I get a lot of emails from people in their forties and fifties who are suddenly panicking about their retirement savings. Often, they don’t have any or they have very little, yet they still want to retire at age 65.

At the same time, I also get emails from people in their twenties who are already saving diligently for retirement. What they want to know is how much they actually need to save so that they, too, can retire at age 65.

The people in the first group obviously spent a big chunk of their adult life not having to save for retirement. This gave them more flexibility with their money in their twenties and thirties than people who were already saving for retirement.

On the other hand, people who start saving early don’t have to save as much overall as people who start later on.

So, which approach is better? Let’s look at the two cases.

Let’s say you’re 20 years old right now. You want to have $2 million set aside for retirement at age 65 and, magically, there’s an index fund out there that will return 7% a year (I’m using this index fund as a convenience, basing the 7% on what Warren Buffett suggests is a good number to use for average stock market returns going forward).

If you start investing at age 20, you’ll need to put aside about $510 a month to reach this goal.

If you start at age 25, you’ll need to set aside about $725 a month to reach this goal, but you don’t have to save anything from ages 20 to 25.

If you start at age 30, you’ll need to set aside about $1,050 a month to reach this goal, but you don’t have to save anything from ages 20 to 30.

If you start at age 35, you’ll need to set aside about $1,530 a month to reach this goal, but you don’t have to save anything from ages 20 to 35.

If you start at age 40, you’ll need to set aside about $2,270 a month to reach this goal, but you don’t have to save anything from ages 20 to 40.

If you start at age 45, you’ll need to set aside about $3,480 a month to reach this goal, but you don’t have to save anything from ages 20 to 45.

If you start at age 50, you’ll need to set aside about $5,600 a month to reach this goal, but you don’t have to save anything from ages 20 to 50.

As you read through those previous sentences, you probably thought that the amounts early on were quite manageable, but when you got to age 50, you’re likely thinking that it’s bordering on impossible.

That’s the lesson here. You can forego the early retirement savings, but catching up later on can be incredibly punishing and the longer you wait, the more punishing it gets.

Thus, my advice is to start saving for retirement right now, no matter what age you are. Even if you can’t save very much, start by saving something. If you’re not saving, you need to be doing something else that’s financially urgent with your money.

For example, if you just save $100 per month starting at age 20 in the above retirement account, increase it to $200 a month at age 30, $300 a month at age 40, $400 a month at age 50, and $500 a month at age 60, you’ll have $720,000 saved for retirement. Double each of those numbers and you’re getting close to where you need to be.

Start saving now, even if it’s just a little bit. Don’t burden your future self with crippling amounts of retirement savings or employment until the very end of your life.

Connie writes in:

Roth, IRA, 401(k), 403(b), FERS, TSP – what on earth does it all mean? I know they all have to do with retirement savings, but it’s all just a word salad to me.

This is going to be something of a “dictionary” post where I spell out, as simply as I can, what these terms mean and what it means for you. I’m not going to get into every single detail of each term, but instead I want to give you enough information that you can sensibly navigate other articles you might read about retirement planning.

A 401(k) is a retirement plan, meaning it’s a special way for you to put aside money for when you’re of retirement age. What makes a 401(k) better than a normal retirement account? For one, you can put aside money directly from your pay before taxes are taken out of it. This reduces the income tax you have to pay right now.

For most people, it means that you sign up to have a certain amount of money withdrawn from your paycheck each pay period. This money will come out before taxes, as mentioned above. This means your paycheck will be a bit smaller than it otherwise would, but it won’t go down quite as much as the amount you withdraw (because your taxes will be smaller, too). So, if you sign up to have 10% of your check taken out, your gross income might go from $2,000 to $1,800, but your take-home might only drop from $1,700 to $1,530.

When you’re retired and go to take money from a 401(k) account, that’s when you’ll pay income tax on your withdrawals. In a way, you’ll be able to think of it as a normal paycheck coming out of your 401(k) account, as it’ll have taxes taken out of it.

