Retirement Savings Options in the U.S.: Maximizing Your Future Financial Security

 The end of the year is fast approaching. Just as we get a health check-up every year, it’s advisable to review your financial situation and plan for taxes as the year changes.

Saving for retirement is a critical step in ensuring a stable financial future. The U.S. offers a range of retirement accounts and savings options, each with unique benefits, tax advantages, and suitability for different employment situations.

1. Individual Retirement Accounts (IRAs)

IRAs are retirement accounts designed for individuals. They can be opened independently of your employer and offer flexibility in terms of contributions, investments, and tax advantages.

(1) Traditional IRA

• Tax Advantages: Contributions are tax deductible, which means they can reduce your taxable income for the year. However, distributions in retirement are taxed as ordinary income.
• Contribution Limits: For 2024, your earned income or $7,000 (or $8,000 if you’re 50 or older), whichever is lower.
• Phase-out: If you’re covered by a retirement plan at work, single filers with Modified Adjusted Gross Income (MAGI) $77,000~$88,000 (partial) & above $88,000 are not eligible to contribute, and married couples filing jointly (MFJ) $123,000~$143,000 (partial) & above $143,000 are not eligible to contribute. If you’re not covered by a retirement plan at work, only MFJs with over $240,000 are not eligible.
• Withdrawals before age 59½ may be subject to a 10% early withdrawal penalty, along with income tax. Required Minimum Distributions (RMDs) begin at age 73.

(2) Roth IRA

• Tax Advantages: Contributions are made with after-tax dollars, meaning no immediate tax benefit. However, qualified withdrawals in retirement are tax-free.
• Contribution Limits: For 2024, your earned income or $7,000 (or $8,000 if you’re 50 or older), whichever is lower.
• Phase-out: For 2024, single filers with Modified Adjusted Gross Income (MAGI) $146,000-$161,000 and married couples filing jointly $230,000-$240,000. If your income is above this threshold, you can’t contribute to Roth.
• Withdrawal Rules: Since contributions are made with after-tax dollars, you can withdraw your contributions (but not earnings) at any time without penalties. There are no RMDs with a Roth IRA, making it a good option if you want to leave an inheritance.

2. 401(k) Plans: employer-sponsored retirement plans

(1) Traditional 401(k)

• Tax Advantages: Contributions are made pre-tax, reducing your taxable income in the year of contribution. However, withdrawals in retirement are taxed as ordinary income.
• Contribution Limits: In 2024, the annual contribution limit is $23,000 for individuals under 50, and $30,500 for those 50 or older.
• Employer Matching: Many employers offer a matching contribution, which is essentially free money towards your retirement. Be sure to check your employer’s policy and try to contribute at least enough to get the full match.
• Withdrawal Rules: Withdrawals before age 59½ are subject to a 10% penalty plus income tax. RMDs start at age 73.

(2) Roth 401(k)

• Tax Advantages: Contributions to a Roth 401(k) are made with after-tax income, but qualified withdrawals in retirement are tax-free.
• Contribution Limits: The contribution limits are the same as a traditional 401(k), and you can split contributions between both accounts if your employer allows.
• Employer Matching: Employer contributions to a Roth 401(k) are always made on a pre-tax basis and go into a separate account.
• Withdrawal Rules: Withdrawals follow the same age-related rules as traditional 401(k)s. However, RMDs are required, unlike Roth IRAs.

3. Self-Employed 401(k) (Solo 401(k))

In this gig economy, if you received 1099-Nec from your side-hustle or freelance income or if you’re self-employed or have a small business with no employees other than yourself (and possibly your spouse), the Self-Employed 401(k), also known as a Solo 401(k) or Individual 401(k), could be a powerful retirement savings tool.

• Contribution Limits: The Solo 401(k) allows for high contribution limits since you can contribute both as an “employee” and an “employer.” In 2024, the employee contribution limit is $23,000 (or $30,500 for those 50 and older). In addition, the “employer” (your business) can contribute up to 25% of your compensation, with a combined total cap of $66,000 (or $73,500 for those 50 and older).
• Roth Option: Many Solo 401(k) providers now offer a Roth option, allowing you to make after-tax contributions for tax-free withdrawals in retirement.
• Tax Advantages: Contributions to a traditional Solo 401(k) are tax-deductible, while Roth contributions are made after-tax but grow tax-free.
• Loan Provisions: Some Solo 401(k) plans allow you to take a loan from your retirement savings (up to the lesser of $50,000 or 50% of your balance), which can be helpful in times of financial need.
• Withdrawal Rules: The same early withdrawal penalties and RMD rules apply as with traditional and Roth 401(k)s. Early withdrawals before age 59½ are generally subject to a 10% penalty plus income tax.

4. Simplified Employee Pension (SEP) IRA

The SEP IRA is another good option for self-employed individuals and small business owners.

• Tax Advantages: Contributions are tax-deductible, helping to reduce your taxable income.
• Contribution Limits: For 2024, the SEP IRA allows you to contribute up to 25% of your compensation, with a maximum cap of $66,000. However, employees cannot contribute directly to their SEP IRAs; only the employer makes contributions.
• Eligibility: SEP IRAs are designed for business owners with or without employees, but if you have employees, you must contribute the same percentage for them as you do for yourself.
• Withdrawal Rules: Similar to traditional IRAs, withdrawals before age 59½ may incur a 10% penalty. RMDs begin at age 73.

SEP IRAs vs. Solo 401(k)s

While both the SEP IRA and Solo 401(k) allow high contribution limits for the self-employed, a Solo 401(k) generally allows for higher contributions at lower income levels due to the employee and employer contribution structure. Additionally, a Solo 401(k) offers Roth contributions, whereas a SEP IRA does not.

Conclusion: Choosing the Right Retirement Account for You

Deciding on retirement saving options ultimately depends on your employment status, income level, and tax strategy. Here’s a quick guide:

1. If your employer offers 401(k) with employer matching contributions, never miss it out. It offers significant tax-deferred growth and high contribution limits.
2. If you receive 1099-NEC or you’re self-employed, Self-Employed 401(k) (Solo 401(k)) is best with high contribution limits and tax flexibility.
3. If your income is not above the threshold, make sure to contribute, in addition to 401(k), to either Traditional IRA or Roth IRA. If you wonder which one is better, please check my next article.

Each retirement plan offers its unique advantages and considerations. If you’re uncertain, consulting a financial advisor can help you make an informed decision tailored to your financial situation and retirement goals. By taking proactive steps now, you’ll be better positioned to enjoy a financially secure retirement in the future.