Nearly half of all Americans have nothing saved for retirement, and the U.S. government knows it. In fact, the Social Security Administration recently added and bolded the statement below on the front page of your social security statement to ensure you’ve been warned.
“Social Security benefits are not intended to be your only source of income when you retire. On average, Social Security will replace about 40 percent of your annual pre-retirement earnings. You will need other savings, investments, pensions, or retirement accounts to live comfortably when you retire.”
What’s worse, most employers have abandoned pension plans and the responsibility is now on the employees to aggressively save for their retirement. Saving for retirement takes time and should happen throughout your career. Then, time and compound interest work to help grow whatever savings you have.
Good news: You have several ways to save for retirement, and this article gives you an overview of seven different places to save for retirement and get tax benefits to help you reach your goals.
1. Traditional 401(k) or 403(b)
The 401(k) and 403(b) are tax advantaged retirement accounts offered by employers. You make contributions before taxes come out of your check, which lowers your taxable income. The catch is, you will have to pay taxes on this money in retirement, and you pay taxes plus a 10 percent penalty if you take money out before age 59 ½.
One great feature of these accounts is your contributions are deducted from your paycheck so you don’t have to remember to make deposits. As of 2018, the IRS will allow you to contribute up to $18,500 per year or $24,500 if you are over the age of 50. Also, if your employer matches a percentage or up to a specific dollar amount of your contributions, always contribute enough to get the free money offered by your employer. This additional money can help boost your retirement savings.
The 401(k) and 403(b) are pretty much the same. The difference is a 401(k) is offered by most private sector companies and the 403(b) is limited to employees that work for nonprofits, religious organizations, school districts and some government organizations.
2. Roth IRA
For those that qualify, it makes sense to invest in your employer’s fund to receive your matched contributions (if your employer offers a match) and then to put any extra money into a Roth Individual Retirement Account (IRA). You invest after-tax income into a Roth IRA and then are allowed to withdraw the money tax-free in retirement. Additionally, you can take out the principal invested (not the growth) after five years without penalty, giving a Roth IRA some liquidity compared to other accounts. In 2018, if you are under 50 years old you can contribute up to $5,500 per year into a Roth IRA. Anyone over 50 can contribute up to $6,500.
Income determines who can contribute to a Roth IRA. Single people who want to contribute to a Roth IRA cannot have a modified adjusted gross income (also known as MAGI, which is the income after some deductions) that exceeds $135,000, and if you are married your household’s MAGI cannot exceed $196,000. Many employees do not qualify for a Roth IRA for long if they have high salaries or a high combined household income. So if you want to get the benefits of a Roth IRA, invest in one while you are making a lower income or just starting out in your career.
Stay-at-home spouses and your own children that work (for your company or someone else’s) may qualify for a Roth IRA. In terms of where to open an IRA, we are big fans of Wealthfront. Wealthfront is a robo-adviser, which means it uses algorithms, instead of people and emotions, to balance your portfolio, allowing them to be up to eight times cheaper.
3. Traditional IRA
A traditional IRA is a tax-deferred retirement account. This means you pay taxes on your money only when you make withdrawals in retirement. While you are working and contributing to your traditional IRA, the IRS allows you to claim tax deductions for your contributions in the year they are made. Traditional IRAs do not have income limits, so you can invest in them regardless of your annual income. However, there are limits on your ability to claim your contributions as tax deductions.
Your deduction may be limited if you (or your spouse, if you are married) are covered by a retirement plan at work and your income exceeds certain levels. Your deduction is allowed in full if you (and your spouse, if you are married) aren’t covered by a retirement plan at work.
If you are single, tax deductions are no longer allowed if your modified adjusted gross income exceeds $73,000. If you are married and file your taxes jointly, your MAGI may not exceed $121,000 in order to claim the tax deduction.
4. Health Savings Account
Most don’t know this but you can use a health savings account (HSA) to save for medical expenses and retirement, effectively making it a retirement account. HSAs are best for individuals with certain high-deductible health insurance plans. In these accounts, you can save money tax-free and contribute up to $3,450 if you are single and $6,850 per year if you have a family. You can withdraw money from your account to pay for medical expenses, including co-pays for doctor visits, eyeglasses and even massages.
If you don’t spend the money, it can rollover and apply to future medical expenses. Then, at age 65, you can withdraw money without penalty, but you will have to pay income taxes if the money is used for a non-medical expense. If used for medical expenses, the money is withdrawn tax-free. If you withdraw the money before you’re 65 for non-medical expenses, you have to pay taxes and a 20 percent penalty. So it’s best to use your emergency fund for an expected expense before resorting to cashing out your HSA. If you find yourself in impeccable health in retirement and don’t need the money for medical expenses, you can reinvest the money elsewhere.
5. SEP IRA
The Simplified Employee Pension, also known as SEP, is a retirement account for self-employed individuals (think 1099 recipients) or business owners. The IRS allows you to contribute up to 25 percent of your income into a SEP or up to $55,000 per year, whichever is less. If you are a business owner contributing to your own SEP IRA, then you must also contribute to the accounts of all employees that meet certain criteria. Also, for those with a side business, it is possible to contribute to a SEP IRA in addition to your employer’s 401k, which can help you accelerate building your wealth in tax-advantaged accounts.
6. Solo 401 (k)
A Solo 401(k) is specifically for sole proprietor business owners. The annual contribution limits are $55,00 or $61,000 if you are over 50. You are allowed to make contributions as the employer and the employee. How much you can contribute in each role is based on the income of the business in a given year. These accounts can be a bit complicated to set up so it’s best to consult a company that offers them to help you.
7. SIMPLE IRA
The SIMPLE IRA stands for Savings Investment Match Plan for Employees. This tax advantaged retirement account is only available to small companies with 100 or fewer employees. They require less paperwork to get started and the employer has the flexibility to contribute matched or unmatched contributions. An employee can contribute up to $12,500 per year or $18,500 if over the age of 50.
Utilizing a retirement account can truly help you build wealth and allow you to avoid or delay taxes on your money. Whether you are just getting started and young or trying to catch up before retirement, understand your options and maximize your wealth building. Leave a comment, and share any tips, tricks or questions.
Acquania Escarne is an entrepreneur, real estate investor, and licensed insurance agent. Passionate about financial literacy, she also blogs about ways to help you improve your money habits on Medium. Follow Acquania on Twitter and Facebook for daily tips.