There are a variety of ways to save and various accounts to choose from to build a nest egg for retirement. Making decisions about how much to set aside and which accounts to open will depend on your income, ability to contribute and the retirement lifestyle you envision.
Some common retirement accounts include:
- 401(k).
- Traditional IRA.
- Roth IRA.
- Health savings account.
Here’s how to decide which accounts to use to save for retirement.
Understand the Limits of Only One Retirement Account
Opening a single retirement account is a great way to get started on saving for retirement. It’s simple to keep track of just one retirement account. However, there are potential drawbacks to consider if you put all your savings in a sole spot. For instance, if you keep all your retirement savings in a 401(k) or traditional IRA, you may be able to deduct the amount you contribute from your taxable income for that year, provided your income qualifies. When you withdraw funds in retirement, the amount you take out will be subject to income tax. If tax rates increase in the coming decades, you could end up paying more in taxes than planned.
With a Roth IRA, the contributions are made with after-tax dollars, and the withdrawals in retirement are generally not subject to income tax. You can also make contributions to a health savings account and claim a tax deduction for that year. The money can grow tax-free and be taken out for medical expenses tax-free. You are only eligible for a HSA if you have a high-deductible health plan.
There are also IRA contribution limits and income caps to consider. The IRA contribution limit is $6,000 in 2021 and 2022, or up to $7,000 if you are 50 or older. However, once your income reaches a certain point, you’ll no longer be eligible to make Roth IRA contributions. If your modified adjusted gross income is $140,000 or more in 2021 or tops $144,000 in 2022 and you file taxes as a single person, you won’t qualify to make a Roth IRA contribution. If you are married and file taxes jointly, the Roth IRA income limit is $208,000 in 2021 and $214,000 in 2022.
Evaluate the Benefits of Multiple Retirement Accounts
If you max out one type of retirement account, it could be worthwhile to open more accounts. Saving in several types of retirement accounts also provides a chance to diversify your savings and tax allocations. “It can be beneficial to have multiple retirement accounts, as they all provide different benefits that a person may need to take advantage of,” says Matt Nadeau, a financial planner and wealth advisor at Piershale Financial Group in Barrington, Illinois. For example, you might max out your contributions to a company 401(k) and contribute to an HSA in the same year.
However, there could be some disadvantages to owning multiple retirement accounts. It can be difficult to keep track of investments held in too many different retirement accounts. If you change employers and leave your 401(k) account with the former company, you could end up with several 401(k)s if you change jobs frequently. It might be time consuming to check how your money is allocated across several accounts.
Should I Contribute to Both a 401(k) and IRA?
If your employer offers a 401(k) plan, you might be able to save in a 401(k) and an IRA. “They both provide advantages,” Nadeau says. It may make sense to begin by contributing to the 401(k), especially if the company provides a 401(k) match. Some employers offer to match contributions to the account, up to a certain amount. The contribution limit for a 401(k) is $19,500 in 2021 and $20,500 in 2022, and the contribution limit climbs to $26,000 in 2021 and $27,000 in 2022 if you are 50 or older. The 401(k) contribution limits are higher than some other types of retirement accounts, including the IRA, which has limits of $6,000 in 2021 and 2022, or $7,000 if you are at least age 50.
After you max out your contributions to a 401(k), you might pursue the option of contributing to an IRA. “You can always contribute to an individual IRA,” says Michele Lee Fine, founder and CEO of Cornerstone Wealth Advisory in Jericho, New York. However, you might not be able to deduct the IRA contribution from your taxable income for that year if you earn too much. If you and your spouse are covered by a work retirement plan, the IRA tax deduction is phased out if your adjusted gross income exceeds a certain amount. If you have a 401(k) and make $76,000 or more in 2021 ($125,000 for couples), you won’t be able to deduct your traditional IRA contribution from your income taxes for that year. In 2022, the adjusted gross income limits are $78,000 for individuals and $129,000 for married couples filing jointly.
