Are you wondering what type of retirement plan is best for you? In this blog, we’ll cover the primary types of retirement savings plans: IRAs and 401(k)s. Keep reading to learn how each type of retirement account works, the benefits and tax considerations, and who they are best for.
What is an Individual Retirement Account (IRA)?
An IRA is a type of personal retirement account that offers certain tax advantages as well as the chance to earn competitive dividends on your savings. There are two main types of IRA accounts, Traditional and Roth. Each has different requirements and offers its own unique benefits.
Traditional IRAs: Good for Everyone
A traditional IRA is available to anyone who earns income. Whether you are a full-time employee, an independent contractor, or self-employed, you can open an IRA to start saving for retirement. IRAs are fairly low maintenance, especially if you choose an index fund, mutual fund, ETF, or CD. A financial advisor can also help you manage your IRA, set goals, and more.
Contributions to a Traditional IRA may be tax-deductible. For 2023, the annual contribution limit for a traditional IRA is $6,500. People age 50+ can make an additional $1,000 “catch-up contribution,” bringing the limit to $7,500.
If you or your spouse have a 401(k) or pension plan through an employer, you can still contribute to your IRA but your allowable deduction may be lower depending on your Modified Adjusted Gross Income. Consult with a tax advisor to learn more.
Once you turn 59 ½, you can take withdrawals from your IRA without penalty. If you haven’t touched the account by age 73, you’ll be required to start taking Required Minimum Distributions. Withdrawals are taxed as current income.
The only exception to the age limit for penalty-free distributions is up to $10,000 for first-time homebuyers. Just keep in mind that you’ll still have to pay income taxes on the amount you withdrew.
Roth IRAs: Enjoy Tax-Free Growth
With a Roth IRA retirement account, your contributions come from post-tax income, so you don’t see tax advantages now but get to enjoy tax-free growth and untaxed withdrawals in retirement.
A Roth IRA is a good option if you think you will be in a higher income tax bracket in retirement than you are now. Penalty-free withdrawals begin at age 59½ as long as you’ve had the Roth for at least five years. There is no mandatory withdrawal at any age. You can pass your Roth IRA to an heir, and they will also enjoy tax-free withdrawals.
Like a Traditional IRA, you can open and manage a Roth IRA on your own or work with a financial advisor. The annual contribution and catch-up contribution limits are the same. However, your income dictates whether you can contribute at all and how much. For single filers, your contribution limit starts to decrease at $138,000 in annual income and $218,000 for joint filers.
401(k): A No-Brainer If Your Employer Offers One
A 401(k) is an employer-sponsored retirement savings account. Like a Traditional IRA, your contributions are made from pre-tax money and can reduce your federal taxable income. Many employers offer a 401(k) match for a certain percentage of your salary. For example, if the employer match is 3%, you must contribute at least 3% to get the full employer match. This is why a 401(k) is a no-brainer if your employer offers one. If you’re not at least taking advantage of the whole match, you’re leaving money on the table. You can choose from a variety of mutual funds and indexes to invest in. 401(k)s don’t require a lot of maintenance, but you may want to work with a financial advisor to determine your risk tolerance, choose what to invest in, and rebalance your portfolio once a year.
Public school employees and certain non-profit organizations may have the option of participating in a 403(b), which is like a 401(k).
In addition to a traditional 401(k), you may have the option to contribute to a Roth 401(k), which offers the same tax advantages as a Roth IRA. If you’re looking for tax free retirement accounts, a Roth IRA and Roth 401(k) are both good choices.
One cool feature of 401(k) is that employer contributions don’t count toward the annual limit. The 2023 retirement contribution limits for 401(k)s and 403(b)s are:
- $22,500 for employees under age 50
- $30,000 for employees age 50+ who utilize the catch-up contribution
How To Open a Retirement Account
You can open a Roth or Traditional IRA from SkyOne–request an IRA Kit. To participate in your employer’s 401(k) or 403(b) plan, contact your HR representative.
FAQs About Retirement Accounts
Still have questions about saving for retirement? See our answers to common questions below.
Should I max out my IRA and 401(k) contributions?
Saving anything for retirement will help you in the long-term. While maxing out your contributions is a great goal to reach for, don’t stress if you aren’t there yet. Just contribute as much as you can.
What are the penalties for withdrawing money before the requirements?
With some exceptions, you can expect to pay a 10% early withdrawal tax, in addition to income tax (except for Roth) on withdrawals from your retirement account before age 59 ½.
Can I convert a Traditional IRA to a Roth IRA?
Yes, you can convert some or all of your Traditional IRA to a Roth IRA. You will have to pay income taxes upon conversion, but then you’ll get tax-free growth and withdrawals in retirement.
Should I have both a Traditional IRA and a Roth IRA?
Maintaining both a Traditional and Roth IRA will help you maximize your options and diversify your tax liabilities in retirement. So, if your income doesn’t exceed the ceiling for contributing to a Roth, it could be a good idea to have both types of IRAs. Talk to a financial advisor to learn more.
Open a Traditional or Roth IRA today with SkyOne!
Ready to start saving for retirement or add to your existing portfolio? Open an IRA from SkyOne Credit Union in Los Angeles or online. Looking for personalized advice on retirement savings and other financial goals? Contact our CFS Wealth Management team.
In addition to saving for retirement, make sure to open a regular savings accounts for your emergency fund. If you can deposit $1,000/month, earn a higher interest rate with our Sky-High Savings Account. Since you can’t tap your retirement savings until age 59 ½, you need to have a financial cushion to handle emergencies and temporary losses of income.
Non-deposit investment products and services are offered through CUSO Financial Services, L.P.(“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The credit union has contracted with CFS to make non-deposit investment products and services available to credit union members.