Planning for retirement is one of the most important financial decisions you’ll make. A well-structured savings plan can provide long-term security and generate a steady income to support your lifestyle once you retire. With various retirement accounts available—including 401(k)s, IRAs, and more—understanding their benefits and limitations can help you maximize savings and minimize taxes.
This guide outlines the different types of retirement accounts, how they work, and key considerations when choosing the best option for your financial needs.
401(k) Plans: Employer-Sponsored Savings
A 401(k) is a retirement plan offered by many employers, allowing employees to contribute a portion of their salary before and after taxes. If your employer offers a matching contribution, it’s an excellent way to boost savings.
Key Benefits of a 401(k):
- Tax Advantages: Contributions to a traditional 401(k) lower taxable income and grow tax-deferred until withdrawal.
- Employer Matching: Employer matching contributions to your 401(k) is a benefit that boosts your retirement savings at no extra cost to you.
- Higher Contribution Limits: 401(k) plans allow for larger contributions compared to IRAs.
Traditional vs. Roth 401(k):
- A Traditional 401(k) allows pre-tax contributions, with withdrawals taxed as income in retirement.
- A Roth 401(k) allows after-tax contributions, meaning withdrawals in retirement are tax-free if the account has been established at least five years and the owner is age 59.5.
Which option is best for you? Explore our Traditional 401(k) vs Roth 401(k) calculator.
Individual Retirement Accounts (IRAs)
An IRA is a tax-advantaged retirement account that individuals can open on their own, without an employer. There are two primary types: Traditional and Roth IRAs.
Traditional IRA:
- Contributions may be tax-deductible, depending on income and participation in an employer-sponsored plan.
- Earnings grow tax-deferred, and withdrawals in retirement are taxed as ordinary income.
- Required Minimum Distributions (RMDs) are mandatory withdrawals that must begin once the account holder reaches the designated age set by the IRS.
Roth IRA:
- Contributions are made with after-tax dollars, and withdrawals in retirement are tax-free, provided the account has been open for at least five years and the owner meets the required age for eligibility.
- No Required Minimum Distributions during the account holder’s lifetime, providing flexibility.
- Income limits apply for eligibility.
Beyond the Basics: Other Retirement Savings Options
If you want to save beyond a 401(k) or IRA, other accounts can offer additional tax advantages and flexibility.
SEP & SIMPLE IRAs (For Business Owners and the Self-Employed)
- SEP IRA: Employers can contribute up to 25% of an employee’s salary, subject to annual IRS limits. Maximum contribution amounts are updated periodically, so it’s best to check the latest limits with the IRS or a financial advisor.
- SIMPLE IRA: Allows both employer and employee contributions, though with lower contribution limits than a 401(k).
Health Savings Accounts (HSAs)
While primarily for medical expenses, HSAs can also serve as a retirement savings tool. Unused funds roll over annually, and after age 65, withdrawals for non-medical expenses are tax-free.
Annuities & Other Investments
- Annuities provide guaranteed retirement income but may come with higher costs and limited flexibility.
- Taxable brokerage accounts offer investment growth potential and can supplement retirement savings with more withdrawal flexibility.
Choosing the Best Retirement Account
The right retirement savings strategy depends on several factors:
- Tax Planning & Income Level: If you expect to be in a higher tax bracket in retirement, a Roth account may be beneficial. If you want to lower taxes now, a traditional account may be a better fit.
- Employer Contributions: If your employer offers a 401(k) match, contributing enough to take full advantage of it is a smart financial move.
- Diversification: Using a mix of retirement accounts (e.g., a 401(k) and an IRA) can provide tax diversification.
- Financial Guidance: A financial advisor can help tailor a retirement plan that aligns with your long-term goals.
Common Retirement Planning Mistakes to Avoid
Avoid these pitfalls to maximize your retirement savings:
- Not Maximizing Employer Matching: Failing to contribute enough to receive the full 401(k) match leaves money on the table.
- Ignoring Tax Implications: Understanding the tax impact of Roth vs. Traditional accounts can help optimize savings.
- Withdrawing Too Early: Early withdrawals can trigger unnecessary taxes and penalties.
- Failing to Adjust Investments Over Time: As retirement approaches, shifting toward more conservative investments can help protect your savings.
Start Planning for a Secure Future
Managing retirement accounts may seem complex, but choosing the right plan can significantly impact your long-term financial security. By saving in a 401(k), IRA, or other retirement vehicles now, you can build a solid foundation for a more secure future.
Explore more retirement planning strategies at the Central Bank Learning Center.
Disclaimer: The information in this article is not presented as personal, financial, tax, or legal advice and should not be relied upon as a substitute for obtaining advice specific to your situation. Additionally, this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing, or recommending any transaction or matter addressed herein.
