The Complete Guide to Investment Options for Retirement

Retirement may seem like a far off place in some distant future that has absolutely nothing to do with us but before you know it, you’ll be 59 and your retirement will be staring you in the face.

Will you be ready? Will you have enough saved so that you can live out your retirement free from financial worries?

Many of us don’t look so far ahead. But we should. Because if we are going to be ready for our retirement in the years to come, we are going to have to start preparing now.

Is it better to invest in a 401k or an IRA? Matter of fact, what is a 401k? And what’s the difference between a Roth IRA and an IRA? What is a brokerage account?

There are lots to consider when investing for your retirement and you will want to make sure that you at least know the basics.

Don’t worry. In this blog post, we’ve got you covered.

Your Retirement Account Options

Where Can I Invest My Money?

There are many places that you can put your money if you are looking to invest – a 401k/Roth 410k, IRA/Roth IRA, HSA, a Brokerage.  Some come with great benefits such as being tax deductible or tax-free.

Others, allow you to really maximize the return on your investments.  And others still, provide you with the diversification to keep you sane in times of high volatility.

Check out the table below to see what your options are as far as investment vehicles (where you park your money) and the benefits each one provides.

¹Contributions are pre-tax (or tax deductible) but withdrawals are taxed.

²Contributions are made with after tax dollars so future earnings withdrawals are tax free.

*Contribution limits listed are for the 2020 tax year and can be made anytime this year up to April 15, 2021.

This is just a brief overview of several investment options but there’s so much more to each of these that we will cover below.

What is a 401k?

A 401k plan is an employer-sponsored tax deferred retirement account named after the tax code from which it came.  It gives you some control over your investments and can help you automate your savings for retirement.  

You can set up automatic withdrawals from your pay checks to be put into your 401k account.  These contributions are made with your pre-tax dollars and so this reduces the amount of taxes you will owe.  

Once the money is in your 401k account, you can choose how you want to invest it. 

This varies by company but they usually offer a variety of investment options from stocks and bonds index funds , your company’s stock, target date funds, or guaranteed investment contracts.

The Employer Match

The best part of a 401k is the employer match.  Many companies will offer to match a portion of your contribution.  Free Money Honey!!

Some will match 100% of your contribution amount up to 6% of your salary, others maybe 50%, and so on. Note that some employers required vesting.

Meaning you must work for them for a specific amount of time before you have access to their match. Check with your employer to find out more about employer matching and always always contribute enough to get the employer match.

The downside of the 401k is that the fees for having the account can be high. This will greatly impact the growth of your money over time. Furthermore, it can be hard to withdraw your money from these accounts before the retirement age of 59 ½.

Doing so will result in a 10% penalty and taxes on the amount withdrawn. Also, starting from the age of 70 ½ you will be required to take distributions from your 401k whether you want to or not.  

The amount is determined by your life expectancy.  If you are still working though, you may not have to take your required distributions.

Be sure to name a beneficiary!

What is a Roth 401k?

The Roth 401k is virtually the same as the regular 401k with one big exception.  The contributions you make to a Roth 401k is made with after tax dollars, meaning this money has already been taxed.  

What this means then is that when you take money out, it will be tax-free, as you cannot be taxed twice.

What is an IRA?

IRA stands for Individual Retirement Account.  You may want to open up an IRA account in addition to your 401k as they offer more investment options and can act as an additional source of income in retirement.

You can open one with $0 but you need to start adding money and choosing investments to take advantage of this tax advantaged vehicle.

There are 4 main kinds of IRAs: Traditional IRA, Roth IRA, Simple IRA, and the SEP IRA.  Like the 401k, it is a tax-deferred retirement account so money is allowed to grow tax free in the account but it will be taxed upon withdrawal (except for Roth IRAs).

However, unlike the 401k there are income restrictions placed on Traditional IRAs (for deductions) and Roth IRAs (for contributions). In general, you must have earned some type of income to contribute to an IRA. Gifts don’t count.