Sometimes, employers will match what you have withdrawn from your check. If this is available to you, get every dime you can. This is free money. Yes, you don’t have access to it right now, but there’s no easier way to cause your retirement savings to skyrocket than to get every dime of matching you can.

Typically, a 401(k) plan offers a lot of different options for how to invest your money. This can seem overwhelming. Thankfully, there’s a pretty easy solution that works for most people. Just ask your investment advisor for a “target retirement” fund and put all of your money into that fund. Usually, there are several different funds of this type, each of which “target” a specific retirement year. So, let’s say you’re 25 and you want to retire when you’re 64. That’s 39 years from now. Since I’m writing this in 2011, that puts your retirement date at 2050. Thus, you’d want to put your money into a “target retirement 2050″ fund. These funds take care of things like rebalancing for you so you don’t have to worry about it.

A 403(b) is almost identical to a 401(k). Why the different name? Generally, 403(b) plans are offered at non-profit organizations and institutions of public education, whereas 401(k) plans are offered from businesses. A 457 plan is also similar, except it’s typically offered by governments.

An IRA is a retirement account that you can set up on your own, usually with an investment house like Vanguard. You have to make your own contributions to this plan, which is usually done via an automatic deduction from your checking account.

Contributions to an IRA are tax-deductible, which means that when you do your taxes, you can subtract the amount you contribute to your IRA from the total amount of income you’ll be paying income taxes on. For many people, this means a larger rebate check from the IRS.

As with a 401(k), when you make withdrawals from an IRA at retirement age, you have to pay taxes on those withdrawals as though they were normal income.

An IRA involves a lot more effort than a 401(k) for most people. You have to independently sign up for an IRA with an investment house. Once signed up, you’re going to have many more investment options than you would have with a 401(k), which is both good (options are good) and bad (lots of options can be overwhelming). As before, I typically encourage people to use a “target retirement” fund for all of their retirement savings if they’re unsure, which you can read about above in the 401(k) section.

OK, so what does Roth mean? A Roth IRA or a Roth 401(k) work similarly to the plans described above, except that instead of using pre-tax money, you’re using post-tax money for contributions.

How does that work? Your contributions come out of your take-home money in the case of a Roth 401(k), and your contributions aren’t tax deductible in the case of a Roth IRA.

Well, what do you get in exchange for that? All of the money you withdraw from these accounts at retirement is tax free. You won’t pay a dime of tax on any of it.

Naturally, this causes people to start asking questions like “is it better to pay taxes now or pay taxes at retirement time?” This is a debate that’s gone on for years and, frankly, there is no clear answer to it. My usual suggestion to people is to diversify. If you can, put some money into a Roth IRA or a Roth 401(k) and put some money into a regular 401(k) or a regular IRA.

A final note: what about FERS? FERS is essentially a federal pension plan available to federal employees. Many states offer a similar program with similar benefits to their employees. Typically, these plans offer a retirement pension based on years of service and salary and, typically, you don’t have to make any decisions after the initial sign-up.

Hopefully, this article helps you with the basics of various retirement plan options and makes it possible to navigate more in-depth articles about setting up things to cover your retirement.

Every Sunday, The Simple Dollar reviews a personal finance or other book of interest. Also available is a complete list of the hundreds of book reviews that have appeared on The Simple Dollar over the years.

One common request I get is more discussion on the specifics of retirement plans. For me, whenever someone mentions a topic that they want to hear more about, that means a trip to the library. I try to find books that cover the topic well, particularly from a fact-oriented point of view.

This is exactly the angle of A Commonsense Guide to Your 401(k) by Mary Rowland. Part of the “Bloomberg Personal Bookshelf,” a series of books on personal finance and investing topics, it seeks to discuss from a very fact-based perspective what a person needs to know about 401(k) plans and how to use them for retirement.

The Retirement Landscape
The book opens with a section briefly covering the retirement landscape in general, which is the one place where this book really looks at non-401(k) retirement options, particularly for the self-employed and other groups. The big idea here is that you need to be prepared for what’s going to happen down the road, and it’s going to take a lot of preparation, ideally starting now. The information here really moves almost too fast to really put non-401(k) plans into perspective, though.

