10 Retirement Accounts You Should Know About
By: David Rae - September 04, 2018
From well-known options like IRAs and 401(k)s, to more obscure ones like Cash Balance Pension Plans or Rich people Roths, these accounts can help you grow your savings. They also help you pay less taxes along the way. Here are 10 Retirement accounts you should know about.
Anyone reading this should be able to benefit from more retirement savings. At the very least, you should be happy to pay less taxes along the way. The bottom line is most people need to be saving more for retirement and there is no better day than today to take important steps to fund the retirement you want.
The federal government has created a number of tax-advantaged retirement accounts to incentivize you to save for retirement. It also set up these accounts to try and make it harder for you to raid your life savings. The most common of these include the Roth IRA, 401(k) and the Individual Retirement Account (IRA). The tax advantages of these various accounts can make it easier to sock away larger amounts of money each year.
If you are lucky enough to have a retirement plan through work, you may be eligible for matching contributions. This is essentially free money from your employer. For example, if you put in three percent (or more), your employer may match that amount with an additional three percent. This would essentially double your money overnight. Sadly, the average worker leaves $1,336 per year of employer match on the table. This alone could result in nearly $1 million dollars less in retirement savings over your working career.
If you are self-employed, you may think you are too busy or cash-strapped to start a retirement plan. You also have quite a few more options to choose from, which can be another hurdle to overcome. Work with your financial planner and CPA to find the right Small Business Retirement Plan, the tax savings alone could be huge.
Step one is determining which type of account(s) you should use to save for retirement. Next, pick a financial services company or custodian to handle your account. When using an employer plan, this choice has already been made for you. Lastly, pick the investments to fund the account. This is where a fee-only financial planner can add a lot of value, or at least reduce the stress of you having to pick and monitor the investments by yourself.
Each type of retirement account does come with a set of rather complex IRA rules. Some of these accounts are only available to people with certain income levels. Others are only offered to those who are business owners or have self-employment income. Contribution limits for certain accounts will vary for those younger than 50 and for individuals who are older than 50 years of age as well. Your retirement plan may include several of these accounts.
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401(k), 403(b) 457 offered by your employer - For the average person, these types of plans will be the easiest and most convenient places to start investing for retirement. Your financial institution will have already been chosen for you, by your employer, and the money will be taken, pre-tax, out of your paycheck and contributed to these accounts. There will be list of investment options to choose from and you may even get an employer match. You can contribute up to $18,500 for 2018. Individuals, 50 years of age or older, can also make an additional $6,000 catch up contribution.
Solo 401(k) - A sole proprietor can set up an individual 401(k) but this can also be set up for someone working with a spouse. This account is similar to the 401(k) listed above. You will be allowed to make contributions as both the employee and employer. Potentially, you can contribute up to a total of $55,000 in 2018 (or $61,000 for someone 50 years of age or older). Total contributions will depend on your net business income. Read more about the Solo 401k here.
SEP IRA - Also known as a Simplified Employee Pension, the SEP IRA is easier to set up than a Solo 401(k) but harder to max out pre-tax contributions. This account is also typically used by people with self-employment income or small business owners. As the employer, you can contribute up to 25% of your income, or $55,000, whichever is less. There are no catch-up contributions on SEP IRAs.
Simple IRA - This type of plan allows smaller employers (businesses with less than 100 employees) to set up a workplace IRA. This type of plan comes with a little less paperwork and administration expenses employer versus setting up a proper 401(k) plan. You, as the employer, will have to either match some level of contribution or make an unmatched contribution even if you do not contribute. An employee can contribute up to $12,500 for 2018 and there is a $3,000 catch up contribution allowed for workers who are 50-years-old or older. Plus the employer matching contributions.
Individual Retirement Account (IRA) - Essentially anyone can contribute up to $5,500 a year to an IRA ($6,500 if you’re 50 or older). The money will grow, tax free, while it is in the account. Taxes will have to be paid when you take out money.
You can contribute to both an IRA and a 401(k). However, if you have a retirement plan at work, you can’t deduct your IRA contributions from your taxable income if you earn more than $73,000 annually (for single filers) or $121,000 (married filing jointly). After earning $63,000 and $101,000, respectively, you get only a partial deduction for your IRA contributions. If you fall in between these income ranges your amount of your tax deductions will be limited.
