Many millennials find themselves confused by all the different investment and retirement accounts that exist. I mean how could they not when there are so many and each have different rules, different contribution limits, different income limits, etc. so I thought it would be helpful to create a longer post on the main type of accounts you will see, the basics about them, and how much you can contribute. This does not include every single option out there but it does have the most common ones you will see.
It is important to specify that each of these are just types of investment accounts, they are not investments themselves. You can invest in whatever investments you want inside of these accounts (based on the options they have). This is something many people get confused about in the beginning. Think of each of these as accounts as vehicles (example: 401(k) is a ford, ROTH IRA is a BMW, etc.), then the investments are the drivers that determine how fast it’s going and that speed is how much risk is taken.
Employer Sponsored Retirement Accounts/Small Business Retirement Accounts
- 401(k)
- What is a 401(k) – a 401(k) is employer sponsored defined-contribution plan. Meaning that you can only have one if your employer has it. You can make contributions on a pre-tax basis, meaning it reduces your taxable income today, but that money will be taxed at your income tax rate when you pull the money out in retirement. With a 401(k), your employer has the option to match a certain amount of the contributions you put in but not all do it.
- Contribution Limits – With a 401(k) you can put up to $19,500 a year in if you are under the age of 50, but you cannot take this money out until you are 59.5 without a 10% penalty and paying taxes.
- There is an exception to this called Rule 72t where allows you to take withdrawals before age 59.5 without a 10% penalty. Read more about it here.
- ROTH 401(k)
- What is A ROTH 401(K) -It has the same rules as a traditional 401(k) except the dollars you are putting in are post-tax instead of pre-tax. So it does not reduce your taxable income today, but this money grows and you will never be taxed on these dollars again.
- Contribution Limits – You can contribute $19,500 a year (this is just your contributions, your employer’s match adds on top of that) into the ROTH 401(k) as well. One thing to note is that even if you do ROTH, the employer’s contributions they make on your behalf (the match) will be pre-tax.
- 403(b)
- What is a 403(b) – It is basically the exact same thing as a 401(k), the only difference is that a 403(b) is used at nonprofits or tax-exempt organizations. There are both pre-tax and Roth 403(b)’s depending on the organization.
- Contribution Limit – You can contribute $19,500 a year plus the employers contributions.
- 457(b)
- What is a 457(b) – It is a deferred-compensation retirement plan offered to people who work for state and local governments. With this type of plan, you contribute pre-tax dollars from your paycheck, and that money won’t be taxed until you withdraw the money, usually for retirement.
- Contribution Limits – If you have one, you can contribute $19,500 if you are under 50. The one difference here is that you can withdraw funds before 59.5 without a penalty unlike the other accounts above.
- Solo 401(k)
- What is a solo 401(k) – A solo 401(k) is exactly what it sounds like, it is a retirement plan for those who own their own individual business and have no workers. That is the only way to qualify for it. Solo 401(k)’s are a pre-tax account which means it reduces your taxable income today, then you don’t pay taxes on it until you withdraw money in retirement. However, there are also ROTH options for solo 401(k)’s (as a reminder, ROTH means using post-tax dollars instead of pre-tax).
- Contribution Limits – You are able to contribute up to $58,000 a year into your solo 401(k) if you are under the age of 50. T
- Simple IRA
- What is a Simple IRA – It is for people who work at a small business with less than a 100 employees. This account is very similar to a 401(k) again where the contributions reduce your taxable income today, but then you pay taxes when you pull out money in retirement. You also cannot withdraw funds before age 59.5 without a penalty.
- Contribution Limits – You can contribute up to $13,500 into your Simple IRA if you are under the age of 50.
- Simplified Employee Pension IRA (SEP IRA)
- What is a SEP IRA – It is an IRA (individual retirement account) for small business owners who have multiple employees and self employed individuals. This is another pre-tax account, so it reduces your taxable income today and then you won’t pay taxes until you withdraw the funds at 59.5. Only the employer can contribute to your SEP IRA.
- Contribution Limits – Those who are eligible can contribute up to 25% of their compensation or $58,000, whichever is less of the two.
Individual Accounts Outside of Work
- Individual Retirement Account (IRA)
- What is an IRA – An IRA is a pre-tax retirement account only available for those who have earned income. An IRA has the same tax benefits as a 401(k) where your contributions reduce your taxable income today and then you won’t be taxed until you withdraw the funds in retirement after age 59.5
- There is an exception to this with a spousal IRA. This is where a spouse can contribute to an IRA for their non-working spouse (or one with little income). The working spouse’s income has to be equal to or more than the total contributions between both IRA’s.
- Contribution Limits – You can contribute up to $6,000 a year into your IRA if you are under the age of 50. But you can only contribute up to how much you make. If you make $4,000 a year you can only put $4,000 into your IRA.
- Income Limits – You can only deduct your contributions if you make under a certain income level (based on your adjusted gross income). This is if you are covered by a retirement plan at work. If you are not, check out this resource to see the income limits.
- Single – Can deduct if you make $66,000. Can partially deduct if you make between $66,000-$76,000. Can’t deduct at all if you make above $76,000 AGI.
- Married filing jointly – Can deduct if you make $105,000. Can partially deduct if you make between $105,000-$125,000. Can’t deduct at all if you make above $125,000 AGI.
- ROTH IRA
- What is a ROTH IRA – It is a post-tax individual retirement account only available to those with earned income. With a ROTH IRA you are contributing with post-tax dollars so these dollars will never be taxed again.
- The spousal rule applies here just like the traditional IRA.
- Contribution Limits – You can set aside $6,000 a year into your ROTH just like your IRA, if you are under the age of 50.
- A ROTH IRA has other rules that allows you to take out your contributions at any point without a penalty, but that does not include the growth, only your contributions. Learn more about it here.
- Income Limits – The income limits are based on your Modified Adjusted Gross Income (MAGI)
- Single – You can contribute the entire $6,000 if your MAGI is less than $125,000. The contribution begins to phase out when your MAGI is between $125,000 and $139,999. And you are no longer able to directly contribute if your MAGI is above $140,000.
- Married Filing Jointly – You can contribute the entire $6,000 if your MAGI is less than $198,000. The contribution begins to phase out when your MAGI is between $198,000 and $207,999. And you are no longer able to directly contribute if your MAGI is above $208,000.
- Note: if you are above the income limit, you can do a backdoor ROTH IRA to get ROTH contributions. This is where you put your post tax dollars into a non deductible IRA, then move it over to a ROTH IRA. Read more about this here. Stay tuned in the next few weeks for a guide on ways to get more tax-free money when you are above the ROTH limit.
- Health Savings Account (HSA)
- What is an HSA – An HSA is meant to be used for health care costs, but it can be used to build funds for retirement or retirement health care costs. In order to be eligible for an HSA, you have to have a high-deductible health insurance plan that allows it.
- Contribution Limits – For individuals under age 55, you can contribute up to $3,600 a year and for families you can do $7,200. The contributions you put into an HSA are triple tax advantaged, meaning it reduces your taxable income today, can get invested and grow tax deferred, then be used tax free on health care costs. It is a very powerful account.
As you can see, there are many types of accounts, different rules, and different contribution limits for each. Hopefully you can use this as a resource in the future as you get confused about the various types of accounts that exist.
