In this article, we outline some options for using retirement savings plans to save for future needs.
Where should I save for retirement if I’m employed?
A financial advisor can help provide you with information specific to your situation and also, provide you with practical advice so you know exactly what steps you should take right now to plan for the future. This article is intended as general information only, not specific advice.
One of the first questions I hear from new clients is: How much should I save for retirement? Once that question is addressed, the second part is: where should I save for retirement? Where a person saves can have many impacts and must be carefully considered. Here is a rundown on some of the basic retirement savings plans that might be available – but they don’t include a piggy bank!
Note that if you are married, there may be additional options open to you based on your spouse’s work situation.
401k or 403b Option
If your employer offers a 401k, 403b, or other defined contribution plan, that’s often the first place to consider saving. Contributions to this account can come directly out of your paycheck, making it easy to save automatically. Often these plans will offer both a pre-tax and after tax (Roth) savings option. Depending on your tax situation now and what you expect it will be later, one of these may be a better choice. Consult an advisor and talk to your company’s representative for more information.
Many employers also offer matching contributions or profit sharing, meaning that the employer may contribute to your retirement savings account in addition to whatever you are contributing from your paycheck. This can be a great benefit that you might not earn if you didn’t participate in your employer’s retirement savings plan.
There are limits to the amount you can contribute annually to a 401k, in 2023 $22,500 for those under age 50. Your employer contribution is separate and doesn’t count towards the maximum you can contribute.
In addition to pretax and after tax Roth contributions, your employer may allow another type of contribution that would allow you what’s called “mega backdoor Roth capability”. This capability allows you to make after tax contributions, and immediately convert the contributions to a Roth election. It’s especially valuable for those who are high income earners and already contributing the maximum permitted in traditional contributions.
If your company doesn’t offer a retirement savings plan, consider opening an IRA (Individual Retirement Arrangement) or Roth IRA. According to the IRS (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits), in 2023, the maximum amount you can contribute to these accounts is either a) $6,500 for those under age 50 ($7,500 for those 50 and over), or b) your taxable compensation for the year, if your compensation was less than this dollar limit. The main difference between IRAs and Roth IRAs is related to when taxes are owed on the money you contribute and the earnings.
IRAs (https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras) are pre-tax, meaning that the money you contribute does not have taxes removed before you contribute. When you withdraw money from this account in retirement, you must pay taxes on withdrawals.
Roth IRAs (https://www.irs.gov/retirement-plans/traditional-and-roth-iras) use contributions after tax has already been taken out. When you retire, no taxes are owed on the withdrawals.
For either an IRA or a Roth IRA, it can be helpful to set up automatic contributions to the account directly from your checking account so you are regularly, and automatically, contributing. There are many other nuances and rules associated with these accounts, so be careful to follow IRS guidelines (https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras). Be especially aware of the income limits for IRA contribution deductions and Roth IRA contribution eligibility.
SEP IRA and Simple IRA Accounts
If you’re self-employed, there may be other options available for you, such as a SEP IRA (Simplified Employee Pension Individual Retirement Arrangement) or a Simple IRA (Savings Incentive Match PLan for Employees Individual Retirement Arrangement). Here is some basic information about these types of accounts. Check irs.gov for more information.
SEP IRAs (https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-sep) can work for businesses with no or few employees, and require the employer to contribute to the account, up to $66,000/year per IRS rules in 2023. Simple IRAs (https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-simple-ira-plan) can be better for larger businesses, and permit employees and employers to contribute at different levels. Employees/participants can contribute up to $15,500/year, while the employer must contribute a specific amount (with caveats) such as a 3% match or 2% flat contribution per IRS rules.
Note that the federal government establishes annual contribution limits, early withdrawal penalties, and other rules which must be followed when contributing to – or withdrawing from – a retirement account.
Most importantly, begin now and start saving consistently.
Your Specific Situation
There are many additional factors that impact where you choose to save your retirement money, including tax implications now and later; earning potential of your savings in these accounts; and what withdrawals are allowed before and after retirement. To really get a complete picture of your personal financial situation, a financial planner or tax professional can help. Consult with yours to ensure you’re making a decision that is best for your financial health, both now and in the future.
The information and illustrations presented above are hypothetical and do not represent the return on any particular investment nor specific financial advice. All investing is subject to risk, including the possible loss of the money you invest.