Saving for retirement should be an important financial goal for everyone, no matter their age or income. Everyone has dreams for retirement, whether it is soaking up the sun on a beach somewhere or traveling the country in an RV, and saving for retirement is the key to making those dreams come true. One struggle that people face, especially younger workers, is that retirement is so far away that it's hard to acknowledge the benefit of saving for retirement now, which is why it helps to view a retirement account as both a savings account and a tax reduction tool. In the world of retirement plans, there are a variety of options available for everyone, whether you are an employer, employee, or self-employed.
401(k) plan
This is probably the most common retirement vehicle out there. The 401(k) plan is typically offered by employers, and allows employees to contribute a portion of their wages to an account. The contributions are "pre-tax" meaning that they go in before payroll and income taxes are calculated. The employee usually can direct the investment of the funds within the account, either by buying individual investments or selecting an allocation between mutual funds / ETFs offered within the plan. Employers also have the option (but not the obligation) to make profit-sharing or matching contributions (i.e. free money). The catch is that employee contributions are limited to $17,500 for 2013, and catch-up contributions of $5,500 for employees 50 years old and over.
Individual retirement account (IRA)
The traditional IRA is a useful product for many reasons, but does not carry the same tax deduction characteristics as other retirement accounts. An IRA can be opened by anyone at a participating institution and contributions can be made at any time during the year up to a maximum of $5,500 or taxable compensation for the year. The catch to an IRA is that distributions are almost always taxable, but contributions are not always tax deductible. In other words, the contributions have the potential to be taxed twice. For example, for a married filing joint taxpayer that is covered by a retirement plan at work with AGI in excess of $115,000 gets no deduction. Limits can be found on the IRS website here.
Roth IRA
The Roth has grown in popularity in recent years due to its tax deferral attributes. The Roth functions almost entirely the opposite as a traditional IRA in that contributions are made "after-tax" i.e. they are still included in your taxable income, but the distributions in future years are not taxable. This is a great resource for someone with the ability to make contributions and still pay the taxes currently such as a young worker with a higher level of disposable income. There are two catches to a Roth, 1) the contribution limit is the maximum of $5,500 or taxable compensation for one year (2013) and 2) taxpayer's with AGI in excess of $188,000 MFJ / $10,000 MFS / $127,000 S cannot make a contribution to a Roth.
All of the options above are also available to self-employed individuals depending on the income level of the business and whether or not it has employees.
The 401(k) and IRA plans can be useful tools in reducing taxable income. By making higher contributions to a 401(k) plan, an employee's W-2 taxable income will decrease. Also, if a taxpayer's income is in a certain range, IRA contributions can also help reduce taxable income. Contributions to a Roth IRA have a different benefit. Although current contributions are not deductible, distributions from the plan in the future are not taxable, meaning that a taxpayer can experience years of tax free growth for their retirement.