For those not covered by an employer-sponsored retirement plan, you can get the full IRA tax deduction no matter how high or low your income may be. The only exception is if you file jointly with a spouse who has a retirement plan at work.
Roth IRA – When it comes to taxes, this IRA works differently than the other retirement accounts. Contributions will be made post-tax meaning you will not get a tax deduction when you put in money. You might wonder, “Why the heck would I put in money if I don’t get a tax deduction?” Well, your money will grow tax free while in the account. The biggest benefit of the Roth IRA is the money will come out tax free after you reach the age of 59 ½. (Your cost basis can be withdrawn tax free five years after you put it into the Roth IRA).
Unlike the aforementioned retirement accounts, a Roth IRA does not have required minimum distributions. So, you will not be forced to take out money when you turn 70.5. To contribute to a Roth IRA, you must make less than $135,000 (single) or $199,000 (married filing jointly). If you earn less than that but more than $120,000 (single) / $186,000 (married filing jointly) your contributions will be limited. There is a little bit of a marriage penalty here.
You are allowed to contribute to both a Roth IRA and Traditional IRA in the same year. However, the contribution limits apply to your total contributions. A Roth IRA, 401(k), SEP IRA and 403(b) have their own, separate contribution limits.
Additionally, there is a Roth 401(k) option. It is important to note that a Roth IRA and a Roth 401k are not identical. The following link provides more information.
Health Savings Account (HSA) - This type of account is typically associated with health insurance and medical expenses but some creative savers are using it as an additional de facto retirement account. If you have certain types of high-deductible health insurance plans, you can put money away, tax free, into an HSA. Contribution limits are $3,450 for an individual or $6,900 for a family. If you are 55-years-old, or older, you can make an additional $1,000 contribution. The money can be used at any time for allowable medical expenses.
If you don’t end up using the money for current medical expenses, it can rollover year to year. Some people have strategized to contribute and get the tax deduction. Invest the money and let it grow over time. They will ideally use it later in life when they are retired and facing higher medical costs. The money will come out tax free, assuming it is used for a long list of approved medical expenses.
If you raid the account before you are 65, for a reason other than a medical expense, you will have to pay taxes and a 20% penalty. To avoid this, keep medical receipts for things you’ve paid for directly. You can reimburse yourself for past medical expenses.
Cash Balance Pension Plan - This is essentially a personal pension for high earners looking to sock away large amounts of money pre-tax. Small business owners can play catch up for retirement and dramatically reduce their tax liability with a Cash Balance Pension Plan combined with a Profit Sharing 401(k) plan. With potential tax savings north of $100,000 per year, it’s hard to believe more people aren’t talking about this type of retirement planning technique. Of course, to get these huge tax savings you have to be able to contribute large amounts to the plan.
Consider this type of plan once you have maxed out your other retirement accounts. If you are a small business owner, your would need to contribute for our employees as well.
Rich People Roth - This option can be quite alluring to those who make too much to contribute to a regular Roth IRA or who plan to retire before 59 ½. It is also a potentially good option for those who need to save more than the paltry $5,500 that is allowed into a regular Roth IRA per year. The Rich People Roth has no contribution limits assuming the account is set up properly. You use a life insurance policy with a cash value to grow your money, tax free, and generate tax-free income. Basically, you are creating a Roth IRA without income or contribution limits.
This type of tax-free retirement account should be used once you have maxed out your other, more common, retirement accounts. While it can generate large amounts of tax-free retirement income, it is important to note it can also be pushed on people who don’t need them. This may happen due to the potentially large commission that often comes with selling life insurance.
Non-Qualified Annuity – Quite a few of you reading this probably own an annuity. While I am not a big fan of people buying these policies, they can be beneficial for those looking for lifetime income or guarantees that are not available with mutual funds or ETFs. In general, these should only be used once the other retirement accounts, listed above, have been maxed out.
You should also be aware that in some cases they come with extremely high fees. They are often pushed by stock brokers due to their sky-high commissions. There is a new generation of fee-only annuities coming to market which were designed to be Fiduciary Rule compliant. The result will be lower commissions, and in many cases, much lower fees. It may make sense to have your old policy reviewed to see if you can slash your cost of ownership.
With 10 different types of accounts from which to choose, the process can be intimidating. The important thing is to get started and strive to save 10-20% towards retirement. I know that will be a stretch for some of you, but you can increase your retirement contributions over time.
Article Source: Forbes
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.