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|This article is a part of Wikinvest's Personal Finance section and Guide to Investing. Please contribute or edit to improve it.|
A 401(k) is set up through your place of work and allows a specific dollar amount to be placed in the account yearly that is tax-free. What this means is that you will not have to pay taxes on any money placed in a 401(k) during the year, as long as you qualify by not exceeding the maximum allowable income. The maximum amount you can put in a traditional 401(k) is $17,000 for the year (as of this writing), although this amount varies, depending on the employer. The exception for depositing more than $17,000 is if you are taking advantage of the "catch up" allowed by law. If 50 or over, you can put in an additional $5,000 each year to catch up on saving for retirement.
Some employers provide contributions to the 401(k), once the employee is vested. Now, that's an offer that any money-savvy person simply should not refuse. Even if you don't stay long enough to get the employer contributions, the 401(k) is still a fantastic way to save. Be sure you contribute enough to receive the maximum contribution amount from your employer. After all, that's "free" money they are willing to give you, as long as you contribute up to the amount they require. The contributions are taken out of your paycheck, so saving is convenient and automatic.
If you withdraw your 401(k) funds before the age of 59-1/2, you'll have to pay a 10% fee on the amount withdrawn. Although there are exceptions to this rule, they are few and very specific. Upon turning 59-1/2, you can withdraw 401(k) funds without paying any penalty. At 70-1/2 years, you must begin withdrawing some money from the 401(k).
To set up a traditional 401(k) account, see the Benefits Manager at your workplace. For more specific information regarding traditional 401(k) accounts, see the Money/CNN website.
With a traditional IRA, your tax advantage is upfront, you deduct the taxes you paid on the money you put in the account (as long as you didn't deposit more than the maximum allowable amount of $5,000 yearly). However, when you draw the money out years later during retirement, you must pay taxes on it. Those over 50 can contribute an additional $1,000 yearly to catch up, so that's a total contribution of $6,000 each year.
The traditional IRA can be a bit tricky when it comes to withdrawing funds. In fact, you are required to withdraw minimum amounts from a traditional IRA after you turn 70-1/2 years of age, or pay a penalty for not doing so.
To open a traditional IRA, you may go to your banker or a stock broker at a financial institution for assistance.
Canadian Investment Accounts