By Carolyn Heger
When I was in high school, my grandfather frequently stressed to me that I should begin saving for my retirement early. Back then, putting money aside for me to spend when I would be in my 60s and beyond was not at the forefront of my mind. I was focused on applying to colleges at that time, not on whether I would have enough money to live comfortably once I would stop working.
Nearly six years have passed since my grandfather started giving me his retirement lectures, and I now grasp why I should kick off my retirement saving process as soon as I begin working full time next year. It’s a relatively straightforward, common-sense concept, but if you open a retirement account when you are young and immediately begin stocking money away in it, you will have more funds available when you retire than if you had started putting money aside later in your life.
Compounding lies at the root of why you should invest your first dollar for your retirement sooner rather than later. To use an example from CNN Money’s “Ultimate Guide to Retirement,” if you invest an annual amount of $3,000 in a tax-deferred retirement plan from ages 25 to 35 only, you would have more than $338,000 in your account by the time you turned 65. This scenario uses a 7 percent yearly return.
Now that you understand why it’s crucial for you to start investing for retirement early in your career, let’s take a look at some of the retirement accounts available to you.
Retirement Account Types
Traditional Individual Retirement Arrangements (IRAs): This type of retirement account limits your total annual contributions to either $5,500 ($6,500 if you are 50 or older) or your taxable income for the current year if you make less than these amounts. You are not able to regularly contribute to a traditional IRA when you reach the age of 70 and a half. Traditional IRAs are generally tax deductible, but only a smaller deduction is allowed if you or your spouse have a retirement plan through your job and if your income is higher than a certain level. The full deduction for a traditional IRA is permitted if you or your spouse do not have a retirement plan through your job. You can roll the funds in a traditional IRA over to another traditional IRA, a Roth IRA, an SEP-IRA, a 401(k) plan and a SIMPLE IRA (only after two years for SIMPLE IRAs).
Roth IRAs: The contribution limits for a Roth IRA are the same as those for a traditional IRA. However, the contributions to a Roth IRA are not tax deductible, but the distributions from a Roth IRA are tax free in some circumstances. Unlike a traditional IRA, you can contribute regularly to a Roth IRA past the age of 70 and a half. You can roll the funds in a Roth IRA over to another Roth IRA, but you cannot roll over from a Roth IRA to a traditional IRA, a SIMPLE IRA, an SEP-IRA or a 401(k) plan.
401(k) Plans: 401(k) plans are profit-sharing plans that permit employees to set aside a portion of their wages in an individual retirement account. Employers are able to make contributions to employees’ 401(k) accounts, and distributions from your account can be included in your taxable income at retirement. You can roll the funds in a 401(k) plan over to another 401(k) plan, a traditional IRA, a Roth IRA, an SEP-IRA plan or a SIMPLE IRA plan (only after two years for SIMPLE IRAs).
SIMPLE IRA Plans: “SIMPLE” stands for “Savings Incentive Match Plan for Employees,” and a SIMPLE IRA gives employees and employers the ability to make contributions to traditional IRAs established for employees. Small businesses can use SIMPLE IRA plans as an initial way to offer retirement savings plans to their employees. You can roll the funds in a SIMPLE IRA plan over to another SIMPLE IRA plan, but you must wait two years before rolling a SIMPLE IRA plan over to a traditional IRA, a Roth IRA, a 401(k) plan or an SEP-IRA.
SEP-IRA Plans: “SEP” stands for “Simplified Employee Pension Plan,” and SEP-IRA plans give employers the ability to make contributions to traditional IRAs established for employees. Companies of any size, including people who are self employed, can set up an SEP-IRA plan. You can roll funds from an SEP-IRA over to another SEP-IRA, a traditional IRA, a Roth IRA, a 401(k) plan or a SIMPLE IRA (only after two years for SIMPLE IRAs).
There are other types of retirement plans in addition to the ones I have listed above, but the ones I have detailed are some of the most common. To learn more about these plans and others not listed in this post, visit the “Types of Retirement Plans” webpage on the IRS’ website: https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans
Heger is a senior majoring in business and journalism at the University of Missouri.