Traditional IRAs 

Your earnings growth is tax-deferred in this retirement account.  Anyone no matter their income can contribute to an IRA; however, the amount you can deduct from your taxable income depends on how much you make.  

Your contributions are fully deductible on your taxes if, as a single filer, you make less than $64,000 and as a married couple filing jointly if you make less than $104,000. Partial deductions can be taken for income up to $75,000 (single filer) and $124,000 (filing jointly).

Check out the tables below as these values change if you or your spouse are covered by a retirement plan at work.  With traditional IRAs, withdrawals are taxed as income and penalties apply if taken out before you are 59 ½.  

There are exceptions to this 10% penalty rule check IRS Pub 590 for more details.

Income Limitations for Tax Deductible Contributions For IRA (2020)

If you are covered by a retirement plan at work...

If you are not covered at work...

~ Note: If a contribution is made and withdrawn in the same tax year (before you file your taxes), there will be no penalties and it will be treated as if the contribution never happened.

Roth IRAs

Contributions to this retirement account are made with after tax dollars so future withdrawals are tax-free after 59 ½.  The good thing about Roth IRAs is that if necessary you can withdraw your regular contributions penalty free after 5 years.  

Also, you can make early withdrawals of contributions and earnings without a penalty if your account has been opened for at least 5 years and it is used for medical bills, a down payment on a house or other qualified distribution.  

The downside is Roths aren’t available to everyone.  Check out the table below for the income restrictions. If you are a single filer and make between $122,000-$137,000 (for 2019), you can make a partial contribution.

For married filing jointly (for 2019) it’s between $193,000-$203,000 for a partial contribution. Anything less and you are eligible for the full contribution.

Contribution Limits Based on Your Income

~Note: If you don’t qualify for the Roth IRA because of your income, you can do a Backdoor Roth to lock in future tax-free status. You will have to pay taxes on the amount you rollover though.~

SEP IRAs

These are for self-employed people and small business owners. Like the traditional IRAs, contributions to your SEP (Simplified Employee Pension) is deductible and earnings grow tax free but you are taxed for withdrawals later.

If you have employees you must contribute the same percentage that you are contributed to yours. Employees cannot contribute to their own accounts.

The amazing thing about SEPs is the annual limit is $56,000 for 2019. However the catch is you can’t contribute more than 25% of your earnings. SEPs are also subject to the same required minimum distributions as traditional IRAs.

SIMPLE IRAs

SIMPLE stands for Savings Incentive Match Plan for Employees. Similar to SEPs it is for small business with 100 employees or less. Unlike the SEP plan, in this one, employees can contribute to their own retirement account.

For the 2019 tax year they could contribute up to $13,000 with rules just like a traditional IRA. They are also subject to required minimum distributions once you turn 72 years old.

IRA Rules

• Contribution Limits (for all IRA accounts combined):  $6,000 or $7000 (over 50)
• For Roth IRAs: Withdrawals of contributions can be taken after 5 years and for qualified uses
• Unqualified withdrawals before 59 ½ subject to 10% penalty and a tax bill (unless it’s a Roth)

Note: The Contribution and Income Limits change every year so make sure to check regularly!

There are a few more IRAs that I wasn’t able to touch on in this post but have covered in a separate post. If you are interested in knowing more about loopholes for non-working spouses and for people whose income disqualifies them from a Roth check out my other post here!

What is an HSA?

The HSA is the BEST account ever created in my opinion. Not only does it offer a triple tax benefit but it also provides great opportunities for those of us in pursuit of FIRE. 

Contributions to an HSA are tax deductible, your contributions and earnings are allowed to grow tax free, AND your withdrawals are tax-free for qualified medical expenses.  

However, once you turn 65 it converts to a regular retirement account and your nonqualified withdrawals are subject to income tax. 

