Understanding Your Options

Want to know another reason you’re smart to start saving for retirement now? Preparing for retirement is so important that the federal government provides tax incentives for those who take advantage of retirement savings accounts.

One way to take advantage is through an employer-sponsored retirement plan, such as a 401(k) or thrift savings plan (TSP), if offered by your employer. These plans are designed to put your retirement savings on autopilot with automatic contributions and carefully selected investment options designed to provide asset allocation and diversification. If your employer offers a plan, then all you need to do is sign up, decide how much to contribute each paycheck and choose which investments you’d like.

Are you more of a do-it-yourselfer? You can also take advantage of individual retirement accounts (IRAs). IRAs are available to just about anyone with earned income. You can set up an IRA with Navy Federal Credit Union and other financial institutions.

Employer-Sponsored Retirement Plans

As the name suggests, employer-sponsored retirement plans are offered by employers (the plan sponsors) to their workers. There are several different types of plans. The 401(k) is the most well-known. Others include:

403(b) plans—offered by school districts and some hospitals 

457 plans—offered by state and local governments 

Thrift savings plans (TSPs)—offered to federal government employees and uniformed servicemembers Although the plans differ in their rules, they have a few things in common. Plan participants (eligible employees) can usually make automatic, pre-tax contributions to plan accounts from their paychecks, up to annual limits. (Note that Roth accounts don't allow pre-tax contributions, but we’ll discuss that later.) In some cases, employers may offer a matching contribution. Participants may choose from a range of investments. Finally, all have rules about when and how you can take the money out of the account.

Traditional and Roth Employer-Sponsored Plans

Employers may offer 401(k), 403(b) and 457 plans, plus TSPs in both the traditional form and as Roth accounts. For simplicity’s sake, we’ll use traditional and Roth 401(k)s as examples.

The main difference between traditional and Roth plans is the tax treatment of contributions (the money going in) and distributions (the money coming out at retirement).

With a traditional 401(k), contributions to the account are made on a pre-tax basis. Distributions (withdrawals) from the account during retirement are taxed at whatever your ordinary income tax bracket is at that time.1

With a Roth 401(k), contributions are made after taxes. However, distributions at retirement are untaxed.2So which is better? It really depends on your current taxable income and the tax bracket you expect to be in when you retire. Many people prefer to have the tax break during their earning years and opt for the traditional plan. They expect their tax bracket may be lower once they retire and no longer have a steady paycheck. Those who anticipate a higher tax bracket in retirement may be more inclined to choose a Roth 401(k). Some people opt to split their contributions between both options.
 

 

401(k)

Roth 401(k)

Contributions

Before-tax

After-tax

Tax Advantages

With pre-tax contributions, you don’t pay federal income tax on the amount contributed to the account. Plus, earnings grow tax-deferred.

Earnings grow tax-deferred. At distribution, no federal taxes due, provided certain qualifications met.3

Income Limits3

$265,000
Any income above this limit may not be considered when determining employee contributions and matching contributions.

$265,000
Any income above this limit may not be considered when determining employee contributions and matching contributions.

Contribution Limits3

$18,000
Ages 50 and older eligible to contribute an additional $6,000.

$18,000
Ages 50 and older eligible to contribute an additional $6,000.

Distributions (Withdrawals)

Taxed at ordinary income tax rates. Required minimum distributions must begin by April 1 after the year you turn age 70½; otherwise, penalties may apply.4

Withdrawals of contributions available when permitted by the plan. Assets subject to required minimum distribution rules.4

 

Your Own Plan

Traditional and Roth IRAs

Individual retirement accounts (IRAs) are set up by an individual, rather than through an employer (with the exception of SEP IRAs). Contributions to a traditional IRA may be tax-deductible, depending on your income and whether you have an employer-sponsored plan at work. Contributions to a Roth IRA are never tax-deductible.
 

 

(IRA) Individual Retirement Account

Roth IRA

Contributions

Tax-deductible (if qualified)

After-tax

Tax Advantages

Contributions may be tax-deductible.4 Earnings grow tax-deferred.

Earnings grow tax-deferred. At distribution, no federal taxes due, provided certain qualifications met.4

Income Limits3

None (but ability to deduct contributions potentially limited if you/your spouse participate in an employer-sponsored retirement plan).

Modified adjusted gross income must be below certain limits, depending on filing status.

Contribution Limits3

$5,500 ($6,500 if age 50 or older)3


$5,500 ($6,500 if age 50 or older)3
 

Distribution (Withdrawals)

Taxed at ordinary income tax rates. Required minimum distributions must begin by April 1 after the year you turn age 70½; otherwise, penalties will apply.4

Withdrawals of contributions available anytime, tax- and penalty-free. Withdrawal of contributions plus earnings at retirement tax- and penalty-free, provided certain conditions met. No requirement to take distributions during original account holder’s lifetime.4

 

Why Not Both An Employer-Sponsored and Your Own Plan?

It’s a smart move to take advantage of an employer-sponsored plan—especially if your employer offers a matching contribution. In that case, try to contribute at least enough to get the maximum possible matching amount. Another advantage of an employer-sponsored plan is the contribution limits are much higher than those of IRAs, so you can save more for retirement than if you had an IRA alone.

Even if you have an employer-sponsored plan, other reasons to open and contribute to an IRA are:

You’ve maxed out contributions to your employer-sponsored plan and want to save even more on a tax-advantaged basis.

Your employer offers a traditional but not a Roth plan, and you’d like to open a Roth IRA for tax diversification.

Your employer-sponsored plan has limited investment choices, and you’d like the greater investment flexibility of an IRA.

You’re the non-income-earning spouse of an income earner and would like to start saving for your own retirement.

1Taxes will be due at ordinary income tax rates upon withdrawal from a traditional employer-sponsored retirement plan. Premature withdrawals (generally, those made before age 59½) may be subject to a 10 percent tax penalty, too (does not apply to 457 plans).

2Withdrawals are tax-free at retirement if the account holder is at least age 59½ and has held the account for at least 5 years. Premature withdrawals are subject to ordinary income tax and a 10 percent tax penalty.

32016 limits.

4Consult with your tax advisor for details.
 

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