401(k) Plans: The Basics
Here, Rowland carefully discusses what a 401(k) plan is, how it works, and why you should invest in it. It’s a retirement vehicle, of course, but it’s one tied to your employer and often restricted by whatever plan or arrangement your employer has set up with the investing house offering the plan. Usually, money is put directly into the account as a deduction from your paycheck before you ever take it home. That money usually comes out before taxes are calculated, meaning that Uncle Sam gets a smaller slice of your pay now but will get a slice of that 401(k) money later on when you’re retired.

How to Get In and Get Out
Rowland moves onto the key processes in opening a 401(k) account, which usually involve signing up through a plan representative in your workplace. On the flip side of that coin is the withdrawal phase, where you sign up to begin taking regular withdrawals from your 401(k) at retirement. The topic of rolling over a 401(k) is also touched on here a bit.

Investing It
The big part of signing up for a 401(k) is the question of investing, and it’s the part that often scares people. How do you know what to invest in? Generally, all you need to do is invest in a wide diversity of things and, as you get closer to retirement, slowly shift that diversity into less aggressive things (less stocks, more bonds, for example). Many plans offer a “target retirement” fund which does this for you automatically and is usually the best choice for people who don’t want to handle the minutae for themselves.

Preparing for Change
What things can you do as retirement nears and you’re about ready to begin collecting that 401(k) money? Rowland offers a ton of ideas here, most of which are simply really sound personal finance ideas. Pay off your debts. Understand what your new lifestyle and income level will be like. Delay collecting Social Security so that you can collect a bigger benefit.

Steps to Take in Retirement
What do you do when you’re actually retired? Many of the tactics here deal with specific situations that people may find themselves in, such as a temptation to take out lots of money and splurge (don’t) or how to utilize “alternative” retirement strategies like pension max (don’t). Instead, learn to maximize every dollar you have without risking the dollars that are yet to come.

403(b)s, 457 Plans, Etc.
This is something of a tie-it-together section that discusses alternatives to 401(k)s that some people may have, such as 403(b) and 457s. Mostly, these plans are really similar to 401(k)s for most purposes, and Rowland mostly just focuses on talking about the minor differences between them here.

Is A Commonsense Guide to Your 401(k) Worth Reading?
If you’re a fact-oriented person and are seeking information about how your 401(k) plan works in your workplace, A Commonsense Guide to Your 401(k) is exactly the book for you. It’s very informative, sticks to the facts, and teaches everything you might need to know about your 401(k) plan.

Having said that, it really doesn’t instruct you too much on broader retirement issues and other places to invest. This is a 401(k) book, through and through. Many people seem to substitute “401(k)” in their head for “retirement savings,” but the terms are not interchangeable. This book provides a great view of 401(k)s, but a narrow view of a total retirement picture.

This is a great read as part of your reading on retirement issues, supplemented by a book that provides a broader picture and other specialized books on retirement. It’s incredibly informative, but on a very narrow topic.

Check out additional reviews and notes of A Commonsense Guide to Your 401(k) on Amazon.com.

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

On Facebook, Tyler wanted to know, “Should I stop my retirement contributions while i pay back my college loans? I am 23 and my employer will match up to 5% of my contribution. Should i continue? or hold off until my loans are paid?”

The challenge with any question like this is that it relies so much on future events. What will the stock market do over the next thirty or forty years? That’s unknown. What path will Tyler’s life take over the next ten years or so? That’s unknown as well. Both of these factor enormously into answering the question above.

The best thing we can do is follow some reasonable approximations and rules of thumb for future investment growth while also striving to give Tyler as much freedom as possible in the coming years.

The Ghost of Investing Future
In order to get an estimate of how much someone should be investing for retirement, you have to come up with a few basic assumptions.

When will the person retire? This lets us know how many years of investing we’ll be able to account for. I’ll asume that Tyler will retire at 75, giving us 52 (!) years to work with.

