What will life be like when you no longer go to work every day? Your autonomy will delight you as you fill your days with activities you only dreamed of having time for during the decades of your 9 to 5 work day.
You can make your retirement years even better if you are able to save money for retirement during your working years. As you look into maintaining a strong retirement income or maximizing your retirement benefit package, you can open a brokerage account (investing account) and begin to build your nest egg.
1. Best for People with a 401(k) Option at Work: A Traditional or Roth 401(k)
A 401(k) from the company you work for is the best retirement account you can have. It allows the highest tax-incentivized contribution amount, the possibility of a loan, set-and-forget automatic withdrawals and potential company matching. If you have this benefit at work, use it and try to reach your contribution limit.
2. Best for Small Business Owners and Gig Workers: SEP, SIMPLE or Solo 401(k)
If you have a profitable main or side business and no 401(k) at work, you can start your own retirement plan even if you are your only employee. A company plan allows higher tax- incentivized deferrals and gives you an additional business expense to deduct. A SIMPLE IRA, SEP or Solo 401(k) are relatively easy to set up and maintain.
3. Best for Workers with No 401(k) Option: An IRA
If you have no 401(k) option, max out your contributions every year to an IRA that you set up yourself at a brokerage like E*TRADE, Fidelity, Vanguard or other similar places.
4. Best for a Spouse out of the Workforce: An IRA Based on Your Spouse’s Earnings
If your spouse works but you don’t, you can still contribute to an IRA. The basis of retirement account savings is that you have to earn money to put money in one. But if your spouse earns, you can use his or her earnings as if they were your own to contribute that $6,000 each year. Income limits apply in this case.
The Importance of a Retirement Account
You will still have bills even when you no longer get a paycheck. If you are lucky enough to live into your 80s or 90s, you will probably find it difficult or impossible to work for money. However, you will still need a place to live, food and medical care. These needs cost money, and they may cost more each month than the Social Security payment you receive.
The average Social Security payment is $1,503, which works out to $18,036 a year— about $5,000 above the poverty line for a household of 1. It is likely that you would also be eligible for some state assistance if you had no additional savings, but it would be nicer to age with the security of additional money in the bank to use.
Some people argue that putting money in retirement accounts when you are young ties up money you might want to use in middle age. It’s true that you will incur a 10% penalty if you take money out of a traditional plan before a certain age, but the benefit of definitely saving for retirement usually outweighs the possibility of needing the money. This is why retirement accounts are so important.
If you do need money in a company 401(k), you can usually take a low-interest loan. Exceptions also exist that allow a retiree to withdraw money early from an IRA. Retirement income, then, should represent a consistent flow that’s best for your situation. You can also speak with an investment advisor if you have questions about how to layer these investments.
Brief Comparison of Retirement Accounts
All these retirement accounts seem like an alphabet soup of letters and rules. The table below provides a general outline of the characteristics of each. An important distinction to understand is the difference between a traditional or pre-tax retirement account and a Roth retirement account.
The traditional retirement account, whether it is an IRA, 401(k), 457b, military TSP or others, gives you a tax break when you put your contributions in as a younger person. The Roth account, which can also be an IRA, 401(k) or other plan, gives you a tax break when you are old and taking money out to use.
Remember, you don’t need to keep just one retirement account. You can allocate your resources to different places if you feel that’s best for your financial situation. Remember, some people will want to use a brokerage account while others will prefer a less active retirement account.
|Roth 401(k), Roth IRA and Pre-Tax 401(k) Retirement Accounts
|Designated Roth 401(k)
|Pre-Tax (traditional) 401(k)
|Designated Roth employee elective contributions are made with after-tax dollars.
|Roth IRA contributions are made with after-tax dollars.
|Traditional, pre-tax employee elective contributions are made with before-tax dollars.
|No income limitation to participate.
|Income limits: 2021 - modified AGI married $208,000/single $140,0002020 - modified AGI married $206,000/single $139,000
|No income limitation to participate.
|Maximum Elective Contribution
|Aggregate* Employee elective contributions limited to $19,500 in 2021 and 2020 and $19,000 in 2019 (plus an additional $6,500 in 2021 and 2020 and $6,000 in 2019 for employees ages 50 or older).
|Contribution limited to $6,000 plus an additional $1,000 for employees age 50 or older in 2019, 2020 and 2021.
|Same aggregate* limit as Designated Roth 401(k) Account
|Taxation of Withdrawals
|Withdrawals of contributions and earnings are not taxed provided it’s a qualified distribution – the account is held for at least 5 years and made:Because of disability,On or after death orOn or after attainment of age 59½.
|Same as Designated Roth 401(k) Account and can have a qualified distribution for a first-time home purchase.
|Withdrawals of contributions and earnings are subject to federal and most state income taxes.
|Distributions must begin no later than age 72 (age 70 ½ if reached age 70 ½ before January 1, 2020), unless still working and not a 5% owner.
|No requirement to start taking distributions while the owner is alive.
|Same as Designated Roth 401(k) Account.
