Which types of retirement savings accounts should I consider?
When it comes to saving for your future, there are many decisions to navigate — from how to set your goals to how much to set aside for each — 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 using — several types of accounts, the question may remain: Which are the right accounts for me to use in saving for retirement?
Here is an overview of three common types of savings accounts that come with tax advantages — allowing you to save money for retirement that would otherwise go to taxes — and the key characteristics to know about them.
This discussion focuses on US federal taxes. State and local tax consequences may vary.
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.
— Kevin O'Neil, managing director and product management executive,
Personal Retirement Solutions, Investment Solutions Group at Merrill
What is a 401(k) and how does it work?
How do I get one?
Offered by many employers
What are the big benefits?
What can I invest in?
Investment options offered under your 401(k) plan will vary between plans, but may include mutual funds and exchange-traded funds (ETFs)
What else should I know?
- If you're age 50 or over during the plan year, 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
- Required minimum distribution (RMD) rules mandate account holders begin withdrawing money at a specified age, generally age 73, or be subject to an additional 10% to 25% tax
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
- No RMD for the original account owner
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 in a traditional plan until you withdraw them.
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 a description of your 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 or other types of retirement plans. A 403(b) plan is a tax-advantaged retirement account that is similar to a 401(k), but there are some differences. Be sure to check with your employer to learn about your options.
What is an individual retirement account (IRA) and how does it work?
How do I get one?
You can open one with a bank, brokerage firm or certain other financial institutions
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-deferred or tax-free investment growth
What can I invest in?
May allow investing in stocks, bonds, mutual funds, ETFs or CDs, and potentially other investments
What else should I know?
Traditional: Potentially pay taxes later
- Eligibility: No income limits, but tax deductions may be limited by income level
- Funded by tax-deductible pre-tax dollars
- RMD rules mandate account holders begin withdrawing money at a specified age, generally age 73, or be subject to an additional 10% to 25% 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 generally federal tax-free provided certain requirements are satisfied
- 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 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.
— Kevin O'Neil, managing director and product management executive,
Personal Retirement Solutions, Investment Solutions Group at Merrill
What is a health savings account (HSA) and how does it work?
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 potentially 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 eligible 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 — depending on the HSA provider's policies and any qualifications they may impose — can be invested in a range of mutual funds or cash. They can be used to pay for current or future qualified healthcare 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. Once you turn 65, you can use the money in your HSA for anything but you'll pay income taxes on non-qualified healthcare expenses. 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.
Footnote 1 You cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth account and you have reached age
59½, become disabled or the distribution is due to your death.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Bank of America, N.A. makes available the Health Savings Account as a custodian only. The account beneficiary establishing the HSA is solely responsible for ensuring satisfaction of eligibility requirements set forth in IRC sec 223. If an individual/employee establishes an HSA and s/he is not otherwise eligible, s/he will be subject to adverse tax consequences. In addition, an employer making contributions to the HSA of an ineligible individual may also be subject to tax consequences. We recommend that applicants and employers contact qualified tax or legal counsel before establishing an HSA.
Potential Tax Advantages: You can receive federal income tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax, unless an exception applies. Any interest or earnings on the assets in the account are federal income tax-free provided the interest or earnings are distributed for qualified medical expenses. You may be able to claim a tax deduction for contributions you, or someone other than your employer, make to your HSA directly (not through payroll deductions). In addition, HSA contributions may reduce your state income taxes in certain states. Certain limits may apply to employees who are considered highly compensated employees. Bank of America and Merrill recommend you contact qualified tax or legal counsel before establishing an HSA.
Bank of America, N.A., Member FDIC
Mutual Fund investment offerings for the Bank of America HSA are made available by Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a registered broker-dealer, registered investment adviser, Member SIPC, and a wholly owned subsidiary of Bank of America Corporation ("BofA Corp."). Investments in mutual funds are held in an omnibus account at MLPF&S in the name of Bank of America, N.A., for the benefit of all HSA account owners. Recommendations as to HSA investment menu options are provided to Bank of America, N.A. by the Chief Investment Office ("CIO"), Global Wealth & Investment Management ("GWIM"), a division of BofA Corp. The CIO, which provides investment strategies, due diligence, portfolio 379 construction guidance and wealth management solutions for GWIM clients, is part of the Investment Solutions Group (ISG) of GWIM.
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