Investment Tools

Determine the Best Investment Tools for your Retirement Goals

Retirement accounts are truly great investment tools. Because of this, some people question the wisdom of saving money anywhere other than a retirement account. The benefits of retirement accounts are tax deferral and significant savings over time. On the other hand, once your money is in a retirement account it becomes hard to access. If you decide you need that money before the set time of withdrawal (age 59'), you'll get hit with heavy withdrawal penalties. This is why it's important to plan your savings strategy based on your specific life plans. In other words, figure out when you'll need your money. Despite the best-laid plans though, you may come to a point where you really must draw early from your retirement account. If so, be aware of the penalties that exist and how you might avoid them.

Diversify your savings

Instead of tying up all your money in retirement accounts, it's a good idea to keep some money in other types of accounts. This is known as diversifying your savings. By doing this, you'll have multiple ways to access money should you ever need it.

The way you diversify your savings should be dependent on your savings priorities. Say retirement is your number one priority and the only major goal you have on the horizon. In that case, you should invest significant reserves in a retirement account.

If you've got other major financial goals, take time to consider how soon you hope to accomplish them. If you think you'll need money for those goals before age 59' then you should explore other ways to invest.

Additional investment options

You're on the right track toward a sound financial future if you've got a retirement account and you regularly add money to it. The only snag you might run into is the fact that retirement accounts have caps on the amount of money you can donate each year. Ideally, this means you'll have leftover money that you can invest elsewhere.

If this is the case, you can put money in traditional savings accounts or money market funds. Be aware though that these accounts don't grow wealth as efficiently as other investment methods. On the plus side, money is much more accessible from either type of account.

Investing in stocks and bonds can give you huge returns and losses. Success in playing the stock market is greatly affected by the amount of money you invest. It's also dependent on how much time you can leave the money invested. Your level of risk tolerance also plays a role in successful stock market investments. If you can stomach high risk, you might enjoy substantial gains. Just know that you might get hit with substantial losses.

Understanding early withdrawal penalties

In the event you do need to withdraw money early from your retirement account, the best approach is to be informed about what the withdrawal will mean to your bottom line.

Because the money in your retirement account is tax-deferred, you have to pay income taxes on it when you take it out. Remember that you did not have to pay any taxes on those earnings when you initially deposited your money. Instead, the money sat in the account and grew for you over time. Now that you're ready to take it out, you have to pay the income taxes on it that never got paid in the first place.

The situation changes if you elect to take money out of your retirement account before the age of 59'. In such a case you have to pay income taxes along with early withdrawal penalties. Such penalties usually amount to 10% in federal taxes on the amount withdrawn. On top of that, you must pay whatever early withdrawal penalty your state charges.

Ways to avoid early withdrawal penalties

Fortunately, there are ways to avoid some of these early withdrawal penalties.

' Early retirement
If you start working hard and saving well at a young age, you might find that you're able to retire before age 59'. You can access your retirement money in such a case if you make equal, annual withdrawals. The amounts of these withdrawals are based on your current life expectancy.

' First time home purchase
If you're buying a home for the first time, you can make a penalty-free withdrawal from your retirement account to help pay your home expenses. However, you can only withdraw a maximum of $10,000.

' Higher education
You can also make a penalty-free withdrawal from your retirement account to fund college education expenses. Again, you have a maximum withdrawal limit of $10,000. The withdrawal amount is allowed to cover college costs for your children, grandchildren, your spouse, or for you.

' Major medical expense
If you suffer major medical expenses that amount to more than 7.5% of your income, you gain exemption from early withdrawal penalties.

' Disability
You may be exempt from withdrawal penalties under certain conditions related to a disability.

Borrowing from your retirement account

If you ever find yourself in an unexpected financial rut, you might consider borrowing against your retirement plan. Some companies allow you to do this provided you started your retirement account through them and you remain employed with them at the time of the loan. When you borrow against your own account, you are required to pay back the amount in full. The only difference between this and paying back a regular loan is that the interest payments go straight back to you. That is, they go into your account along with the payments for the amount borrowed.

Be sure to consider the tax implications before you borrow from your own account. It's wise to consult a tax advisor first. It may not always be worth the price of borrowing. The loss in money growth may not justify it.

Having a plan and being aware is the best approach

As with most things, the best approach is being informed. Take the time to think about the goals most important to you. Decide when you want to reach those goals. When you answer these questions, you'll find it much easier to decide whether and when to use the investment tools available to you.