* This limitation is by individual, rather than by plan. You can split your annual elective deferrals between designated Roth contributions and traditional pre-tax contributions, but your combined contributions can’t exceed the deferral limit —$19,500 in 2021 and 2020 and $19,000 in 2019 ($26,000 in 2021 and 2020 and $25,000 in 2019 if you're eligible for catch-up contributions).
How Do Retirement Accounts Work?
Governments use policy and legislation to shape citizens’ behavior. U.S. policymakers wish to encourage Americans to save money for retirement, so they offer incentives in the form of tax breaks for those who save. Retirement goals can be lofty, but you must remember that there will be some pull on those accounts in terms of taxation, etc. You can use a retirement calculator to better understand those tax liabilities, or you can simply use the calculator to learn how much you need to retire comfortably.
Traditional 401(k)s and IRAs let you defer paying taxes on some of your earnings until you are older and theoretically in a lower tax bracket. Roth 401(k)s and IRAs let money you have already paid tax on grow and be withdrawn tax free.
Imagine you earn $60,000 a year. If you want to reduce your taxes now, and you contribute $6,000 to a traditional 401(k) or IRA this year, you reduce your taxable income for that year to $54,000. If over the next 20 years that $6,000 grows to $26,000, when you take that money out, you pay taxes on the $26,000.
If you want to reduce your taxes in the future, and you contribute $6,000 to a Roth 401(k) or IRA this year, your taxable income that year is still $60,000. Roth contributions are after-tax money. If over the next 20 years that $6,000 grows to $26,000, when you take $26,000 out, you don’t pay taxes on the original, already-taxed $6,000 or on the $20,000 that money earned.
The Roth retirement account concept is unique in the American tax world because it is one of the few ways you can earn money without paying taxes on it. In a normal brokerage account or in a traditional retirement account, when you make money, you pay taxes either at income tax rates or capital-gain rates. The Roth lets you accumulate gains without paying taxes. The $20,000 you earned in the example above is never taxed.
If you have access to both traditional and Roth versions of retirement accounts, you might decide that contributing a portion of your retirement savings to both options might be the best choice. That way you get some tax break right now while reserving the possibility of getting more tax breaks later.
Best Retirement Financial Advisers
After you decide which is the best type or types of retirement accounts for you, you’ll want to pay attention to the investment choices you’ve selected. The long-term nature of retirement account investing means that you will make fewer changes than you might in a more active stock trading account, but you still want to be aware of where your money is invested and how it is doing.
Check out our Benzinga Guide to the Best Retirement Planning Apps to choose the best robo-adviser for your retirement account success.
- securely through Beagle Financial's websiteBest For:Every Day WorkersRating:
Save Now, For Later
Gone are the days when age 60 saw you rocking on the porch with one foot in the grave. Today we live into our 90s, and we need cash to live well. Any saving you can do for retirement now will help you then, so take advantage of tax-deferred plans in retirement accounts, savings accounts, cash management accounts and more.
Frequently Asked Questions
Can you open a 401(k) on your own?
The 401(k) is a type of retirement account that is opened and operated by a company; a regular person cannot set one up. Individual people without access to a 401(k) must content themselves with contributions to an IRA. If the company you work for does not offer a 401(k), you cannot participate in one.
However, if you own a small business, you can set up your own 401(k), even if you are the sole employee. Consider setting up a Solo 401(k), SEP or SIMPLE retirement account through your LLC, partnership or other side business to increase your retirement savings.
Can you lose money in a retirement account?
Money in a retirement account is not guaranteed to go up. It may earn a great return for you; it may stay about the same; or it may go down. You can lose money, even in the best retirement accounts. Part of what determines whether you gain or lose money in a retirement account depends on the kinds of investments you choose to put the money in.
If you invest in stocks, exchange-traded funds (ETFs) or mutual funds that hold stocks, or bond funds or target date retirement funds, the money you’ve put in (the principal) could increase or decrease.
If you buy 100 shares of Gamestop (GME) stock at $170, your principal in GME is $17,000. If GME’s stock price increases to $190 and you sell those 100 shares, you end up with $19,000, which is a profit of $2,000 that increases your principal to $19,000.
However, if GME’s stock price decreases to $150 and you sell your 100 shares for $15,000, which is a loss of $2,000, then you have lost $2,000 of your principal. You come out of that investment $2,000 poorer. That can happen in any investment account where stocks are held, even a retirement account.
Unlike IRA retirement accounts where the investor can own individual stocks, most 401(k) accounts limit investment choices to ETFs or mutual funds. The same gain or loss can occur with those funds.
If you had the Vanguard 500 Index Fund Admiral Shares (VFIAX) in your 401(k) and you bought 10 shares at $350, your principal is $3,500. If the share price dropped to $250 and you sold those 10 shares, you would get back $2,500, which means you lost $1,000 of your principal.
Investing in the stock market over the long term carries risk along with potential reward, and only you know how much risk you feel comfortable with.
About Kathryn Hauer, CFP®
Kathy is an expert in finance (personal, corporate), financial planning, financial literacy, tax preparation and laws, saving and investing, retirement, insurance, careers, college education planning and financing, cannabis, gig economy, forming and running a business, credit and debt issues, blue-collar workers, and military issues. She has a strong interest in crypto, DeFi, FinTech, InsureTech, AgTech.