Perhaps you are already familiar with one of the basic principles of investing – the magic of compounding when you reinvest your earnings. With compounding, your money earns more every year. A $1,000 investment earning 12% a year, reinvested, will be worth $2,000 in just 6 years. In 30 years, your $1,000 will turn into $32,000.
Congress and the Internal Revenue Service have provided a variety of incentives to encourage workers to set aside money for retirement, giving us all a prime opportunity to take advantage of compounding. By setting up and contributing to a pension or other deferred compensation plan, you can either minimize current taxes (which gives you more money to invest), and defer taxes on the earnings, or with a ROTH IRA you can avoid tazes permanently on the earnings.
There are 6 basic categories of pension/deferred compensation plans. Some are employer-sponsored and some are designed for individuals. As an employee, you are limited to the plans offered by your employer and Individual Retirement Accounts; self-employed persons can choose from the whole dizzying array. The very simplest form is the Traditional IRA. The annual contribution limit, which stayed at $2000 for years, has been going up gradually so that now, with a limit of $5000 per year, or even $6000 once you hit age 50, this option is an ira simple enough yet powerful enough to meet the needs of a lot of self-employed people.
If you don’t have employees that you want to offer retirement plan benefits to, and you can only afford to contribute $5000 a year to your own retirement savings, then keeping it simple with a traditional IRA is the way to go.