Which retirement account is right for you?
The retirement landscape has shifted. Gone are the days of the defined-benefit pension plan that saw employees rewarded for their many years of loyal service with a steady stream of checks in retirement. Now the responsibility of saving for retirement often rests on your shoulders.
Fortunately, the team of retirement planning professionals at Elevage Partners can help you navigate the process with confidence and select a retirement plan that suits your individual needs and circumstances. Let’s take a look at some of the options.
The Individual Retirement Account (IRA)
An Individual Retirement Account (IRA) is a tax-advantaged investment account that’s meant to make it easier to save for retirement. IRAs generally afford superior flexibility and access to a broader range of investments compared to other accounts like the popular 401(k), but at the cost of lower annual contribution limits. IRA owners are able to invest in almost any asset they choose, from stocks, bonds, and mutual funds to ETFs and real estate.
In most circumstances, if you withdraw funds from an IRA before you’ve turned 59½, you will have to pay a 10% early withdrawal penalty as well as state and federal income taxes.
Traditional IRA
These accounts are funded with pre-tax dollars and contributions can be invested in the account on a tax-deferred basis. What it means to be tax-deferred is your account’s earnings are not taxed until you withdraw them, at which point they’re treated as ordinary taxable income. This treatment essentially allows you to lower your taxable income in the year you make the contribution and kick your tax burden down the road.
You must take Required Minimum Distributions (RMDs) from your traditional IRA each year after you turn 73. Your RMD specifies the minimum amount you must withdraw each year to avoid a steep penalty.
Roth IRA
Roth IRAs are funded with after-tax dollars and the investments within these accounts are allowed to grow tax-free. This means withdrawals after the age of 59½ do not incur income taxes. Unlike tax-deferred accounts, Roths do not involve RMDs, which may provide you more control over how you make withdrawals.
Another potential benefit of the Roth IRA is that you can withdraw contributions (but not the earnings on those contributions) anytime without penalty. Additionally, you may be able to take distributions prior to retirement age to cover qualifying expenses like college tuition or to buy your first home.
In many instances, Roth IRA funds are subject to a five-year waiting period. If you make a withdrawal from your Roth before five years have passed, you may be required to pay a 10% penalty plus income taxes on the withdrawal. Additionally, you cannot contribute to a Roth IRA directly if your annual income exceeds a certain amount.
SIMPLE or SEP IRA
SIMPLE and SEP IRAs can fulfill the retirement-saving needs of small business owners and self-employed individuals.
If you run a small business, the Savings Incentive Match Plan for Employees (SIMPLE) IRA can help you create a retirement plan for yourself and up to 100 workers. You’re required to match your employees’ contributions up to 3% and make a 2% non-elective contribution for all eligible employees each year. SIMPLE IRAs are taxed upon withdrawal, and there’s a costly 25% penalty for any withdrawals made within two years of opening the account.
Simplified Employee Pension (SEP) IRAs are also funded with pre-tax dollars and are allowed to grow on a tax-deferred basis. They involve significantly higher annual contribution limits than traditional IRAs but are only eligible to those who fulfill certain requirements. Because all plan participants must receive equal contributions, SEP IRAs may be best suited for self-employed individuals or small business owners with a small number of employees. Both SIMPLE and SEP IRAs have RMDs.
The 401(k)
The employer-sponsored 401(k) is one of the most widely used workplace retirement account. You can invest in securities like stocks, bonds and mutual funds, depending on which investment options your employer permits.
A 401(k) may be available in both the traditional and Roth variants. Traditional 401(k)s are funded with pre-tax dollars and grow tax-deferred. Withdrawals are then taxed as ordinary income. Roth 401(k)s are funded with after-tax dollars and grow tax-free. Withdrawals are also tax-free, assuming certain conditions are met.
As with an IRA, the contents of the account are generally “locked up” until the owner reaches age 59½, at which point they can start taking withdrawals without incurring early withdrawal penalties.
One of the unique features of the 401(k) is the ability for your employer to match a portion of each of your contributions. Your employer may offer to match your contributions up to 5% of your salary, for instance. Keep an eye out for any employer contribution matches, because they can help increase the amount you’re contributing each period without costing you extra money. The contributions your employer makes on your behalf do not count toward your annual contribution limit.
Solo 401(k)
Whether you’re a self-employed worker or you own a small business, a Solo 401(k) offers a tax-advantaged way to save for retirement. With a Solo 401(k), you play the role of both employee and employer, which means you can make contributions for yourself and on behalf of your company. This plan brings with it a higher annual contribution limit than a traditional or Roth 401(k).
Health Savings Account (HSA)
Health savings accounts (HSAs) aren’t technically retirement accounts, but they can still prove invaluable in the pursuit of your retirement goals. The primary function of an HSA is to help people save for healthcare expenses by providing tax-advantaged growth for the investments in the account. Funds committed to the account are tax-deductible and then grow tax-free until you need to withdraw them to cover medical costs. Withdrawals can be made at any time and are also tax-free — so long as they’re used to pay for a qualifying healthcare expense.
Once you turn 65, you can use your HSA funds however you’d like – not solely on medical costs – without having to pay a penalty or fee. However, you’re still required to pay income taxes on your distributions as you would with a tax-deferred investment account like a traditional IRA.
Taxable Brokerage Account
If none of these plans is sufficient to meet your retirement planning needs on its own, there’s always a taxable brokerage account. Many opt for a brokerage in addition to their tax-advantaged retirement account in order to save more or enjoy greater flexibility with their investments. Bear in mind that these accounts aren’t afforded any of the special tax breaks as the retirement accounts discussed previously.
Planning Your Retirement
Remember that the annual contribution limits for IRAs, 401(k)s and HSAs are independent of one another, so there’s nothing keeping you from investing in more than one of these accounts at once if you choose to. In fact, you may find that some combination of the above savings plans can better suit their needs.
For help selecting the best retirement savings approach for you and your WHY, contact an Elevage Partner advisor today.
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