Retirement plan rules are incredibly complex and change frequently, but for most plans like the 401K and IRA, you won't pay income taxes on the money you contribute until you withdraw it.  So, for example, if you earned $65,000 from your employer and contributed $5,000 to your 401K plan, you would only pay income tax that year on $60,000 of income.  This is an oversimplified example, but it helps illustrate the idea.

Now let me explain the other investments in the question.  The money you contribute to the retirement plan can be used to buy many different kinds of investments.  These can range from investing in a small business to buying stocks, bonds, CD's or mutual funds.  The retirement plan is just a basket that holds money that you use to buy investments, but it has great tax benefits.

Now on to the original question of which is better.  No one is better than the other, it's a matter of timing and making sure you have the right mixture of investments to fit your needs at the time.  The IRS generally imposes stiff penalties for withdrawing money from retirement plans before age 59 ½, so if you may need (notice I did not say will need) the money sooner, you should probably eliminate those plans as an option.

Then you need to decide which investments to buy either within or outside the retirement plan.  Here again it's a matter of how soon you'll need the money. Generally if you'll need the money within five or fewer years, stocks are probably not the best way to go and a CD, money market or short term bond are more appropriate.  When your time line is five or more years away, stocks become a better idea.

At the risk of completely complicating things, mutual funds are investments that buy all of the investments we've discussed so far--stocks, bonds, real-estate, and CD's. So you really need to examine what the mutual fund is invested in to make an informed decision.

I've tried to tackle a whole range of complicated topics and give you a basic idea of "which investment is best." Obviously there are entire books on these topics, but hopefully you have a better idea of the difference between an investment (stock, bond, CD and mutual fund) and a retirement plan (401K and IRA) so you can get closer to your own retirement.

I think a better description of retirement is “financial independence.” This means different things to different people, but I suggest it means you no longer HAVE to work, because your money works for you. It does not necessarily mean you quit working, but in retirement you only do the kind of work you want to do. To get there, you need to have saved enough money so that you can live off the earnings of the money you’ve accumulated.

So have you ever estimated how much money you’d need to save—your “Number”? Most people have no idea. It’s hard to stay motivated saving for some unidentified goal, but when you have a rough idea of your “Number,” saving and investing become a lot more interesting. This is because every time you put money away, you know just how much closer you are to reaching financial independence.

Figuring out your Number is less than perfect because there are many factors that are hard to predict. Variables like inflation, investment returns, health care costs and time in retirement, can dramatically change your Number. There are many more accurate ways to forecast how much you need, but here’s a simple formula you can play with today. Estimate how much money you would need to live per month. Multiply that by 12 and divide that by .04.

For example, let’s assume you need $4,000 per month to live happily ever after. Multiply that by 12 to get an annual income of $48,000. Then divide that by .04. In this example you would need $1,200,000 invested to earn $4,000 per month for as long as you live.

It’s a VERY rough estimate, but it can give you an idea of how much you need invested to live off the earnings instead of working. This calculation will show you how near or far you are from retirement. You should do a more comprehensive retirement analysis, because this estimate is very imprecise, but a rough estimate is better than none at all.

Discover more at http://www.cjrylantwealthmanagement.com and get the FREE workbook “The 7 Secrets to Financial Independence.”

Chuck J. Rylant, MBA, CFP®

C. J. Rylant Wealth Management

You can listen to the audio interview here. In the interview I share a little about my background as a police officer and how I became a financial planner. I also share a bunch of financial planning tips as well. So if you are curious, this lengthy interview gives you a chance to get to know me a little better and get some great financial and business advice as well.

I resisted Facebook for a couple of years while in graduate school because I thought it was for a younger crowd.  Eventually I caved and created a Linked In profile and since then my life has changed.  I have reconnected with so many old friends that I lost touch with.  I've also been able to find new friends that share very similar interests.  Some say the internet is reducing personal contact; I disagree.  I am able to meet more like minded people and get to know them better because of how efficient it is to keep in touch.

Few in the financial planning field are using social media so I guess I have become somewhat of an expert.  Many have asked my advice on how to use it and most recently I was interviewed by the National Underwriter magazine for an article on social media.  Two other friends, Carl Richards and Russ Thornton that I also met online, were interviewed for the article.  You can check out the National Underwriter article here.  If you are not using these tools, you should at least give it a try and I'm sure you'll find it worth your time.

1. Choose your attorney with caution

If you can end the relationship without a legal fight, you will begin your new life with far more money. Legal battles are very expensive. A good attorney can prevent you from making a major financial mistake, but be cautious, because it’s easy to be taken advantage of during a divorce. There are many ethical attorneys practicing family law, but there are a few that will take advantage of people when they are most vulnerable. Because of the design of our legal system, attorneys may provoke fights between spouses that result in long, drawn out, legal battles that will drain your assets. These stressful battles rack up fees that, if prevented, could have been used for retirement, education or bills. Consult with many attorneys until you find one you are comfortable with and who is interested in efficiently resolving the divorce. You do not want an attorney that will drag you and your spouse through an unnecessary battle.

2. Leaving debt in your spouse’s name

During marriage you probably obtained credit that was also in your spouse’s name. It’s very important to pay off or refinance debt so it’s only in the name of the spouse that will be obligated to pay the debt. Often one partner takes responsibility for joint debt which leaves the other at risk of negative credit ratings from late payments. Even if payments are made on time, the other spouse may worry about the payments which can lead to stress and arguments.

3. Staying in the house

For some reason, during a divorce spouses will fight to the end to keep a house. There is probably a scientific reason for this, but I assume it’s because we want to maintain some stability in what is otherwise an out of control situation. The income that used to support your family must now support two. Keeping the home that was probably a stretch on the finances before now spreads the budget even thinner. More often than not, selling the home allows both parties to downsize until they are able to reestablish themselves. Sometimes we take one step back to take two steps forward. So try not to fall in love with something (a house) that can’t love you back.

4. Not considering the tax consequences

Divorce may force you to make the largest financial decisions you will make in your life. You may need to sell or refinance your home. Your retirement accounts may be split or used for other expenses and you may have alimony and child support obligations that last for decades. These transactions can have huge tax ramifications that affect both of you. You should not let taxes drive your decisions, but it is prudent to seek professional advice from an accountant or a fee-only financial advisor before making decisions. Attorneys are not expected to analyze your divorce decisions for the tax impact, so it is up to you to seek professional tax advice. More than likely, the fee you pay these professionals will be more than offset by the savings their advice provides.

5. Ignoring Insurance

An often overlooked, but important consideration in divorce is insurance. As soon as your divorce is final, notify all of your insurance providers that you are divorced and no longer living together. Changes in address can affect your coverage. You may also need to apply for individual health insurance or pay COBRA rates. Finally, do not forget to change beneficiaries on life insurance policies if appropriate. Very often people forget to make life insurance beneficiary changes and mistakenly leave the first spouse as the beneficiary even after a second marriage. Be cautious of making changes during the divorce because you can violate court orders, so it’s best to seek advice from your attorney before making these changes.

BONUS

I know the title said five pitfalls, but this last one is so important that I will share it as a free bonus. It’s the most important and may also be the most difficult for you to implement. Although ending a relationship is emotionally hard, try to separate your emotions from the financial side of the divorce. Do not try to win, because there are no winners in a divorce. The harsh reality is that the financial side of the divorce needs to be a business decision. Unfortunately, it doesn’t matter who was at fault in the divorce or who is to blame. The more you are able to look at the finances as a business transaction, the smoother it will go and the better off you, your spouse and children will be.