It is important to distinguish between two types of IRAs, the traditional IRA and the Roth IRA. Here’s how they work:

• The traditional IRA gives you an immediate tax deduction and the ability to avoid paying taxes on the growth in your account until you withdraw the money someday. The IRA shelters your money, even after you retire. The earnings continue to compound and escape taxation until you’re ready to make withdrawals. Assuming you wait until age 59 1/2 to withdraw money or meet other conditions, you won’t pay the 10 percent penalty that applies to premature withdrawals.

• The Roth IRA came into existence years after the traditional IRA. Although the Roth IRA offers no immediate tax deduction, you may be entitled to make tax-free withdrawals someday if you follow the rules. That’s a nice option if your account grows over the years with additional deposits and earnings on your investment.

Your income determines whether you are eligible for a traditional or a Roth IRA.

401(k)s and Other Employer-Sponsored Retirement Accounts

The days of traditional pensions are gone. The traditional pension, otherwise known as a defined benefit plan, offered employees a specified payment after the worker attained milestones based on years of service, salary and age.

Today, most workers are eligible to participate in defined contribution plans that specify what the employee may contribute to the company’s qualified retirement savings plan. There are no guarantees as to what workers will receive when they reach retirement age. Employees’ nest eggs are based on how much they contributed and how well their investments performed.

When you enter the workforce, here are a few of the plans that are typically offered:

• 401(k) retirement savings plan – The 401(k) is the most common retirement savings plan offered by companies. The plan permits employees to make contributions prior to taxes. The employer usually matches some or all of your contribution. For example, if you contribute $100 per month to a 401(k), your employer might add $50 to your account. All of the money in your 401(k) is shielded from taxes until you make withdrawals.
• 403(b) retirement savings plan – The 403(b) plan is similar to the 401(k), but is offered to public school employees and certain tax-exempt organizations.
• 457 plan – The 457 plan is available to employees in the public sector.

The names of these plans aren’t catchy. They take their names from the tax code section that authorizes them.

The employer’s contribution is not yours to keep until you are with the company for a specified period of time. At that point in time, you are vested as to the some or all of the employer’s contributions. With some companies, the vesting period can be a matter of years. With others, you might be vested in your employer's contributions right away or within a matter of days.

Some companies offer 401(k) plans where the employer’s contribution is vested sooner than required by these vesting schedules.

Tax Considerations >>