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401(k), Roth or SEP: Which Retirement Plan Is Best for You?

John Divine

If you're worrying about what type of retirement plan is best for you, you're not alone. Pension plans are becoming less and less common, and Social Security as it stands today is essentially doomed to fail unless it undergoes some major systemic changes.

With recent studies showing that the median working-age American couple has just $5,000 saved for retirement, it's essential that we figure out better ways to save for our golden years. Fortunately, there are several retirement plan options available to individual investors.

Of course, everybody's situation is different. Always speak to a certified tax professional or retirement planner to make sure you're doing what's best for you.

[Read: The Best Ways to Invest $5,000.]

Employer plans. Employer plans come in many shapes and sizes, and the majority of American taxpayers can take advantage of these vehicles.

"The 401(k) is offered by for-profit employers, the 403(b) is offered by not-for-profit organizations, and the 457 plans are offered by governmental entities," says Michael Zovistoski, partner and co-founder of the wealth management practice UHY Advisors in New York. "All of these plans allow the individual to make contributions from their paychecks."

That's an important feature for -- believe it or not -- psychological reasons. If you don't see your contribution getting deducted, well, it doesn't seem like it's getting deducted. You see the same paycheck every two weeks, so it doesn't really feel like you're contributing.

The most important thing you should know about 401(k) plans? Just do them.

"If you are eligible for this type of plan, you should contribute," says Robert A. Massa, director of retirement at Ascende, an employee benefits consulting firm in Houston. "Since the large majority of employers offer an employer match, contributing at least enough to get the maximum employer match is simply common sense. By failing to contribute enough to get the match, you are giving up a tax-deferred raise, and everybody wants a raise."

IRAs. IRA stands for individual retirement account. Essentially, anyone who doesn't have an employer-sponsored plan should definitely be contributing to one of these. Within IRAs, there are three major types, although there are roughly a dozen overall.

Traditional IRAs "are great for people that either don't have a retirement plan, or have maxed out their employer-provided plan, such as a 401(k), already," Massa says.

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Lew Baker, principal at Baker Schilling Smith Wealth Strategies in the District of Columbia, says traditional IRA contributions can be made in pre-tax dollars and can be deducted from your adjusted gross income for tax purposes. This typically makes sense for wealthier people, or those closer to retirement.

They are "best for people who have a shorter time horizon until retirement, and are also in a high tax bracket, as the current year tax-deduction can be very important," Baker says.

Roth contributions, however, are made in post-tax dollars and can't be counted as a deduction on your taxes. With traditional IRAs, you get hit with taxes when you finally make withdrawals on the back end, when you need the money. Not with Roths: You pay taxes going in, and pay nothing coming out.

Conversely, Baker says that Roths are "best for younger people with a long time until expected retirement age and currently in a low tax bracket," especially since you'll likely be in a higher tax bracket later in life -- when you'd be forced to pay taxes on your withdrawal in a traditional IRA.

The SEP IRA is for self-employed workers. Zovistoski calls it "an inexpensive way for the self-employed individual to save for retirement."

Remember though, there are obscure rules surrounding most retirement vehicles, one of which is the maximum contribution.

"Traditional and Roth IRAs have contribution limits of $5,500 for individuals under 50 years of age and $6,500 for those over 50," Baker says. "Traditional 401k/403b plans allow for $18,000 and $24,000, respectively."

There are also early withdrawal penalties, and even requirements for when you must start taking withdrawals, depending on the plan. Again, check with a tax professional for the specifics in your situation.

Other options. The truth is, there are too many ways to save and invest for retirement to list them all in thorough detail here. But it's important to understand that 401(k) plans and IRAs aren't the only vehicles you have at your fingertips.

Annuities are another great option for retirement investors: You plop down a lump sum, fork it over to the annuity company, oftentimes an insurance company, and in exchange you receive a stream of future annual payments. Anyone who wants guaranteed cash flows late in life should give these a look.

Annuities are purchased with after-tax dollars. "Once distributions occur during retirement, the principal will be tax-free as a return of capital and the earnings would be taxable," Zovistoski says. "Annuities will typically offer certain guarantees in relation to death benefits and/or returns relating to distribution."

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Other IRA plans and health savings accounts also have various tax and savings benefits. And of course, there's always the option of opening plain vanilla investing accounts of your own, which won't be subject to any contribution, withdrawal, or investment limitations.



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