A retirement plan is an investment account designed to encourage you to save money for retirement by providing special tax benefits. The plans are open only to account owners (called participants) who meet certain qualifications based on income and other factors. There are dozens of types of retirement plans available to US workers but over the next few weeks, I’ll cover:
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- Traditional Individual Retirement Accounts (IRAs)
- Roth IRAs
- SEP IRAs
- SIMPLE IRAs
How Retirement Plans Work
Retirement plan accounts are like regular investment accounts, but with a few twists. Here’s how they work:
- Set up an account: You establish a retirement plan account through your employer, a bank, a financial services firm, or an … my personal favorite … a discount online brokerage like Scottrade , E*Trade , or Charles Schwab’s optionesXpress .
- Contribute money to the account: Depending on the plan, you can contribute by deducting money from your paycheck at each pay period or by depositing money from your savings into your retirement account whenever you choose. The amounts you can contribute depend on several factors, including the plan’s contribution limits and your income.
- Invest the money in your account: Most plans allow you to choose among various investment options, such as stocks, bonds, and mutual funds.
- Sell your investments and withdraw money: Though you can withdraw money from a retirement account at any time, for most plans you’ll incur a 10% penalty for withdrawing money before age 59 1/2, unless you qualify for certain exemptions. Depending on the type of plan you have, you may or may not owe taxes at the time of withdrawal on gains (profits) you’ve earned from your investments in the account. Though early withdrawals may be penalized, you can buy and sell investments within the account at any time.
Why Invest in a personal Retirement Plan?
Regardless of your age or income, investing in retirement plans is a great idea. Retirement plans offer tax advantages, encourage financial discipline, and in many cases make you eligible for employer contributions to your savings.