Retirement Fund: Money Or Investment?

Retirement planning is an important aspect of personal finance, and there are various options available to individuals looking to save for their retirement. These include tax-advantaged retirement accounts such as 401(k)s and IRAs, regular investment accounts, and employer-sponsored plans. When investing for retirement, individuals typically have three main options: utilizing an employer-provided retirement account, opening a personal tax-advantaged retirement account, or investing through a regular investment account.

Retirement accounts can be a great way to save for the future, offering tax benefits and, in some cases, employer matching contributions. However, it is important to carefully consider the different types of accounts and investments available, as well as one's financial goals, risk tolerance, and time horizon, to make informed decisions about retirement planning.

Retirement accounts are not investments in themselves

Retirement accounts are a place to hold your investments. There are many types of investments to consider, including mutual funds, exchange-traded funds (ETFs), individual stocks, bonds, and certificates of deposit (CDs). Mutual funds and ETFs are popular choices because they offer diversification and professional management.

When choosing investments for your retirement account, it's important to consider your asset mix, which refers to the balance of stocks, bonds, and cash investments in your portfolio. As you get closer to retirement, it's generally recommended to lower your risk of losses by investing in less risky assets while still earning more than the rate of inflation.

Retirement accounts can also provide tax advantages. For example, 401(k)s and IRAs offer tax-deferred or tax-free growth, making them ideal tools for retirement savings. Traditional accounts may allow you to deduct contributions from your taxes now, while Roth accounts allow you to invest with money you've already paid taxes on, and withdrawals in retirement are tax-free.

You need to select investments to buy with your cash

Simply adding money to a retirement account is not the same as investing it. If you have a retirement account, you are already on the path to setting yourself up for financial success later in life. However, you need to select investments to buy with your cash.

An IRA or 401(k) is simply a vehicle, not an investment in itself. If you don't purchase assets with your contributions that align with your financial goals, your money won't grow and may even lose value over time due to inflation.

Research by Vanguard found that 28% of investors who rolled over funds into their IRAs from a different account, such as a previous employer's 401(k), still had those assets in cash after a year. That number jumped to 55% for investors who made direct contributions to their IRAs.

The Vanguard report also found that rollovers that are in cash after a year are likely to remain in cash seven years later. Since the amount of time your money is in the market is generally more important than the amount you contribute, investors who leave their funds in cash are potentially missing out on substantial gains.

If you have an employer-sponsored 401(k), you probably had the option to select your portfolio when you set up contributions. But if it's been a while since you signed up for your retirement plan, you should log into your account to make sure.

If you contribute independently to a Roth or traditional IRA or another type of retirement plan, or if you've rolled over funds from an old employer's plan, you should check to ensure you've actually selected and purchased investments. If your money is currently held in a cash or money market account or a settlement fund rather than in mutual funds, bonds, or other investments, do some research or consult a financial advisor to determine your risk level and select a portfolio as soon as possible.

• Target-date funds: These funds automatically adjust their asset allocation over time based on a selected target date for retirement. They are a low-maintenance way to maintain an appropriate asset allocation.
• Mutual funds: Actively managed by professional fund managers, mutual funds involve analysts and portfolio managers researching, analyzing, and selecting stocks that are expected to outperform. Passively managed funds, or index funds, have gained traction for their lower costs and ease of ownership.
• Exchange-traded funds (ETFs): ETFs are similar to mutual funds but can be traded throughout the day on exchanges like individual stocks and bonds. They often have lower share prices than comparable mutual funds, making them more accessible to investors.
• Individual stocks and bonds: Some investors prefer to research and purchase shares of individual stocks and bonds to build a diversified portfolio. This approach can be riskier and requires more knowledge and investment.
• Annuities: Purchasing an annuity shifts the risk of outliving your assets to an insurance company, which guarantees to pay an income stream for life. However, annuities can be costly, so it's essential to consider your needs and choose one with only the features you require.
• Robo-advisors: If you're wary of handling investment choices on your own, consider using a robo-advisor. These low-cost services use computer models and algorithms to customize investments for your portfolio.

