Making Cents of Retirement Accounts
June 20th, 2021 by D.C. Poc
As you follow along with us in the future, you will quickly realize how much we stress the importance of retirement savings. This is for various reasons including the present-day tax savings, achieving the “set it and forget it” mindset, diversity, etc. If you are new to this, the vast array of choices can be kind of intimidating. I’m going to summarize the most common types of retirement accounts below, hopefully opening your eyes to a world of possibilities!
This is probably the most common among the accounts we’ll discuss. These are extremely popular as more and more employers are offering them each year. 401(k) accounts have something called ERISA protections, which in short, ensures the account provider acts in your best interest. The maximum contribution permitted by the IRS for 2021 is $19,500 with a catch-up of $6,500 for those age 50 and older. 401(k) contributions are tax-deferred, meaning you don’t pay tax on the contributions until you withdraw in retirement. Some plans offer a Roth 401(k) option, in which employees can make an after-tax contribution in-lieu of or in combination with their traditional, although still not exceeding $19,500 (or $26,000 for age 50+). In short, these accounts provide a simple way to defer tax on up to $26,000 per year depending on your age. Even more advantageous is an option called the “Mega Backdoor Roth”. This option allows you to contribute even more, all the way up to the combined employee/employer contribution limit, which at the time of this writing is $57k for those under 50, and $63.5k for those 50 and older.
Traditional & Roth IRA
These accounts are gaining popularity by the day, and rightfully so. With quality brokerages like Vanguard, Fidelity, and Schwab offering these accounts, saving for retirement doesn’t have to be hard! The maximum contribution per the IRS for 2021 is $6,000 with a $1,000 catch-up for those 50+. In order to contribute to one of these accounts you must have earned income (spouses income counts if married filing joint) of at least your contribution amount. (EXAMPLE: your spouse earns at least $12,000 per year but you don’t work. You can still contribute $6,000 for your spouse, and $6,000 for you.) The Traditional IRA is sometimes tax deductible based on several factors, and is taxable upon withdrawal at retirement. The Roth IRA is filled with after-tax money, meaning it will grow tax-free and be withdrawn tax-free at retirement. For this reason, the Wealthy Idiots are huge proponents of the Roth IRA!
NOTE: There are income limits which determine eligibility to contribute to Roth IRAs. If you are over, don’t fret, you can utilize the Backdoor Roth IRA.
403(b) & 457(b)
These plans are most commonly associated with those working in public education, the nonprofit sector, or certain ministries. These plans function much like the aforementioned 401(k) plans, however, there are some key differences. For instance, 401(k) plans have ERISA protections which protect the account owners. Many 403(b) and 457(b) plans do not have this protection, and therefore, can be less advantageous to the investor, often having higher expense ratios and charging maintenance fees. Additionally, non-governmental 403(b) and 457(b) plans lack some “financial protections” that are afforded to those plans within the government. With these plans, it’s more important to explore the vendors that are available and decide which is best based on the structure, fees, and their specific agreement with your organization.
Self-Directed IRA/Roth IRA
This is similar to your basic IRA/Roth IRA, except, you’ll get the opportunity to invest in other investments not normally allowed by IRA providers. For example, let’s say you had $175k in a Self-Directed Roth IRA. You take $125k and buy a house that needs a little work. You then use the remaining $50k to renovate. Now that your project is complete and the home is HGTV-worthy, you list it for $300k and get an early, full price offer. You’re ecstatic! But wait… you also won’t pay tax on the flip! Instead, the entire profit will be returned to your Self-Directed Roth IRA. Let’s assume that after fees you had a net profit of $275k. Your Roth balance just lept from $175k to $275k in a much shorter period of time than previously imagined. You can now take this $275k, and continue to pursue other types of investments.
Taxable Brokerage Account
This is an account that is offered by nearly every big banking/investment institution. With these accounts, you have the ability to invest in stocks, ETFs, and mutual funds. These “taxable” accounts can be very tax efficient if you are using total market ETFs or mutual funds. This account is more flexible as the money can be accessed at any time, not just retirement age. I am a huge proponent of brokerage accounts and I think everyone should have one!
Don’t forget to protect your future self, financially. Start saving in your available retirement accounts today!
D.C. joined the Marine Corps right out of high school. When he left active duty, after 5 years of service, he quickly earned a bachelors degree and an MBA. He got his first private sector job at a modest salary and quickly worked his way up through promotions. Once he started making decent money ($38k at the time) he quickly realized he needed to learn how to save to secure his future. After nearly ten years of research, he wants to share his knowledge and financial best practices so more people can become Wealthy Idiots!