When it comes to retirement, it's important to understand the financial jargon and plan ahead. A retirement fund is a special account sponsored by your employer or set up on your own to invest contributions for future retirement income. A 401(k) plan is an employer-sponsored retirement savings plan, also known as a defined contribution plan. This plan allows employees to make regular, tax-deductible contributions to an investment account for use during retirement.
Contributions have a maximum annual contribution limit set by the Internal Revenue Service (IRS). An IRA is an investment account to save for retirement. These accounts have an annual contribution limit set by the IRS. One type of IRA is a traditional IRA, which is a tax-deferred retirement option.
This means you make contributions with your pre-tax money and don't pay taxes until the money is disbursed. You pay taxes based on your current income tax rate at the time of retirement. Another type of IRA is a Roth IRA, where you contribute after-tax dollars. However, you can withdraw your contributions (the money you deposited in the account) at any time without taxes or penalties.
Earnings from contributions can also be withdrawn without taxes or penalties, only if the conditions set by the IRS are met. The IRS determines the maximum annual contributions you can make and Roth IRAs do not have any RMD requirements. A pre-tax retirement account is an account where you don't pay taxes on your contributions or earnings until you start withdrawing them. For many, the benefit of this type of account is that contributions made up to the annual contribution limit declared by the IRS are exempt from federal income tax for that year.
With an after-tax retirement account, the contributions you withdraw are not taxable since they were made with after-tax dollars. A pension plan is another type of retirement plan, also called a defined benefit plan. With this type of retirement plan, your employer funds and invests contributions for you and they define the income you will earn from the investment pool based on a fixed calculation that may include total profits, age and years worked in the company. A retirement annuity is another option to provide a stable source of income during retirement.
You pay a lump sum or a series of payments to an insurance company and, in return, they will pay you a lump sum or series of payments over a predetermined number of years or for the rest of your life. Annuities may also be subject to income tax and, if taken before age 59 and a half, an additional 10% IRS tax penalty may apply. The average retirement income depends on many factors such as Social Security benefits and private and government pension earnings. There are other options that can help increase your income stream such as delaying the start of Social Security, increasing 401(k) contributions and opening an IRA.
A financial professional can help determine if any of these strategies are right for you by asking detailed questions about your financial situation, lifestyle and expectations for the future. When calculating how much you'll need in retirement, it's important to realistically approximate your living costs and calculate how much you're likely to receive from Social Security and any pension you may have, as well as any other savings. The Social Security Administration's quick calculator can provide an estimate in current and inflation-adjusted dollars. Are you ready to learn more about your retirement savings options? Get an overview of the different types of retirement funds.
All articles in the Learning Center are general summaries that can be used when considering your financial future at various stages of life. The information presented is for educational purposes only and should not be considered investment advice.