a Roth because your income is too high.
  • You think you'll be in a lower tax bracket when you retire.

4. Guaranteed savings annuities. If you've made the most of the first three options, a guaranteed savings annuity can be an excellent choice. This is a tax-deferred retirement-savings vehicle that has no contribution limits (as long as it's not held inside an IRA). Regardless of income, anyone can put money in an annuity.

There's no tax deduction for your contribution, but you'll sidestep taxes on your interest until you make withdrawals. Like IRAs, withdrawals before 59½ are subject to a penalty and taxes on the earnings.

Unlike IRAs, however, when you retire, you can turn your annuity savings into income that's guaranteed to last your entire life. Until then, guaranteed savings annuities protect your money against losses and accumulate interest. Since annuities are sold by insurance companies, the financial strength of the company providing the annuity is an important consideration. Companies such as A.M. Best rate and review insurance companies across the country.

Reaching for the Max

Can you have too much of a good thing? When it comes to tax-deferred retirement accounts, the government seems to think so. There are limits on how much you can contribute to them in a single year, with one wide-open exception: There is no IRS limit on how much you can add to annuities held outside IRAs.

Contribution Limits*
Type of Plan Younger Than 50 50 and Older
Roth and Traditional IRAs 2012: $5,000 2013: $5,500 2012: $6,000 2013: $6,500
401(k), 403(b), 457(b) and Thrift Savings Plan 2012: $17,000 2013: $17,500 2012: $22,500 2013: $23,000
Guaranteed Savings Annuities No limits if held outside an IRA

* The amount of your contribution can't be more than your taxable compensation for the year.

Choosing Your Investments

After deciding on which types of accounts you'll use to save for retirement, you'll need to think about how to invest within them. Diversification is key -- that's the strategy of combining many different types of investments that won't all increase or all drop in value at the same time. Diversification doesn't guarantee you'll earn a profit or prevent you from losing money.

There's a way to achieve diversification while taking into account how long you'll put your money to work. It's called a target fund, and it's become widely available in employer plans and IRAs. These funds come in a series that allow investors to pick one based on the year they plan to retire. For example, if you plan to stop working in the year 2030, you might choose a Target 2030 fund. The fund manager will gradually adjust the types of investments held in the fund, making them more conservative as your retirement gets closer.

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