The max contributions for HSAs in 2020 are $3,550 for an individual and $7,100 for families. For people over the age of 55 the catch contribution is $1,000.

There are no time limitations as there is with an FSA (Flex Spending Account).  Anything unspent in the account rolls over to the next year.

Also, anyone can contribute to your HSA though the contribution limits still apply. The penalty for making non-qualifying withdrawals is 20% plus taxes.

Who Qualifies?

Not everyone can open an HSA account.  It is restricted to those who have a High Deductible Health Plan (HDHP) with deductibles starting around $1,400.  Furthermore, for some plans, you will need to keep your receipts as proof in order to be reimbursed.  

* This may not be suitable for people with serious illnesses that will have major expenses quite frequently.

Try to find a provider that doesn't charge monthly maintenance fees.

What is a Brokerage Account?

A brokerage account is a place where you can buy and sell assets.  It can be opened individually or jointly with a spouse or relative.  When you open an account at a brokerage you will be able to invest your money in stocks, bonds, and mutual funds.  

Having your own brokerage account gives you the ultimate control over your investments.  You aren't subjected to contribution limits of a retirement account and can withdraw your money without any penalties. 

Although it is not tax efficient, I recommend using a Brokerage account if the fees for your 401k are too high and if you have already maxed out your Roth IRA.

In Conclusion

The beauty of using tax-deferred accounts is that your earnings can compound and grow a lot faster than if it were in a taxable account. However, the IRS is still gonna want their money so you will be taxed on your withdrawals. 

That’s why it’s good to not only have a tax-deferred retirement account but a tax-free one as well.  That way if necessary you can choose to withdraw from your tax-free account and skip out on paying taxes.

While there are many options out there, you will want to make sure you chose the right one for you.  We are all going to retire someday.  So we had best prepare for that day, now.

Related Questions

What happens to my 401k if I’m let go, change jobs, or my company goes under?

If this happens, don’t worry.  There are 4 ways you can handle this: Roll it over into an IRA, roll it over to your new company’s plan, leave it with your old company (unless it’s gone under of course), or withdraw it.  

The money you have in your account is safe and you can simply roll it over into an IRA. Doing this will avoid the 10% penalty and taxes.

What about 403b retirement accounts?

A 403b plan is quite similar to a 401k.  It is a tax-deferred retirement account provided by nonprofits, educational institutions, religious groups, and governmental organizations. 

The 403b plan helps save your employer money because there are less administrative fees associated with them. 403b plans are generally exempt from the regulations of the Employee Retirement Income Security Act (ERISA). 

This means they do not have to do nondiscrimination testing to prevent management from getting way more benefits than regular employees. However, if your employer has a matching program they must follow the regulations of ERISA.

Contributions to your 403b can be made with pre-tax dollars up to $19,500 in a given year with the same restrictions as the 401k on early withdrawals.

In addition, a benefit that is not offered with the 401k, with 15 years of service you would qualify to add an extra $3000 to your 403b plan.

403bs have a reputation of having very limited investment options in the form of high cost annuities but in the recent years they have added lot more low cost index funds to their plans.

What is a 457?

A 457 retirement plan is a plan offered by the state and local governments and some nonprofits. The contribution limits work the same as a 401k however if your company has both options, you can contribute $19,500 to both the 401k and the 457 plan.

Furthermore, if you are within 3 years of retirement you can double up on your contributions for a max of $39,000.

The 457 plan also allows you the benefit to withdraw your contributions with no penalty if you no longer work for your employer. A downside of this plan is if your employer does contribute to your plan it decreases they amount that you can contribute.

Is there a penalty for contributing over the limit for IRAs?

Yes, your account will be taxed 6% per year as long as the excess contribution amount remains in your account.  To avoid this tax, be sure to take out the excess amount by the tax filing deadline.

Can expats open a retirement account?

As an expat, you can open and fund a retirement account as long as a portion of your income is taxed in the states.