How much of an annual raise can we assume? I usually just match this at the same rate as inflation. Speaking of inflation…

How much inflation should we assume? I usually peg this at 3%, which is pretty sound based on the economy of the last twenty five years.

How much of an annual return on stocks can we assume? Warren Buffett projects a 7% annual return over the long haul in the American stock market, so I’ll use that number.

Do you see how tenuous all of these calculations are? When you estimate retirement savings, you’re making a lot of guesses for the future.

What you’re going to shoot for is an amount high enough so that the person’s annual expenses equal 4% of the total savings at the time of retirement.

I ran the numbers, assuming that Tyler is able to live on about 75% of his salary each year. My calculations showed that Tyler should be saving somewhere between 9% and 10% of his annual income for retirement, so we’ll use 10%.

10% is an excellent thumbnail to use. In this case, Tyler has the advantage of a long period until retirement, but I’m also using some pretty conservative returns on his investments for my calculations.

Tyler’s Choice Today
In order to make it to a healthy retirement, Tyler needs to be saving 10% of his annual income starting today. He can choose to delay it a few years, but then he’ll be locking down 11% or 12% or more to make it to his goals. He’s a lot better off locking things down at 10% starting today.

Tyler’s employer will match up to 5% of his contribution, so if Tyler contributes just 5% of his salary today, he’ll be on pace for what he needs for retirement. This is exactly what I would recommend that Tyler does.

Once that’s taken care of, he should throw every dime that he can at his debts. It is far easier to live a little lean now when you’re single and aren’t weighted down with responsibilities than to live lean later on when you’re burdened with career and personal requirements.

Should Debts Ever Delay Retirement Contributions?
This is a tricky one to answer. Quite often, people eschew retirement savings in order to pay off debts because they don’t want to make lifestyle changes. This is a giant mistake. If you find that you’re in a situation where you can’t make your minimum debt payments, a small retirement contribution, and live your current lifestyle all at once, changes need to be made with regards to your lifestyle first and foremost.

If you are in a situation where further lifestyle changes genuinely are not possible – meaning you have no cable or satellite bill, no cell phone, no new or nearly-new car, no living quarters larger than you need, etc. – then you should take care of your high-interest debts before renewing your retirement savings. Of course, this does need to be coupled with an emergency fund and a commitment to avoid debt in the future, because without that, this is all a moot point.

Personal finance almost always comes back to impulse control, and this is no different. If you can’t control your impulses and desires when it comes to spending money, financial success will almost always be elusive in your life. You won’t get ahead if you can’t control yourself.

A few days ago, Donald left a provocative comment on my recent article How to Get Rich Quickly!. Although I think his tone is a bit aggressive, he does bring up an interesting point:

Yes this is good advice – work for 45 years, squirrel away your income the whole time, and when you are ready to die, you will be rich (*disclaimer – rich in 2011 dollars, maybe not so rich in 2043 dollars)

First of all, I have no interest in being rich. My impression of being rich is that I have enough money saved that my children will have an easy life. I have no interest in that at all.

My goal is financial independence, which means simply that if I choose to engage in activities that don’t earn an income for the rest of my life, I’ll survive financially with a standard of living roughly similar to what I have now (and I don’t live like a rich person). I might choose to earn an income at that point so I can spoil my grandchildren or sponsor a charity or fulfill some other goal, but I don’t need it to survive and I certainly have no interest in supporting my children as adults.

Of course, the core of Donald’s point is that long-term savings goals are pointless because of a perceived short life and low quality of life you would have once you reach a retirement age. Donald mentions working for 45 years and, assuming that you’d start such work at age 25, you would be working until age 70.

Here’s the thing, though. The average person at age 70 can expect to live another fifteen years on average (see Table 6 in the 2007 CDC life expectancy report for the numbers). The simple fact is that people at age 70 aren’t sitting on their deathbeds. This may have been the reality fifty or sixty years ago, but it’s not the reality now. Health care and standards of living have given people much longer healthy and productive lifespans than ever before. The majority of people at age 70 have a decade or more or productive life ahead of them and the percentage will just continue to go up as time marches on.

