Which types of retirement savings accounts should I consider?
When it comes to saving for your future, there are a number of decisions to navigate — from how to set your goals to how much to set aside — but the area that gives many savers pause is choosing which types of tax-advantaged retirement accounts to use. While you may be familiar with — or even already be using — several types of accounts, the question may remain: What's the right retirement account for me?
Here is an overview of three common types of retirement savings accounts that come with tax advantages — allowing you to save money that would otherwise go to taxes — and the key characteristics to know about them.
Making the most of your retirement savings choices now — even in seemingly small ways — can add up over the years and help you be better prepared for the unexpected down the road.
— Debra Greenberg, director and product management executive,
Personal Retirement Solutions, Investment Solutions Group at Bank of America
What do I need to know about a 401(k) Plan?
How do I get one?
Offered by many employers
What are the big benefits?
What can I invest in?
Mutual funds and exchanged-traded funds (ETFs) offered by the plan
What else should I know?
- If you're over 50 you may be able to make additional catch-up contributions
- Taxes and penalties may apply for early withdrawal if no exception applies (before you are age 59½)
- Employers may have a "vesting" schedule before you'll fully own their matching contributions (based on years of service)
Traditional: Pay taxes later
- Funded by pre-tax dollars
- Withdrawals taxed at income tax rate at time of withdrawal (usually during retirement)
- Contributions reduce your taxable income for that year
Roth: Pay taxes now
- Funded by after-tax dollars
- Withdrawals during retirement are federal tax free1
- May save you more on taxes if you expect to be in a higher tax bracket during retirement
One of the biggest advantages of 401(k) plans is that employers may provide matching contributions when you put money into the plan. Some employers will match the contributions you make dollar-for-dollar, up to a certain percentage of your pay. Others may match a portion of each dollar you put in, say, 50%.
This matching is essentially "free money," which makes contributing to a 401(k) one of the most impactful retirement savings moves available. Additionally, you don't pay taxes on matching contributions until you withdraw them in retirement.
There can be differences in the way employers administer a 401(k) — including when you can sign up for one, the amount of matching contributions the employer offers, and any vesting schedules — so refer to your employee benefits for the exact details.
Did you know?
Certain tax-exempt employers, like those in the government, nonprofit, university and religious sectors, may offer their employees a 403(b) plan. This tax-advantaged retirement account is similar to a 401(k), but there are some differences. Be sure to check with your employer to learn about your options.
What do I need to know about an Individual Retirement Account (IRA)?
How do I get one?
You can open one with a bank or brokerage firm
What are the big benefits?
- Anyone with earned income can contribute to one — even if you're self-employed
- Generally has more investment options than a 401(k)
- You may be able to make contributions on behalf of a non-working spouse
- Tax-exempt investment growth
What can I invest in?
May allow investing in stocks, bonds, mutual funds, ETFs or CDs
What else should I know?
Traditional: Potentially pay taxes later
- Eligibility: No income limits, but tax deductions limited by income level
- Can be funded by: Pre-tax dollars
- Withdrawals of deductible contributions during retirement are taxed
- Required minimum distribution (RMD) rules mandate account holders begin withdrawing money at age 73 or you will be subject to an additional 10% tax
- Can be converted to a Roth IRA
Roth: Pay taxes now
- Eligibility: Based on income
- Funded by after-tax dollars
- Withdrawals during retirement are federal tax free
- No RMD for the original account owner
- May save you more on taxes if you expect to be in a higher tax bracket in retirement
If you're married and not working but file a joint return, you may be able to contribute to an IRA even if you did not have taxable compensation — as long as your spouse did, and they earned enough to cover the contribution.
401(k) plans and IRAs are not mutually exclusive and if you have the income and access to contribute to both, you can reap both their benefits. Contributing as much as you're eligible to (or you can manage) could maximize the tax advantages and opportunity for growth in your retirement savings.
— Debra Greenberg, director and product management executive,
Personal Retirement Solutions, Investment Solutions Group at Bank of America
What do I need to know about a Health Savings Account (HSA)?
How do I get one?
Only available to people with high-deductible health insurance plans
What are the big benefits?
Unused funds carry over each year and you own the HSA even if you change jobs or insurance plans
Triple tax advantages:
- Contributions are tax-exempt
- Investment growth is tax-exempt
- Withdrawals for qualified medical expenses are tax-exempt
What can I invest in?
HSAs with investment features allow you to invest your contributions, as well as keep some (or all) in cash
What else should I know?
- Lower contribution limits than a 401(k) or IRA
- Contributions may be made by you and/or your employer
An HSA is a tax-advantaged savings account that's available only to people who have high-deductible health insurance plans. They may be offered by an employer, allowing you to contribute pre-tax dollars to the account, or you can
open one on your own and deduct contributions you make. Contributions are subject to
IRS limits and — once certain qualifications are met — can be invested in a range of mutual funds or cash. They can be used to pay for current or future qualified medical expenses, such as medical, dental, and vision care, prescription drugs and long-term care insurance. Money in your HSA stays there until you use it, and you retain full control over the account and money even if you leave your current job or health plan.
Investing in your future with the tax advantages of long-term savings options now — and continually optimizing your strategy toward your goals — can have big implications for the growth of your savings and your financial stability.
1 You cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth account.
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