Socking away money for your golden years may not be high on your list of fun ways to spend your cash, but you’d be smart to forgo a little pleasure now for a big payoff later. The money you save now will grow over the years to allow you to enjoy your retirement. Once you’re decided to save for retirement, you have to choose a savings program. An IRA and a 401(k) both can help you build a bigger nest egg, and in many cases you don’t have to choose between the two – you can have both.
An individual retirement arrangement, or IRA, is an account you set up yourself. You can choose a traditional IRA, in which you put away up to $5,000 (as of 2012) a year and pay no taxes on it until you take it out years from now. Or you can open a Roth IRA, for which you’ll pay taxes now on the money you put in but pay taxes on neither the contributions you withdraw nor the interest your account earns. You can open an IRA regardless of whether your employer offers a retirement plan.
A 401(k) is a type of retirement plan employers offer their employees. The money you contribute comes out of your paycheck before you pay tax on it, reducing your taxable income. You pay tax on the money you withdraw once you reach age 59 1/2. Your employer might match all or a portion of your 401(k) contributions up to a specified amount. So your account grows even faster with money you don’t have to contribute.
One or Both?
If you have 401(k) at work, you can still open an IRA, though all your contributions might not be tax-deductible. If you’re married and your adjusted gross income is over $110,000 -- or you're single and your AGI is over $66,000 -- you can’t deduct your contributions, but you could still contribute to a Roth IRA. If you can only afford to contribute a little money to retirement, and your employer offers a 401(k), go ahead and sign up. Regular payroll deduction makes saving a no-brainer, and you can take advantage of any free money that comes your way in the form of matching funds.
Borrowing From Your Plan
Some 401(k) plans allow you to borrow up to 50 percent of your vested account balance -- up to $50,000 -- and use it for things like a down payment on a home or paying tuition or medical bills. You don't have to pay taxes or penalties on the money you borrow, and you repay the account with interest. If you leave your job for whatever reason before you’ve paid back all the loan, you have to repay the amount owed right away or you’ll face tax penalties. You can also take money out of an IRA before you reach age 59 1/2 if you need to make a down payment on a first home or pay medical bills that are more than 7.5 percent of your adjusted gross income, or if you become disabled. You will pay taxes on any withdrawals you make from your IRA.
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