I don’t know about you, but my plans for when I’m seventy don’t involve me sitting down in a chair and waiting for the end. I plan on being engaged with my family and with charities and other community activities until I’m truly unable to do it any more, and the statistics indicate that, for me in my early thirties, that time is a long way into the future. Estimates on life span increases indicate that I have more than fifty years of productive life yet to live and I’ve already been in the workforce for more than a decade.

Simply put, if you are young today, saving for the future doesn’t mean saving for retirement and life’s end; it means saving for financial independence and a second career.

Now, with regards to the comment of “rich in 2011 dollars, not in 2043 dollars”: you have to go back for two decades to find a year with an inflation rate higher than 4%, and some recent years have seen microscopic inflation rates. 2008 and 2009 had extremely low inflation and, by some estimates, had deflation. This is the inflation metric you’re trying to beat and if you’re investing over the long term (40 years), a well-diversified investment with diverse stocks and other assets will annihilate these returns, giving you much better than inflation. Simply put, saving properly for a second career over the long term will handle the inflation problem.

But what about the economic bogeyman? You know, the fear of a financial apocalypse that political opportunists and media members who know how to sell fear love to trot out all the time? The only thing we have to fear is fear itself. Most of the people preaching fear have been preaching fear for several years now. All I see is a prolonged recession and a national debt that was worse in the 1940s than it is now.

The things that have worked for the long term throughout human history work now. Spend less than you earn. Invest the rest in a diversity of things because you don’t know exactly what the future holds. Invest in yourself, too, and make sure you have skills and education to handle both the needs of your life and the needs of the marketplace.

One final thing: think and plan for the long term, because the long term is longer now than it ever has been – and it’s full of more opportunity than ever as well.

In 1935, when the Social Security Act was passed by Congress and signed by President Roosevelt, the new law established a national retirement age of 65. At that age, people could begin receiving Social Security benefits and, in the minds of generations of Americans since, effectively set the psychological “retirement” age.

There’s an important fact to consider, though, that’s been left out of this story. In 1935, the average American lifespan was 61.7 years. You had to exceed the average American lifespan by more than three years to begin receiving Social Security benefits.

Let’s roll forward to today. The “retirement age” set by Social Security is still 65. However, today the average American lifespan is 78 years and continuing to rise.

In other words, the national “retirement age” of 65 has remained unchanged for 75 years, but the lifespan of the average American has gone up by 16 years.

Yes, this is an easy explanation for why Social Security is seeing financial problems, but there’s a more vital issue at work here, one that we’re seeing at work all over the place in America.

40 is the new 20. 60 is the new 40. Simply put, people are living far longer and enjoying excellent health much later in life than ever before.

In 1935, a person aged 65 was often quite elderly and in poor health. In 2011, a person aged 65 is often full of vitality and has two more decades of lively activity ahead of them (at least).

There are two key points to pull out of this.

First, if you’re under 50 or so, you’re probably not going to be able to retire when you’re 65. In the past, Social Security could sustain you by providing enough income between the age of 65 and the end of your life that you could survive. Unfortunately, as lives grow longer and future generations grow smaller in size, one of two things will eventually have to happen: either the Social Security age will move back or the amount of benefits will fall.

That means that either you’re going to be going on full Social Security benefits at a later age than 65 or Social Security benefits are not going to be enough to sustain you in retirement at all. In either case, retirement at 65 simply because Social Security is now available is quickly becoming a myth – and will completely become a myth in a decade or two.

At the same time, however, 65 is the new 45. Over the last 75 years, the quality of life for people over the age of 65 has increased drastically. Rather than beginning to lose control of their faculties, most people between the ages of 65 and, say, 80 are quite valuable and have a ton to offer in the workplace and in the marketplace.

Simply put, at the same time that retiring at age 65 is becoming less feasible because of longer lifespans and demographic shifts, it’s becoming much more worthwhile to continue being productive at 65.

What does this mean for retirement planning?

