When securing your financial future, saving for retirement usually is a no-brainer. But between an IRA, Roth IRA, 401(k), 457(b), SEP IRA, and the other retirement vehicles, how can you know which plan or plans are right for you? The answer often depends on your income and tax situation. Read on to learn more about the various retirement plans that may be available in your area.
Plans With Pre-Tax Contributions
These plans, which include 401(k)s, 457(b) and 403(b) plans, and traditional IRAs,1 allow contributions to be made before taxes are withheld.1, 2 Contributions to these retirement plans can help lower your taxable income and/or adjustable gross income (AGI), reducing the total amount of tax you must pay. However, these contributions aren’t tax-free forever. When you begin making retirement withdrawals from a 401(k) or IRA, these withdrawals may be subjected to federal and/or state income taxes.
For 2022, 2021, and 2020, many individuals can contribute up to $6,000 to a traditional IRA (or $7,000 if they’re over age 50). For 2022, many individuals can contribute up to $20,500 to a 401(k) (and $6,500 in catch-up contributions for those over 50).2, 3
Although most people should be able to contribute to a traditional IRA (as long as their earned income is greater than or equal to the amount of their contribution), not all IRA or 401(k) contributions are tax-deductible. Individuals who have access to a retirement plan at work and/or earn above a certain income threshold may not be able to deduct the full contribution.
Plans With Post-Tax Contributions
Plans like Roth IRAs and Roth 401(k)s allow post-tax contributions of up to $6,000 (or $7,000 for those over 50) and $20,500 (with an addtional $6,500 for those over 50).3 One of the biggest benefits of these types of accounts is that gains and earnings generally can be withdrawn tax-free at retirement. In addition, Roth IRA account holders may be able to withdraw contributions at any time without paying a penalty.
To provide more income flexibility in retirement, many financial professionals recommend having a healthy mix of pre- and post-tax accounts.4 For example, if you live in a state with no income tax but plan to move in the next decade, it may make sense to draw down your traditional IRA or 401(k) first, so these withdrawals won’t be subject to state taxes.
Plans for Small Business Employees, the Self-Employed, and Contractors
Those who don’t have access to a 401(k) through work and who would like to contribute more to their retirement accounts than the $6,000 to $7,000 permitted by an IRA may qualify for one or more self-employed retirement plans.
The SIMPLE (Savings Incentive Match Plan for Employees) IRA provides some tax and financial incentives for employers to contribute to traditional IRAs that are set up to benefit employees.5 The similarly-named SEP (Simplified Employee Pension) IRA also allows individuals to contribute to a retirement plan of sorts for themselves or on their employees’ behalf. A SEP IRA allows a contribution of up to 25 percent of the employee’s pay, providing a potential savings vehicle for those who don’t have access to a 401(k).6
When retiring, no one-size-fits-all solution exists. By exploring some of your options when it comes to retirement plans, you’ll be better equipped to make decisions tailored to your financial situation, tax liability, and future goals.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change. 1 https://www.irs.gov/retirement-plans/how-much-salary-can-you-defer-if-youre-eligible-for-more-than-one-retirement-plan
2 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits 3 https://www.irs.gov/newsroom/401k-contribution-limit-increases-to-19500-for-2020-catch-up-limit-rises-to-6500
4 https://www.thebalance.com/pre-tax-vs-after-tax-investments-what-s-this-mean-2388974 5 https://www.irs.gov/retirement-plans/plan-sponsor/simple-ira-plan 6 https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-sep
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