Best Retirement Accounts for Investing in Your Future
- Investing today can help you get more enjoyment out of life in the future. Keep reading to learn more about the best retirement accounts to suit your goals.
Even if you're eligible for Social Security, there's no guarantee your monthly benefit will cover your expenses in full. That's why it's so important to save for retirement. This guide provides an overview of the best retirement accounts for reaching your investing goals. Before you make your first deposit, meet with a financial advisor to discuss your finances and choose the best type of account for your unique circumstances.
What Are the Best Retirement Accounts?
The best retirement account for your situation depends on these factors:
- Your current age
- Your desired retirement age
- How much risk you can tolerate
- Your tax bracket
- Your employment status
- Your current financial situation
In early adulthood, it's a bit easier to tolerate a high level of investment risk. Even if the market dips, you have decades ahead of you to generate a positive return. As you get closer to retirement, however, your tolerance for risk is likely to decline.
A 401(k) plan is a tax-deferred retirement plan sponsored by an employer. Tax-deferred means you don't pay any tax on the money until you start making withdrawals. When you enroll in a 401(k) plan, your employer deducts a percentage of each paycheck and puts the money in an investment account. The IRS' 401(k) plan contribution limit for 2022 is $20,500. If you're 50 or older by the end of the calendar year, you can contribute an additional $6,500 as a catch-up contribution.
Roth 401(k) Plans
If your employer offers a Roth 401(k) plan, you can still have contributions deducted from your paycheck. The main difference between a traditional 401(k) and a Roth 401(k) is that the Roth plan isn't tax-deferred. That means your contributions are taxed immediately. When you make a withdrawal, you won't have to pay any additional taxes.
Is a Pension or a 401(k) Better?
It really depends on your investing goals. Pensions are more stable than 401(k) plans, but you have no control over the investments in a pension fund. If you enroll in a 401(k), you'll be able to pick your own investments, giving you more control over your future. It's also possible to take your 401(k) with you when you leave one employer for another, making a 401(k) plan more flexible.
Individual Retirement Arrangements
An individual retirement arrangement, commonly called an IRA, is a personal retirement account that has certain tax benefits. Traditional and Roth IRAs are the most common, but other types of IRAs are available.
With a traditional IRA, you can usually deduct your contributions in the year you make them. This can reduce your taxable income, leaving you with a lower tax burden each year. If you make a withdrawal before age 59.5, you'll have to pay a penalty.
Pros and Cons of Traditional IRAs
Some retirement accounts have annual income limits. One of the main advantages of a traditional IRA is that you can contribute no matter how much you earn. Another advantage is that traditional IRAs give you access to several types of investments.
Since you don't pay taxes on your contributions in the year you make them, you have to pay income tax on your IRA withdrawals during retirement. You must also begin taking a required minimum distribution by the time you turn 72. The early withdrawal penalty is another disadvantage of investing in a traditional IRA.
Contributions to a Roth IRA aren't tax-deductible in the year you make them. The main difference between a traditional IRA and a Roth IRA is that you won't have to pay income tax on any withdrawals you make after age 59.5. If you make a withdrawal before you turn 59.5, you only have to pay a penalty if the withdrawal is from investment gains, dividends or interest. If you only withdraw from your original contributions, there's no penalty.
Pros and Cons of Roth IRAs
The main advantage of a Roth IRA is that you can take tax-free withdrawals during retirement. One of the main disadvantages of a Roth IRA is that you can't deduct your contributions on your taxes in the year you make them. Additionally, you can't participate in a Roth IRA if your income exceeds $144,000 ($214,000 if you're married and filing a joint return) for 2022.
With a nondeductible IRA, you contribute dollars that have already been taxed, so there's no immediate tax benefit. This type of IRA is often used by high-income taxpayers who earn too much to deduct contributions made to a traditional IRA.
If you're self-employed or own a small business, you may be able to save for retirement with a Simplified Employee Pension Individual Retirement Account. In 2022, employers are allowed to contribute $61,000 or 25% of each employee's salary, whichever is lower, to this type of plan. If you're self-employed, you can contribute up to 25% of your net earnings from self-employment.
The SIMPLE IRA is an option for small businesses that employ no more than 100 workers. For 2022, the employee contribution limit for a SIMPLE IRA is $14,000; if you're 50 or older, the contribution limit increases to $17,000.
In most cases, you must have earned income to open an IRA. Before the spousal IRA became available, this made it difficult for stay-at-home parents and other nonworking individuals to save for the future. If you're not working and your spouse is employed, your spouse may be able to contribute to a spousal IRA in your name.
Self-directed IRAs give you access to more investment options than other types of IRAs. A trustee or custodian administers the account with your input. For 2022, the contribution limit for a self-directed IRA is $6,000 ($7,000 if you're 50 or older).
If you work for a public school or nonprofit organization, you may have access to a 403(b) plan, also known as a tax-sheltered annuity. This type of plan is similar to the 401(k), and it also offers traditional and Roth options.
If you work for a local or state government, you may have access to a 457(b) plan. This type of retirement account has some features in common with the 401(k), but there's no early withdrawal penalty if you take out money before you turn 59.5. The catch-up contribution limit is also doubled.
Which Account Is Best for You?
If you have access to a 401(k), this may be the best option due to its growth potential and the ease of enrollment. You may also qualify for matching contributions from your employer, making it easier to grow your nest egg. If you don't have access to a 401(k), consider investing in a traditional IRA or Roth IRA. SEP and SIMPLE IRAs are typically a good fit for self-employed individuals.