This article is a guest post from Tyler Landes, founder of Tandem Guidance. Tyler and I became friends after meeting at the XY Planning Network conference, and I asked him to write some thoughts on the details of retirement planning as a guest topic for this site.
IRA, SEP, 401(k)… planning for retirement can make you feel like you’re swimming through a big bowl of alphabet soup. To make it through, here’s your guide to understanding what’s what.
Most of us think we’re too busy, too poor, or too young to start thinking about retirement planning. But no matter where you fall on the spectrum of age, income, or readiness, the time to start planning for retirement is now.
That’s because the sooner you start, the sooner you can start taking advantage of the wonderful compounding magic that comes with investing early. But how to get started? There’s a virtual alphabet soup of retirement products, which means taking that first step is often the hardest.
To help with that, here’s a quick explanation of the most common retirement products you’ll most likely encounter when you’re trying to set up a plan for your golden years.
The Old Standard: The Individual Retirement Account (IRA)
If you’ve never heard of an IRA, then it’s time to learn about them. It’s an investment account that you open up through a financial institution, who invests your money so it grows tax-free or on a tax-deferred basis.
There are two types of IRAs:
- Roth IRA.You contribute to your account with money that’s already been taxed. That way, when your retired self withdraws it later on down the road, there won’t be any taxes on it. In the meantime, the money you make on the investments grows tax-free, and is still tax-free when you withdraw it.
- Traditional IRA.Here, you contribute money but when you withdraw it during retirement, you’ll be paying income taxes on those withdrawals. Why would anyone choose a Traditional IRA? Because those contributions may be deducted on your income tax return, thereby saving you money right now on taxes.
The Self-Employed Standard: Simplified Employee Pensions (SEPs)
A SEP has higher contribution limits than an IRA (which for 2015 were $5,500). You can sock away as much as 25% of your net earnings into an SEP, so for super-savers, SEPs are a good option.
SEPs are for business owners, and for those in particular who have no employees, they’re very popular.
The Company Standard: 401(k)
401(k)s are common in companies, but the self-employed use them, too. These also allow 25% of your earnings, and you can defer up to $18,000 of your annual salary.
Whichever option you end up choosing, know this: it’s better to start now than to let any more time go by. If you still need help choosing, consult a financial advisor, who can go into more detail on your options.
About the Author: Tyler Landes is the founder of Tandem Financial Guidance, a fee-only financial planning firm in Kansas City, Missouri.