Budget Sidekick

Retirement Account Types

Financial Education Series

March 20, 2024

Navigating the various types of retirement accounts can be overwhelming, but understanding their features, benefits, and limitations is essential for effective retirement planning. Different account types offer unique advantages that can significantly impact your financial future.

Only 55% of Americans participate in a workplace retirement plan

The right account choice can save $100K+ in lifetime taxes

Most retirement accounts offer protection from creditors

Employer-Sponsored Retirement Plans

Traditional 401(k)

An employer-sponsored plan that allows employees to contribute pre-tax dollars from their paycheck.

Key Features:
  • Pre-tax contributions reduce your current taxable income
  • Employer matching contributions (free money)
  • Higher contribution limits than IRAs ($23,000 in 2024)
  • Additional $7,500 catch-up contribution if age 50+
  • Tax-deferred growth until withdrawal
Limitations:
  • Withdrawals taxed as ordinary income in retirement
  • 10% penalty on withdrawals before age 59½ (with exceptions)
  • Required Minimum Distributions (RMDs) at age 73
  • Limited investment options compared to IRAs
  • Plan fees can be higher than individually managed accounts

Best for: Those who expect to be in a lower tax bracket in retirement and want to reduce current taxable income.

Roth 401(k)

A variation of the traditional 401(k) that allows after-tax contributions with tax-free withdrawals in retirement.

Key Features:
  • After-tax contributions (no current tax reduction)
  • Tax-free growth and qualified withdrawals
  • Same contribution limits as traditional 401(k)
  • Employer matches go into traditional 401(k)
  • No income limits for participation
Limitations:
  • No current-year tax benefit
  • Five-year holding requirement for tax-free withdrawals
  • RMDs required at age 73 (unlike Roth IRAs)
  • Not all employers offer Roth 401(k) option
  • Cannot convert existing traditional 401(k) within the plan

Best for: Young professionals expecting to be in a higher tax bracket in retirement or those who want tax diversification.

403(b) Plans

Similar to 401(k) plans but designed for employees of public schools, non-profit organizations, and certain ministries.

Key Differences from 401(k):
  • Often offers annuity products as investment options
  • May have lower administrative costs
  • Special 15-year catch-up provision (additional $3,000/year for 5 years)
  • Often has simpler investment menus
  • Traditional and Roth versions available

Best for: Employees of qualifying non-profit organizations, especially long-term employees who can utilize the special catch-up provision.

457(b) Plans

Deferred compensation plans available to state and local government employees and some non-profit organizations.

Unique Features:
  • No 10% early withdrawal penalty before age 59½
  • Special "double contribution" catch-up in final three years before retirement
  • Can contribute to both a 457(b) and a 401(k)/403(b) simultaneously
  • Generally fewer investment options
  • Potential concerns about creditor protection (for non-governmental plans)

Best for: Government employees who want to maximize retirement contributions or who may need access to funds before age 59½.

Individual Retirement Accounts (IRAs)

IRAs are retirement accounts that individuals can establish independent of their employer, offering more control and investment options.

Traditional IRA

Key Features:
  • Tax-deductible contributions (income limits apply)
  • Tax-deferred growth until withdrawal
  • Maximum contribution: $7,000 in 2024 ($8,000 if age 50+)
  • Wide range of investment options
  • No employer participation required
Limitations:
  • Deduction phase-out for those with employer plans
  • Withdrawals taxed as ordinary income
  • 10% penalty on early withdrawals (with exceptions)
  • Required Minimum Distributions starting at age 73
  • Lower contribution limits than employer-sponsored plans

Best for: Those without access to employer plans or who want additional tax-deferred savings beyond their workplace plan.

Roth IRA

Key Features:
  • After-tax contributions (no current tax deduction)
  • Tax-free growth and qualified withdrawals
  • Contributions can be withdrawn at any time without penalty
  • No Required Minimum Distributions during original owner's lifetime
  • Same contribution limits as Traditional IRA
Limitations:
  • Income limits for contributions ($161K-$176K single, $240K-$256K married in 2024)
  • Five-year holding requirement for tax-free earnings withdrawals
  • No immediate tax benefit
  • Cannot contribute past age 73 without earned income
  • Backdoor Roth conversion needed for high-income earners

Best for: Younger investors, those expecting higher future tax rates, or anyone wanting tax-free withdrawals and no RMDs in retirement.

SEP IRA

Simplified Employee Pension IRA designed for self-employed individuals and small business owners.

Unique Features:
  • Higher contribution limits: up to 25% of compensation or $69,000 (2024), whichever is less
  • Only employers contribute (including self-employed)
  • Must include all eligible employees
  • Simple administration with minimal paperwork
  • Contributions are discretionary year-to-year

Best for: Self-employed individuals or small business owners with few or no employees who want higher contribution limits.

SIMPLE IRA

Savings Incentive Match Plan for Employees IRA designed for small businesses with 100 or fewer employees.

Unique Features:
  • Employee contribution limit: $16,000 in 2024 ($19,000 if age 50+)
  • Mandatory employer contributions: either 2% for all eligible employees or 3% matching
  • Easier administration than a 401(k) plan
  • Immediate vesting of all contributions
  • 25% penalty on withdrawals within first 2 years of participation

Best for: Small business owners who want to offer a retirement plan with lower administrative costs than a 401(k).

Specialized Retirement Accounts

Solo 401(k)

A 401(k) plan for self-employed individuals with no employees (except a spouse).

Key Advantages:
  • Highest possible contribution limits among retirement plans
  • Contribute as both employer (up to 25% of compensation) AND employee ($23,000 in 2024)
  • Can offer both traditional and Roth options
  • Loan provisions available (unlike IRAs)
  • Can accept rollovers from other qualified plans

Best for: Self-employed individuals with no employees who want to maximize retirement savings.

Health Savings Account (HSA)

While primarily for healthcare expenses, HSAs can function as powerful retirement savings vehicles.

Retirement Benefits:
  • Triple tax advantage: tax-deductible contributions, tax-free growth, tax-free withdrawals for medical expenses
  • After age 65, can withdraw for non-medical purposes (taxed like a traditional IRA, but no penalty)
  • No Required Minimum Distributions
  • Can be invested for long-term growth
  • Contribution limits: $4,150 individual/$8,300 family in 2024 (plus $1,000 catch-up at 55+)
Learn more about HSAs

Strategic Account Selection Framework

Use this decision framework to optimize your retirement account strategy:

  1. First priority: Contribute enough to employer plans to get full matching (free money)
  2. If eligible for HSA: Maximize HSA contributions for triple tax benefits
  3. Tax diversification: Balance between traditional and Roth accounts based on current/future tax situations
  4. Consider flexibility: Roth IRAs offer withdrawal options not available in other retirement accounts
  5. Maximize limits: After optimizing the above, contribute to other available accounts to reach savings goals
Explore Retirement Account Strategies

This content is educational in nature and updated as of 2024. Tax rules and contribution limits for retirement accounts may change over time. This information is not tax or investment advice. Please consult with a qualified tax professional or financial advisor before making decisions about your retirement accounts.