Thursday, 1 May 2008

Saving for Retirement

People often ask in what order should they utilize the various retirement accounts/options.  Below is my take on the matter.

Stage 0 – Have an e-fund (at least 3 months’ expenses) in place – This should be your first priority so that when (not if) the unexpected happens, you don’t have to accrue debt.

Stage 1 – 401(k) up to the company match – This is typically the most beneficial because you get ‘free money’ (the company match) as well as tax savings.  Each dollar you put into your 401(k) reduces your taxable income, saving you between 10 and 35 cents (depending on your tax bracket) for each dollar.

Stage 2 – Traditional IRA, if you’re eligible – Depending on your AGI, you may get a full or partial tax deduction for your contributions.  There is also a saver’s credit for those deemed low-income (under $26K for singles, $39K for head of household and $52K for married filing jointly).

Stage 3 – 401(k) to the maximum ($15,500 for 2008 unless over age 50, then $20,500) – Once again, you are able to reduce your taxable income (and therefore your taxes) by contributing to your 401(k).

Stage 4 – Roth IRA if ineligible for a traditional IRA – While you won’t receive any tax deductions for your contributions, you are using after-tax dollars.  Therefore once you retire, qualified distributions are not taxed.

Stage 5 – Taxable Accounts – I only recommend utilizing taxable accounts for retirement once you have exhausted your other options.  It makes fiscal sense to take full advantage of all the tax-deferred and tax-advantaged accounts that are available to you.

Of course, one size does NOT fit all when it comes to retirement planning.  If you’re self-employed or employed by a company that does not offer a 401(k), then you will need to seek out other options but there are several to choose from.


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