Retirement Planning Step 2: Choosing the Right Account

May 10, 2017

Now that you’ve set your goal, you need to figure out where you are going to save all that money. Do you use a 401(k), an IRA, or something else? What’s the difference?

The 401(k) is the account you can save through payroll deductions at work (or if you work for a not-for-profit like a hospital it may be a 403(b), but they’re basically the same thing).

401(k) positives:

• It’s easy. You just elect your percentage and voila! The money comes right out of your check and you don’t have to do anything else.
• You may get a match. Most employers these days offer a match as an incentive to get you to use the 401(k). As long as you put a certain percentage or dollar amount in your account, your employer will match those dollars. FREE MONEY ALERT!
• You may have other tools available. For example, the rate escalator, where you tell your account that you want to increase what you’re saving on, say, an annual basis. You can make it happen automatically – no calendar reminder or phone alarm needed.
• You can reduce your taxes. If you’re saving in the pre-tax 401(k), your contributions will reduce your taxable income in the year you put them in. In other words, if you increase your contribution by 1%, your check will go down LESS than 1%. Bonus!

Most people start with their 401(k) because it’s easy and to capture their full match. Don’t leave that free money on the table!

What if you want to save more once you’ve reached the match (or even the max) in your 401(k)? At that point, an IRA can come in handy. The big difference between a 401(k) and an IRA is that you’re fully in charge of your IRA. You have to choose where to open it, how to invest it, and what type you want. There are some special rules that may not allow you to deduct deposits you make into a pre-tax IRA or you may not even be able to contribute to a Roth IRA because you make too much money, (although there are ways to get around that) so just beware as you’re making your choice.

Which account you choose will be up to you. But no matter what, it’s important to pick one and start saving. The good news is that you can always switch where your money is going in the future if your circumstances change!