Not all investment strategies are created equal. Whether you’re approaching your 30th birthday or 80th, every income-earning adult should have a solid savings plan in place that aligns with their life goals.

Buzzwords like “tax deductible” and “risk analysis” from your financial advisor are more than just industry jargon. Choosing the right plan could potentially be the determining factor in penny-pinching during retirement versus carrying out long-awaited dreams.

Get a breakdown of these three common investment strategies to match your finances to your endgame lifestyle. Remember, all account types have nuances, and you should speak with a CERTIFIED FINANCIAL PLANNER™ before adjusting your strategy.

401(k)

A 401(k) is an employer-sponsored retirement account, great for those getting their feet wet in the investing world. You can’t customize your strategy in depth, however this financial resource can play an important role in providing income later in life. Many employers even match what you contribute up to a certain percentage of your salary, which in some cases can effectively double long-term savings.

Another perk of a 401(k) is that if you’re temporarily strapped for cash, this is the only plan where you could potentially withdraw funds before reaching age 55 without penalties.

It may sting to see a percentage shaved off your paycheck at first, but remember, the money you set aside could be more than you’d receive after taxes — the income you’re taxed on is lowered by the amount you contribute to your plan.

Young professionals could get away with a small contribution, say, 2% to 7%. But if you’re late to the game, you can strive to make up for time lost with a much higher contribution rate if your budget allows.

Regardless, don’t let your hard-earned money sit stagnant in a checking account. Your lifelong plans to travel, pay for your kid’s college or buy that new house could depend on it.

401(k) Potential Benefits:

  • You can contribute more than a traditional IRA.
  • Contributions grow tax deferred.
  • Contributions are deducted from your current income, saving you on taxes in the short term.
  • Some employers may offer matching contributions.
  • You may be able to access funds penalty-free before age 59.5 if you end your employment.
  • Investments carry more protection against liens or legal judgements.

401(k) Potential Drawbacks:

  • Investment options can be limited and less customizable to your lifestyle objectives.
  • Distributing funds before age 55 could incur penalties, if you don’t look closely.

Traditional Individual Retirement Account (IRA)

This type of account is like a 401(k), but it’s sponsored by the individual rather than the employer.

Compared to a Roth IRA, contributions with this type of account are tax-deductible, but withdrawals during retirement are taxable. With a Roth IRA, contributions are not tax-deductible, but withdrawals during retirement are usually tax-free.

If you’re self-employed, your workplace doesn’t offer a 401(k), or you’ve maxed out your 401(k), an IRA may be right for you. Whether it’s Traditional or Roth, however, is a question for your advisor.

As a general guideline: Traditional may be best if you expect your income to be higher now than in retirement. Roth IRA may be best if you’re confident you’ll have higher income in retirement than you do now.

It all comes down to where you are and where you want to be. Being realistic in assessing your income can give you greater confidence in your overall investment strategy down the road.

IRA Potential Benefits:

  • Contributions grow tax deferred, with no capital gains tax implications.
  • Contributions can be deducted from annual income in many cases.
  • You’ll have extreme flexibility with investment selections.

IRA Potential Drawbacks:

  • You can’t contribute without household earned income.
  • You could incur tax penalties if you take distributions before age 59.5.
  • High-income earners may not be able to deduct contributions from taxable income.
  • You’ll have less protection from credit liens or legal judgement than 401(k).
  • Investments hold a lower limit on annual contributions than 401(k).
  • There’s no option for employer contribution matching.

Roth IRA

This account is similar to a traditional IRA, but it gives you special tax advantages when contributing after-tax dollars. Contributions grow tax free, and distributions are also tax free after you turn 59.5 and meet the plan’s 5-year requirement.

Translation: You don’t pay taxes on growth or withdrawals because you pay them up front instead.
If you aren’t paycheck-to-paycheck and don’t see a need to save on taxes in the short term, this may be the plan for you.

Note that some employers also offer Roth 401(k) — enabling comparable tax-free retirement withdrawals, but through a company-sponsored plan.

Roth IRA Potential Benefits:

  • This is generally the most tax-efficient investment vehicle available.
  • You can distribute contributions (excluding earnings and appreciation) any time, penalty free.
  • Tax treatment for beneficiaries is favorable compared to traditional IRA and 401(k).
  • You’ll have extreme flexibility with investment selections.

Roth IRA Potential Drawbacks:

  • Income determines eligibility. If you earn too much, you may not qualify.
  • You could face tax penalties for withdrawing contribution earnings too early.
  • Contributions aren’t tax deductible — only after-tax dollars are.

Of course, this is just a bare-bones overview. There are many other strategies and ways to personalize your plan to your goals. Your best bet? Talking to a financial advisor you trust.

Our Arizona investment professionals, led by Bud Heintz, CFP®, seek to help you not only succeed in your “next big thing” — but also discover the true purpose behind your retirement lifestyle and legacy.

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