At this point, I don’t view retirement planning as saving for true retirement. Most retirement savings plans allow you to begin taking money out at age 60, which means you likely have a quarter of a century of good health ahead of you at that point.

Instead, I look at retirement planning as building a backbone for a second career. At age 65, I won’t have enough retirement savings or Social Security income to fully sustain me for the rest of my life, but I will have enough retirement income to make it possible to take some significant career risks. I can take a low-paying position with a charity or even do volunteer positions with some perks. I could retreat for a year and write the novel I’ve always wanted to write. I can take a very low-stress job as a greeter or a position on a community board that gives a stipend.

These are all things that are difficult to do right now in my life, yet sound appealing to me and have a firm place on my to-do list.

Simply put, my retirement savings aren’t just for retirement; instead, they create possibilities for a second career or other opportunities later on during my healthy adult life.

Don’t fear the changes coming in retirement savings. Embrace them for the opportunity that they are.

When I think about the long run, I’m usually thinking about what I would call “retirement.” It’s a state I hope to reach in my fifties or sixties or so where I can spend my time working on projects that may or may not result in any sort of financial gain, but simply projects that I can enjoy. Almost every thought about the “long term” in my life leads to that point.

I asked my mother a few days ago about what she considered to be the “long term.” She basically pointed to a point about ten or fifteen years down the road when my children are graduating high school.

I asked my oldest son what he thought about the future and what he thought of as the biggest thing that would happen in his life. He thought about it and he said it would be when he was a parent, roughly when he was my age. Let’s call it twenty years.

I asked my father-in-law what he thought of when I said the words “long term” and he pointed to a point about eight years down the road when he hoped to retire.

Seven years. Twelve years. Twenty years. Thirty years.

One of us is looking at that long term with (relatively) shorter-term retirement savings in mind as a tool to get there. Another sees the route to the long term coming through health maintenance. Yet another sees it as a natural outcome of growing up. For me, it’s all about the long-term retirement planning.

We all have very different definitions of the long term. We all have very different actions we need to take to get there.

Whatever your definition of the long term is, though, you don’t just get there by wandering in the wilderness. It takes work, and it takes a plan.

I’m saving steadily for retirement and putting that money into investments that are fairly high-risk. As time marches on, I’ll be pulling the throttle back and moving into less risky investments.

My son is so excited about school starting in August that he’s already wondering about school supplies.

My mother rather carefully watches the food she eats.

My father-in-law is saving for retirement hand over fist.

We each have our own visions of the long term. We each have our own path to get there.

The key word in personal finance is personal. We all have different goals and dreams. Those goals could be as close as a year into the future or it could be several decades down the road. Depending on where we’re at right now, the things we need to do to get to that point might be drastically different, even if the goals are similar.

What’s the point? You’ll find the most success with personal finance – and with life – if you don’t just copy someone else’s plan. Instead, learn the principles and figure out your own plan that takes you to wherever (and whenever) your long term happens to be. Along the way, don’t be afraid to grab great ideas from others and add them to your own plan, just as long as it keeps taking you to wherever it is you want to go.

Kelly writes in:

I’m reading about retirement and I see terms like Traditional IRA and Roth IRA and 401(k) thrown around without really explaining what they are or what the differences between them are. Do you have a summary of these plans and how they work?

There’s no better time than the present to offer up some great fundamental personal finance information like this. I’m going to ask a series of basic questions about retirement plans and provide the answers for each type of plan so that you can clearly see how they differ in each area.

I myself have had a 403(b) in the past and I currently have a Roth IRA.

One important point to make: this is a summary of the differences between the plans. Plans often change over time as the government alters the tax code and many plans have loopholes that appear and disappear as the years go by. The goal here is to not provide a be-all-end-all reference, but to make clear the big differences between the plans.

Right off the bat, let’s clarify a key point. A 401(k) and a 403(b) are essentially the same thing. The difference between the two is whether or not your employer is a for-profit entity (a business) or a certain type of non-profit entity (such as an educational institution). In terms of the employee, they’re virtually identical in their usage. Some types of non-profit entities also offer a 457 plan, which is very similar to a 401(k)/403(b) except with a few less restrictions on withdrawals.

