What is a 401(k) plan and what are the advantages/disadvantages? What is the best way to save for retirement - IRA, Roth IRA, CD, mutual fund, savings bond, bond funds, life insurance?
The 401(k) is a retirement savings account offered at your workplace. You can contribute up to $17,000 in 2012 of your pay, plus you can add another $5,500 to the contribution if you are over 50. The money is taken out pre-tax and it will grow tax free up to the time you start taking distributions. When you take money out of the retirement account it is taxed as income. You have to be 59 ½ or older to start taking money from your 401(k). If you take money out earlier there is a 10 percent penalty in addition to the income tax. The government requires you to take a certain percentage out every year after you turn 70 ½.
A Roth is also a retirement savings account similar to the 401(k) with a few key differences. The money is added to the account after you have paid taxes on it. The money grows tax free and the contribution limits are the same as a 401(k). When you start taking the money out it is a tax free distribution. Because you paid taxes when you put the money in the government does not charge a tax on any distribution. You also don’t have to take any mandatory withdrawal from a Roth account.
It is important to do a retirement analysis to see what assets you have and try to estimate how much more you need to invest in order to reach your retirement goal. You may need to save more than the $17,000 allowed so you may want to set up an investment account outside of the 401(k). Because the Roth and 401(k) have tax advantages we usually suggest an individual max out those contributions before funding the outside investment account.
I would recommend a well diversified portfolio in all the investment accounts. It has been proven a well diversified portfolio will give a better return with less volatility over a long time horizon. In our accounts we hold bonds, US equities, foreign equities, commodities, real estate and alternative hedge strategies. There are many good mutual funds that you can find to get exposure to each of these areas.
Each person’s situation is unique so it is hard to give specific detailed advice without sitting down with someone and understanding their goals. From there a financial planner can put a plan together that tries to match the goal with the minimal amount of risk. To connect with a qualified financial planner, visit FPA PlannerSearch®.