IRAs and 401(k)s are great deals because money grows tax-free

IRAs and 401(k)s are great options for retirement savings as they offer several benefits, including tax advantages. These accounts are designed to help individuals set themselves up for financial success in the future, and one of their most significant advantages is that the money in these accounts grows tax-free.

With a traditional 401(k), individuals can contribute a percentage of their salary on a pre-tax basis, meaning their taxable income is reduced by the contribution amount for that year. For example, if an individual earns a $50,000 salary and contributes $10,000 to their 401(k), their taxable income for the year would only be $40,000. This provides a valuable tax advantage, especially for those in higher tax brackets. Additionally, the earnings in a 401(k) also grow tax-deferred, meaning individuals won't pay taxes on dividends and capital gains until they start making withdrawals during retirement.

Similarly, IRAs offer tax benefits that allow money to grow tax-free. With a traditional IRA, contributions may be tax-deductible, reducing an individual's taxable income for the year. On the other hand, a Roth IRA is funded with after-tax dollars, but the trade-off is that qualified distributions are tax-free in retirement. This makes it an attractive option for those who don't mind giving up the immediate tax deduction in exchange for tax-free growth and withdrawals.

It's important to note that while IRAs and 401(k)s offer tax advantages, there are also restrictions and penalties for early withdrawals before the age of 59 1/2. Additionally, individuals need to be mindful of contribution limits for these accounts, which change periodically.

In summary, IRAs and 401(k)s are great deals for retirement savings because they provide tax benefits that allow money to grow tax-free. By taking advantage of these accounts, individuals can maximize their savings and benefit from the power of compound interest over time, setting themselves up for a more comfortable retirement.

There are three main options for where to put your retirement money

An employer-sponsored retirement account

These include 401(k), 403(b), or 457(b) plans, and pension plans. These plans are a great deal because the money grows tax-free until you withdraw it during retirement. Depending on whether you choose a traditional or Roth option, you can escape taxes on either the money you put into the plan or the money you withdraw. Many employers match a percentage of your contributions, providing an immediate return on your investment.

A tax-advantaged retirement account of your own

This includes Individual Retirement Accounts (IRAs), which offer similar tax breaks to 401(k)s, with some differences in eligibility rules. IRAs have annual contribution limits and are available to anyone with earned income. Roth IRAs provide tax-free withdrawals in retirement.

A regular investment account without tax advantages

This option does not have the tax benefits of the first two options and has limits on how much money can be contributed annually. However, if you have already maximized your contributions to tax-favored plans and want to save more for retirement, a regular investment account is a viable choice.

Robo-advisors can help you invest for retirement

Robo-advisors are increasingly popular as a low-cost way to invest for retirement. They can help you build an investment portfolio based on your needs, such as your risk tolerance and when you want to retire.

Robo-advisors are automated advisors that use computer models and algorithms to help you invest. They are programmed to do what a human financial advisor does, but at a much lower cost. They can select investments that meet your needs, such as short-term or long-term financial goals.

• Low cost: Robo-advisors typically charge lower fees than traditional financial advisors, which can result in higher long-term returns for investors.
• Customized portfolios: Robo-advisors use your financial goals, risk tolerance, income, and timeline to construct a portfolio of funds that meets your needs.
• Tax advantages: Many robo-advisors offer tax-loss harvesting, which can help reduce your taxes and boost your long-term gains.
• Ease of use: Robo-advisors are easy to set up and use, and you can add money to your investments over time.
• Human advisor access: Some robo-advisors give you access to human advisors for additional support and advice.

• Select a robo-advisor that fits your needs and offers the features you want, such as tax-loss harvesting or automatic portfolio rebalancing.
• Fill out an information sheet and risk questionnaire to provide information about your financial goals and risk tolerance.
• Determine how much you can invest based on your goals and the robo-advisor's recommendations.
• Deposit money regularly into your investment account to take advantage of dollar-cost averaging.
• Retire comfortably, knowing that you have made informed investment decisions with the help of a robo-advisor.

Robo-advisors can be a great tool to help you invest for retirement, offering low-cost, customized investment portfolios and tax advantages. By following the steps outlined above, you can get started on your way to a secure financial future.

Frequently asked questions