Who Offers the Plan?
How can you get involved in each type of plan?

A Traditional IRA is offered directly from investment houses. In order to open a Traditional IRA for yourself, you have to open an account with an investment house. Some well-known investment houses that I use (or at least somewhat recommend) include Fidelity and Vanguard.

A Roth IRA is offered in the same way as a Traditional IRA. You have to set up your account yourself with an investment house (like Fidelity or Vanguard).

A 401(k)/403(b) is offered through your employer. Your employer sets up an arrangement with an investment house to provide individual 401(k)/403(b) accounts to their employees. Rather than having a choice of investment houses, you are stuck with using whatever investment house your employer provides.

Which has the advantage? The IRAs have the advantage here. Because you have the freedom to choose which investing house to use and can move from investing house to investing house, these companies have good reason to offer you strong investment options. With a 401(k)/403(b), you’re locked into whatever investment house your employer negotiates with, which may or may not provide you with the best investment options. This doesn’t mean that the investment choices in a 401(k)/403(b) are terrible; usually, it just means that the fees are a bit higher than they would be with your own IRA.

Who Is Eligible?
Which people are eligible for each type of plan?

You are eligible for a Traditional IRA if you are under the age of 70 1/2. You must also earn some sort of income from work or be married to someone who earns income from work.

You are eligible for a Roth IRA if you are eligible for a Traditional IRA. The requirements are the same.

You are eligible for a 401(k)/403(b) if you are employed by an organization that offers such a plan to its employees.

How Much Can You Invest?
How much money can you invest in each plan each year?

In a Traditional IRA, you can invest $5,000 per year if you are under 50, or $6,000 per year if you are over 50. These numbers are accurate for 2011 and may go up in future years (they’ve gone up in the past).

In a Roth IRA, you can invest the same amount as in a Traditional IRA. However, there are income caps for investing in a Roth IRA. If you are single and earning between $107,000 and $122,000 or if you’re married and earning between $169,000 and $179,000 per year, your upper limit is less than $5,000 or $6,000 per year. If you’re over the top end of that range, you can’t invest money at all into a Roth IRA this year.

In a 401(k)/403(b), you can invest up to $16,500 per year as of 2011.

Obviously, in this regard, 401(k)/403(b) plans are the big winner as you can invest more in them.

What Tax Advantages Are Included?
The purpose of a retirement plan is to take advantage of tax breaks. What tax breaks do you get with each of these plans.

A Traditional IRA offers the ability to make contributions that are fully tax-deductible. In other words, if you contribute $5,000 to a Traditional IRA in 2011, you will be able to subtract $5,000 from your taxable income when you file your taxes early next year. This results in a smaller tax bill right now.

A Roth IRA contribution does not offer the tax deductibility of a Traditional IRA contribution. Instead, once you contribute to a Roth IRA and have the account for at least five years, you can withdraw any money in the account tax-free (gains or otherwise) once you’re 59 1/2 years old. This results in a smaller tax bill later on, as Traditional IRAs require you to pay taxes with all withdrawals from the account.

A 401(k)/403(b) operates much like a Traditional IRA in this regard. You make contributions today that are fully tax-deductible with regards to your taxes for the coming year. However, there are no tax benefits when you withdraw.

Which is better? It depends strongly on what you think tax rates will do in the future. If you expect them to stay the same or go down, then the Traditional IRA and the 401(k)/403(b) route is better. If you expect them to go up, then the Roth IRA is better. I expect them to go up, so I give the Roth IRA the nod here.

When Can I Withdraw?
I have this money in the account. When can I take it out without a stiff tax penalty?

You can withdraw from a Traditional IRA at age 59 1/2 or any time after that. Withdrawals made from a Traditional IRA will be viewed as income and taxed as such. You must start taking withdrawals at age 70 if you haven’t already started.

You can withdraw from a Roth IRA at any time (once you’ve had the account for five years) as long as you merely withdraw your contributions. You can begin to withdraw your investment gains at age 59 1/2. You do not have to start withdrawing at age 70.

