Different Types of Retirement Savings Accounts

While retirement may feel like a ways away – especially if you’re in your 20s, 30s, or 40s – it’s never too early to start planning for it. When you set yourself up for success, you’ll have a lot less to worry about in the future. Let’s take a look at different types of retirement savings accounts.

Retirement savings accounts come in all shapes and sizes. Individual Retirement Accounts, or IRAs, are the most common. When you set up yours, you need to choose between a Roth or a traditional IRA. The biggest difference between the two is how and when you’re required to pay taxes on your savings. 

If available to you from your employer, you can’t forget about 401(k) accounts either. When you sign up for a 401(k) account you deposit a percentage of your paycheck directly into the account. Based on where you work, your employer may match either part or all of your contribution. That money That’s why it’s so important to consider a business’s 401(k) benefits and plans when on the job hunt.

Below, we take a closer look at the three types of retirement savings accounts, and our recommendations.

What is a Traditional IRA?

Whatever savings you place in a traditional IRA are tax-deductible the year you make the contribution. This applies to both state and federal tax returns. These withdrawals are called distributions and are taxed upon withdrawal. You get a tax break the year that you invest, and therefore pay no taxes on the money until you withdraw it

When you contribute to a traditional IRA, your taxable income becomes lower. This lowers your adjusted gross income (AGI), which can help you qualify for other tax incentives. This includes breaks on student loan interest or increased child tax credits.

If you decide to withdraw from your traditional IRA before age 59 and a half, you pay taxes on the money as well as a 10% early withdrawal penalty. There are certain situations in which you can avoid the penalty. This includes using the money for qualified first-time homebuyers or higher education expenses. Be aware that while you can avoid the penalty, you still pay taxes on your savings. 

In general, those with high incomes who expect to make less and be taxed less in retirement (after age 59 and a half) should opt for a traditional IRA.

What is a Roth IRA?

When you contribute to a Roth IRA, you don’t get a tax deduction. That means that your AGI isn’t affected. When you withdraw from the account in retirement you don’t pay taxes on it. You already paid taxes on your contributions upfront so you don’t owe anything else when you withdraw.

It’s important to note that Roth IRAs feature income-eligibility restrictions. Single filers must have a Modified Adjusted Gross Income (MAGI) of less than $144,000. Contributions are phased out at $129,000 in 2022. Married couples who file jointly must have a MAGI of less than $204,000. Contributions are phased out at $214,000.

The Roth IRA “Phase Out” system is the income range in which the government “phases out” a taxpayer’s ability to contribute to a Roth IRA. For example, a singer filer is unable to contribute if they earn more than $129,000, and $214,000 for married couples This is to prevent an even wider gap between the upper and lower classes. 

Roth IRAs have no required minimum distributions (RMDs). This means that you don’t have to withdraw at a certain age, or even during your lifetime. That makes Roth IRAs ideal for wealth transfer. In that sense, your beneficiaries don’t pay income tax on it either.

Withdraw the principal that has been funded to date in your Roth IRA at any time and for any reason before the age of 59 and a half without any penalties. The untaxed earnings, however, cannot be removed until 59 and a half without a steep penalty. 

We believe Roth IRAs serve a good portion of almost all our clients, as it’s a good way to provide tax-free cash flow in retirement. These types of accounts are becoming more popular for use in saving for children’s college expenses and home down payments. We will do a more in-depth article on the benefits of opening a Roth IRA in the future, so stay tuned.

You should have a 401(k) too

We encourage our clients to set up whichever type of IRA is appropriate for their income levels as well as a 401(k) account. This way you can take advantage of compound interest and Dollar Cost Average (DCA) magic. 

Dollar-cost averaging is a simple strategy in which you invest a fixed amount of money in the same fund or stock at regular intervals (monthly) over a long period of time. If you have a 401(k) retirement plan, you’re already using this technique. 

The number of shares that you purchase each month will vary as the price of the share will change over time. Don’t pay attention to those changes – simply keep investing that fixed amount. It’s a great way to work with an ever-fluctuating market while also saving for retirement.

Still stuck?

That’s where we come in. Contact us to book a call to discuss your options!

Photo by Morgan Housel on Unsplash

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