Saving for your retirement early offers you more time to contribute and grow your investments.
The four most common types of retirement funds are:
Traditional 401(k)s: 401(k)s and their variants are retirement plans sponsored by employers. Both you and your employer can contribute pre-tax funds. You can then write the amount off on your tax returns to lower your annual gross income and, therefore, tax bracket. But when you want to withdraw the money, your total investment (including any interest earned) will be taxed at your current tax bracket.
Roth 401(k)s: Roth 401(k)s are also company-sponsored retirement plans to which both you and your employee can contribute funds. But, unlike Traditional 401(k)s, these funds are already taxed. When you want to withdraw your money, you can take it out tax-free, but you won’t be able to write off your yearly contributions on your tax returns in the meantime.
Traditional IRAs: IRAs are individual retirement accounts to help individuals, freelancers and sole employers save for retirement. Like Traditional 401(k)s, they have yearly tax benefits.
Roth IRAs: Roth IRAs are also individual retirement accounts to help individuals, freelancers and sole employers save for retirement. But, like Roth 401(k)s, the funds are taxed at contribution instead of at withdrawal.
There are also other types of IRA plans, such as Spousal IRAs for spouses, Rollover IRAs for anyone rolling over funds from previous ones, Simplified Employee Pension (SEP) IRAs for small-business owners, and Savings Incentive Match for Employees (SIMPLE) IRAs that are similar to 401(k)s for employees.
All types of accounts have different contribution caps and rules for when you’re allowed to (and have to) withdraw your funds.