You can withdraw from a 401(k)/403(b) in almost exactly the same way as a Traditional IRA. You may start withdrawing at age 59 1/2. The withdraws you make are taxed. You must start withdrawing at age 70.

The Roth IRA is clearly the most flexible account here. There are no tax penalties for withdrawing contributions early. There’s also no requirement to begin withdrawing at age 70.

How Can I Withdraw Early?
What if I desperately need the cash early? This is usually a bad idea, but it’s worth knowing.

You can withdraw early from a Traditional IRA if you pay a 10% additional tax penalty on your withdraws. This is beyond the normal income tax you’d have to pay on it. So, if you withdraw $10,000 from a Traditional IRA early and are in the 25% tax bracket, you’ll pay $2,500 in taxes on it plus an additional $1,000 penalty. There are some exceptions to these rules for special situations.

You can withdraw early from a Roth IRA if you’ve had the account more than five years. At that point, you can withdraw contributions with no penalty and no tax. If you’ve not had the account for that long, you’ll have to pay a 10% tax penalty on your early withdrawal. If you withdraw above and beyond your contributions before you’re 59 1/2, you’ll have to both pay taxes and a 10% penalty on those additional withdrawals. There are some exceptions to these rules for special situations.

You can withdraw early from a 401(k)/403(b) much like a Traditional IRA. You pay a 10% additional tax penalty on your withdraws beyond the normal income tax you’d have to pay on it. As always, there are some exceptions to these rules for special situations.

Again, the Roth IRA is the best deal here. It offers more flexibility with early withdrawals than the other plans.

A Final Factor
At this point, a 401(k)/403(b) plan looks like the worst option, but there is one huge factor in that plan’s favor. With many employers, the employer will offer matching contributions. For example, one employer that I know of offers one-to-one matching of every dollar an employee contributes to their 401(k)/403(b) up to 6% of the employee’s pay. So, if the employee makes $50,000 per year and contributes 6% of that – which would be $3,000 per year – the employer would match that, giving that employee a total of $6,000 invested each year.

This blows away the benefits offered by other plans. The strength of this kind of multiplying of retirement funds is the best tool you have available to you – if your employer offers it.

What Should I Do?
Here’s my take on the plans as a whole and how I invest for my own retirement.

If my employer offers matching funds on my 401(k)/403(b) plan, I take advantage of those matching funds first. I would contribute as much as possible to retirement to get every drop of matching funds. This is free money that you should never turn down.

After that, I would fully fund a Roth IRA if I were eligible for it. If you make less than $100,000 a year, you’re eligible for it. Find a trustworthy investment house – I use Vanguard, but do your own research – and open a Roth IRA with them. They’ll make it easy for you to open the account and set up an automatic investment plan that pulls money from your checking account.

If I wasn’t eligible for a Roth IRA, I would fully fund a Traditional IRA.

If I was still not saving 10% of my income for retirement, I would invest enough in my 401(k)/403(b) to add up to 10% of my salary. So, for example, if I were making $100,000 a year and I contributed $4,000 to my 401(k) to get matching and $5,000 to my Roth IRA to fully fund it, I’d still only be saving 9% per year. I’d contribute another $1,000 to my 401(k) to get to that 10% threshold.

I would then pay off any and all debts I have. Before contributing more than 10%, I would get myself to complete debt freedom. I would also take care of buying whatever house I wanted to live in for the long term and make sure that I was saving for major purchases like automobiles. Riding a merry-go-round of debt eats away at your retirement like anything else.

If I were completely and securely debt free, I would increase my personal retirement savings to 15% of my income. This might mean fully funding a Roth IRA, contributing more to a 401(k), or even just saving money in a savings account or non-retirement investment account.

That is the plan I would follow at my age (32, as I write this). My only exception to that is that if I were over 35 and hadn’t saved for retirement yet, I’d put the 15% total savings at a higher priority than total debt freedom, as you have some retirement ground to make up for the years you weren’t saving.

Good luck!