The Basics of Retirement Accounts

Retirement isn’t all front porches and lemonade. It starts with a swirl of financial considerations, options, and retirement accounts.

Whether it’s your first day on the job or your last, retirement savings should always stay near top of mind. Generally speaking, it’s ideal to sock away 10% to 15% of your salary starting early in your career.¹ Most people spend about 80% of their pre-retirement yearly income each year during retirement.² Social Security, pensions, and other forms of passive income may help cover costs during retirement, but you’ll still need your savings to maintain a life you’re accustomed to.

Fortunately, there are many ways to stash your retirement savings along the way. Understanding the basics of retirement accounts is the first step toward maximizing your retirement savings.

Individual Retirement Accounts (IRAs)

IRAs are specialized savings accounts that provide tax breaks as you save for retirement. They come in two flavors: traditional IRAs and Roth IRAs.

Traditional IRA

• Deduct your contributions from your taxable income the same year you deposit them
• Lower tax bill in the present
• 10% penalty if you withdraw before you turn 59½ years old, and you will be taxed on the money

Roth IRA

• Contributions are NOT deducted from yearly taxable income
• Tax-free withdrawals once you hit 59½ years old (provided you’ve been saving in the account for at least five years)

As of 2020, you can save up to $6,000 a year in an IRA — Roth or traditional. Over the age of 50? The government allows an extra $1,000, raising the IRA contribution max to $7,000. IRAs take advantage of compounding interest — so the earlier you contribute, the more money you’ll collect over time.³

IRA eligibility

Keep in mind that not everyone qualifies for an IRA. In 2020, if you have an annual income of more than $139,000 as a single person or a combined income of $206,000 as a married couple filing jointly, you may not contribute to an IRA.⁴

401(k) Accounts

401(k)s work similarly to IRAs, but are instead sponsored by employers and are often funded directly from a portion of your paycheck. Like Roth IRAs, 401(k)s grow tax-free, allowing you to earn without paying capital gains tax.⁵

Some employers will even match your 401(k) contribution, so if you can contribute enough to maximize the match each year, it’s a no-brainer. That’s free money for your future self.⁵

How much can I contribute to a 401(k)?

The maximum you can contribute depends on your salary and your employer’s policies. In 2019, the government limited the absolute 401(k) maximum contribution to $19,000, though people over the age of 50 could contribute an extra $6,000 with their employer’s permission.⁵

Some employers may automatically enroll you, while others will ask you to enroll on your own. Either way, talk to your employer to see what they offer.⁶

Regular Investment Accounts

IRAs and 401(k)s come with maximum annual contribution limits, while traditional investment accounts do not. You’ll want to bolster your retirement savings in a place that won’t cap your earnings, even if it doesn’t come with the same tax advantages.⁷

Certificates of Deposit (CDs) are a great place to start. CDs offer a fixed interest rate that can insulate you against market fluctuations, paying out the same steady interest regardless. Like IRAs and 401(k)s, early CD cash-outs come with a penalty. But for the savvy investor, you can actually invest your IRA in a CD to take advantage of tax-deferred growth. But we recommend you take that to a financial advisor before you make any moves.⁸

Retirement Account Recap

401(k)s, IRAs, and standard investment accounts all carry separate advantages when it comes to retirement planning. Here’s a handy takeaway chart of yearly contributions as of 2020:

Remember, there’s nothing wrong with having more than one retirement account. Most prudent savers will utilize two or more. See where you can trim the fat today, and beef up your savings for retirement. You’ll thank yourself for it when the big day finally arrives.

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