Carrie Schwab Pomerantz

Dear Carrie: I'm trying to be smart about investing for retirement, but all the different accounts out there confuse me. Help! --A Reader

Dear Reader: I believe saving for retirement is one of the smartest things you can do, so kudos for asking this question. You're right that there is a confusing array of retirement account choices out there, but the good news is that they all have benefits that can help you save. There's no right or wrong choice -- only the choice that makes sense for your personal situation.

One good way to understand your choices is to look at the tax characteristics of different accounts.


Probably the most well-known retirement accounts are the 401(k) and the traditional IRA. These are tax-deferred accounts, which means you won't pay income taxes until you withdraw the money, preferably when you're retired. At that time, you'll pay taxes at your ordinary tax rate. (Note: You generally will be charged a 10 percent penalty on top of income taxes if you make a withdrawal before age 59 1/2.)

Now let's look at the different types of tax-deferred accounts. Here are some of the most common:

--(SET ITAL) 401(k) (END ITAL)--This is offered through an employer. You designate a percentage of your pretax income (meaning that you won't pay taxes on this money) to be automatically deposited into your account each month. Often an employer will match a percentage of your contribution. You then generally have a choice of investments. The current maximum annual contribution is $17,000 ($22,500 if you're 50 or over). You are required to start taking annual distributions at age 70 1/2. Nonprofits and tax-exempt organizations offer similar accounts, such as a 403(b) and a 457, which have the same general characteristics.

--(SET ITAL) Traditional IRA (END ITAL)--This account is available to individuals with earned income or their spouses. The maximum yearly contribution is $5,000 ($6,000 for those 50 and over). You may get an upfront tax deduction, depending on your income and whether you are part of an employer-sponsored plan. You can only contribute to a traditional IRA up to age 70 1/2. Like a 401(k), at 70 1/2, you're required to start taking annual minimum distributions.

--(SET ITAL) SEP-IRA, SIMPLE-IRA, Individual 401(k) (END ITAL)--If you're self-employed or own a small business, you have a choice of several tax-deferred retirement accounts depending on your circumstances. Annual contribution limits vary but are generally higher than a traditional IRA.


Carrie Schwab Pomerantz

Carrie Schwab Pomerantz is a Motley Fool contributor.

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