Investing your money is a tried and true approach to building a life worth enjoying after retirement. But with so many options available, you may feel stuck.
Let's break down various investment avenues that can help you save for the future.
Retirement plans
401(k)
A 401(k) is an employee-sponsored retirement plan that allows eligible employees to save for retirement on a tax-deferred basis. Tax-deferred means you pay taxes later, rather than right now. With a 401(k), you can decide how much money you want taken out of your paycheck to go into your plan (as long as those contributions fall within IRS limits). Some employers even offer to match all contributions, which is basically free money with a guaranteed return.
401(k)s can help you: Save for retirement.
Pros of a 401(k): Contributions are tax-free and there is usually no minimum amount.
Cons of a 401(k): Fewer investment options than other retirement accounts, as well as high account fees and early withdrawal penalties.
A 401(k) is right for you if: You are employed with a W-2. Bonus points if your employer offers to match contributions.
The best time to invest in a 401(k): As soon as you start working at your first job.
Traditional IRAs
Traditional IRAs are retirement accounts that offer most individuals an upfront tax break.
Goal: Save for retirement.
Pros: Contributions and investment earnings aren’t taxed. Contributions may be tax-deductible and significantly lower your taxable income. There are no income limits for contributors.
Cons: Withdrawals during retirement are taxed at your tax rate during that time. At age 70½, you are no longer allowed to make contributions. Also at age 70½, you must begin taking distributions even if you are still employed (and therefore, possibly in a high tax bracket).
Best choice for: Individuals who are currently in a higher tax bracket than what they anticipate being in during retirement and employees who don’t have access to a workplace-sponsored retirement plan.
Best age to invest: Age 18, or the minimum age allowed in your state.
Roth IRAs
Roth IRAs are retirement plans that do not allow for tax-deductible contributions, but feature tax-free withdrawals during retirement.
Goal: Save for retirement.
Pros: Withdrawals are tax-free. There is no age limit for making contributions.
Cons: Contributions and growth are both taxed and are not tax-deductible. There are also income limits for eligible contributors.
Best choice for: Individuals who anticipate being in a higher tax bracket during retirement and individuals who may need to access some of their savings before they retire.
Best age to invest: Age 18, or the minimum age allowed in your state.
529 plans
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. The SECURE Act, passed in 2019, expanded tax-free 529 withdrawals to include registered apprenticeship program expenses and up to $10,000 in student loan debt repayment for account beneficiaries and their siblings.
There are two primary types of 529 plans:
529 savings plans
529 savings plans offer a place for tuition savings to grow, tax-deferred. The money in the account is usually invested in a mutual fund.
Goal: Save up for tuition costs and related expenses, like room and board.
Pros: Contributions and growth are tax-free. Withdrawals are also tax-free, as long as they’re used for qualified education expenses. Can be used for K-12.
Cons: May have high fees and can impact the beneficiary’s eligibility to receive financial aid for college.
Best choice for: Parents looking for a safe investment for their child’s college tuition.
529 prepaid tuition plans
529 prepaid tuition plans allow the account holder to save for future tuition payments.
Goal: Prepay tuition costs at designated universities and colleges.
Pros: Lock in lower tuition rates. Make high tuition payments more manageable by spreading them over a number of years.
Cons: May have high fees and can impact the beneficiary’s eligibility to receive financial aid for college. Tuition payments are only accepted by a limited number of states and specific higher education institutions. Can only be used for tuition expenses.
Best choice for: Parents of students who know which college they will be attending and want to lock in lower tuition rates.
Best age to invest: It’s best to open any kind of 529 as soon as the child is born.
Annuities
An annuity is a contract between a contract holder, or annuitant and an insurance company. The contract stipulates that the insurer promises to pay the annuitant a predetermined amount of money on a periodic basis for a specified period, in exchange for regular contributions.
Many people purchase annuities to serve as retirement-income insurance, which guarantees them a regular income stream even after they’ve left the workforce, often for the rest of their life.
There are two primary categories of annuities:
Immediate annuities
Require the annuitant to give the insurance company a lump sum immediately and then begin receiving payments right away. The payment amount may be fixed or variable.
Deferred annuities
Allow the annuitant to make contributions throughout their working life which can be converted into an income stream when the annuitant reaches retirement. They can also be purchased with a lump sum.
Within these broad categories, there are several types of annuities from which to choose:
- Fixed annuity: Provides a specific amount of money every month for the rest of the annuitant’s life, or for the period of time chosen, regardless of how the annuity performs.
- Indexed annuity: Blends the features of fixed annuities with the potential for additional growth, depending on how the markets perform. The annuitant is guaranteed a minimum return along with a return that is directly linked to any rise in the relevant market index.
- Variable annuity: Provides a return based on the performance of a portfolio of mutual funds that the annuitant has selected. The insurance company may also guarantee a minimum income stream if stipulated in the contract.
While each specific annuity will have its own pros and cons, all annuities share commonalities:
While each specific annuity will have its own pros and cons, all annuities share commonalities:
Goal: To guarantee a regular income stream even after retirement.
Pros: Generally, during the accumulation phase of an annuity contract, earnings grow tax-deferred. Withdrawals are taxed at the same tax rate as the annuitant’s income. Contributions to annuities funded through an IRA may be tax-deductible.
Cons: May have high fees. There is generally a minimum age for allowable withdrawals without penalty.
Best choice for: Immediate annuities can be a good choice for individuals who have had a one-time windfall, or who are close to retirement and have significant retirement savings they’d like to invest. All annuities can be a beneficial addition to a retirement plan, especially if the annuitant is afraid they will outlive their retirement savings.
Best age to invest: In general, the best age range for purchasing annuities is between 40-70
Life insurance
Life insurance is an agreement between a policy holder and an insurance provider that the insurer will pay a sum of money to a designated beneficiary when the insured passes on, in exchange for monthly premiums.
Goal: Ensure that one’s family will be provided for after their passing. The payout can also be used to cover funeral expenses and related costs, and to pay off any outstanding debts the policyholder may have had.
Best choice for: Anyone looking to secure the financial future of their children, spouse and family members.
Best age to invest: Individuals in their 20s and 30s will likely get the best rates on a life insurance policy.
There are two primary kinds of life insurance:
Term life insurance
Covers the insured for a set term, generally between 10 and 30 years. The benefit is paid out only if the insured passes away during the term.
Pros: Cheaper premiums and more flexibility.
Cons: No cash value; may not serve its purpose if the policy holder outlives the term.
Permanent life insurance
Covers the insured for life as long as the premiums are paid. Some permanent life insurance policies also allow the policyholder to accumulate a cash value.
Pros: Tax-deferred growth, lifetime coverage and cash value for loans.
Cons: Costly premiums and less flexibility.