401k - 100% Immediate Returns!
Guaranteed 100% return sound too good to be true, right? In fact, most organizations offer matching retirement incentives as a benefit to attract and retain employees. Historically, organizations offered pension plans. Nowadays, instead of offering pension plans, companies offer matching 401k's.
What if I am an entrepreneur or my organization does not offer a matching 401k? A Roth IRA or Traditional IRA are great options.
Establishing a 401k is one of the best investment strategies available. Company match means the employee will be matched dollar for dollar up to a certain %. For example, if the matching program states a 5% match, this would mean the employee is guaranteed to immediately double his or her money! Of course, the employee would first need to enroll in the matching program and elect to contribute 5% of his or her wages.
For simple math, if the employee has an amazing salary of $100k and contributes 5% to the 401k, the organization will also contribute 5% to the employee's 401k. This means the employee contributed $5k and the organization likewise contributed $5k to the same 401k. The employee now has $10k by only contributing $5k! Where else can someone generate an immediate 100% rate of return? Wouldn't it be foolish to only contribute 3% and get the 3% match, and then put the extra 2% savings in the bank that would generate virtually no return? Doesn't make sense. It is shocking how few people take advantage of their entire matching offering.
Any contribution to a 401k reduces your taxable income, but you will pay taxes at your ordinary tax rate upon withdrawal. The 401k contribution limit is $18k/year. For those older than 50, the investor can contribute up to $24k/year.
IRAs: Roth and Traditional
Roth IRAs are wonderful tax advantaged accounts. The investor pays the ordinary taxes now on the contributions, but any withdrawals are tax free. This means that any growth on the contributions are eligible for tax free withdrawals. Simple stated, you pay taxes now, and never get taxed again. There are certain income limit restrictions. Single filers start phasing out at annual earnings of $118k, and $186k for married filers. The individual annual contribution limit is $5.5k, and $6.5k age 50 and older.
A traditional IRA offers tax benefits now rather than later (similar tax benefits as the 401k). Any contributions you make are tax-deductible. The traditional IRA is a great option for those who are already maxing out their Roth IRA or are over the annual earnings of the Roth IRA.
I would first recommend maxing out the 401k up to the maximum company match. Remember, the company match is free guaranteed money. I would then max out the Roth IRA. It seems that taxes will only increase based on economic trends and ballooning national debt. I would rather pay taxes now, and let my money grow tax free. How often do taxes decrease over time? Rarely. Two things are certain in life, taxes and death. Just don't pay a penny more than required.
Health Savings Account (HSA)
An HSA is a tax advantaged account that allows you to save for medical expenses. No taxes are incurred on the contributions. This is not a use it or lose it program like a Flex Spending Account (FSA). Money contributed to the HSA never expires. This means that you could contribute the maximum amount for a family at $6,650 per year and the balance would continue to grow. The carryover feature makes this a better alternative to an FSA. Very few people realize that an HSA can be invested and the earnings grow tax free!
An HSA can be another form of a retirement account, but with better tax benefits! Your contributions are pre-tax or tax-deductible. All earnings, interest, and investment returns are tax-free. Basically, you don't pay any taxes on your contributions, and no taxes on your investment gains. Essentially, you are never taxed on an HSA!