Quick Look
- Once you’ve chosen the company you want to open your account with, you need to choose the account type (or “types” if you’re planning to open more than one) you want to open.
- Your account type is a major component that will define your long-term saving and investing strategy.
- Eventually, you’re likely to have a mix of accounts – some funded with pre-tax dollars and others with post-tax dollars.
- Start with what you think makes sense for you now and modify your strategy later as needed.
Contents
<< Retirement Account Setup Checklist
Account Considerations
Consider the following and then review the table below:
- Funding Dollars – Do you want to get a tax break now (fund with “pre-tax” dollars) or in retirement (fund with “post-tax” dollars)?
All things being equal, the higher your income, the higher your tax bracket. The lower your income, the lower your tax bracket. Therefore, if you believe you are in a higher tax bracket now than you will be in retirement, you may want to choose an account funded with “pre-tax” dollars, thus delaying paying taxes on that money until you retire and are in a lower tax bracket. Conversely, if you believe you will be in a higher tax bracket in retirement, you may want to fund an account with “post-tax” dollars, thus paying taxes on that money now and withdrawing it tax free in retirement when you are in a higher tax bracket. (And if you can’t predict the future, keep reading!) - Contribution Amount – How much do you want to contribute each year?
Because retirement accounts come with certain tax advantages, the government restricts how much you can contribute to different accounts. Generally speaking, accounts funded with “pre-tax” dollars allow for more annual contributions but this is changing with the advent of things like “Roth 401ks” and other comparable options.
- Account Limitations – Are there account limitations on opening the account like income limitations, stipulations for withdrawing the money etc?
There are generally three possible account limitations to be aware of.- Income limitations stipulate how much you can contribute (if anything) if your income rises above a certain threshold in a given year.
- Withdrawal limitations affect whether you pay a penalty for withdrawing either your contributions and/or your earnings prior to a certain age.
- Withdrawal requirements (also known as Required Minimum Distributions or “RMDs”) stipulate how much you must remove each year starting at a certain age in retirement.
- Personal Considerations – If you have (or plan to have) multiple retirement accounts, do you want to create some differentiation between accounts – like the type of funding dollars you use – or keep it the same?
The future is hard to predict. So if you aren’t sure if you will be in a higher or lower tax bracket in retirement (either because your income is fluctuating, you have no idea what the government tax brackets will be in 40 years, how much you’ll have saved and therefore how much you’ll be able to withdraw, or something else) and you’re not sure which account type you should open, consider having an account funded from “pre-tax money” and another funded from “after-tax” money. This is going to give you the most flexibility.
Common Retirement Account Types
The table below provides the highlights for the most common types of accounts. There are additional specific rules not detailed here but this provides the most important information. Find one or two that seem like good contenders and then do a little more research on your own if you want to know all the ins and outs.
| Account Type | 2022 Income Limits | 2022 Annual Contribution Limits | Funding Dollars | Primary Account Limitations |
| 401(k) or 403(b) for public sector and non-profit employees | None | $20,500* (+$6,500 for those aged 50+) | Pre-tax | There is a penalty for withdrawing either your contributions or earnings prior to age 59 ½ and taxes will also be owed. Starting at age 72 (typically) you must make annual withdrawals and pay taxes. |
| Traditional IRA | None | $6,000** (+$1,000 for 50+) | Pre-tax | There are no income limits but tax benefits for this and other “pre-tax” accounts may be reduced if you earn too much. |
| Roth IRA | $144,000 (individual tax filer) or $214,000 (joint tax filer) | $6,000** (+$1,000 for 50+) | After-tax | You can withdraw the contributions at any age for any reason and pay no penalty.You can withdraw earnings starting at 59 ½ but there are no RMD rules. |
| Roth 401(k) | None | $20,500* (+$6,500 for those aged 50+) | After-tax | You can withdraw the contributions at any age for any reason and pay no penalty.You can withdraw earnings starting at 59 ½. RMDs must begin no later than age 72 (typically) |
| Solo 401(k) (officially “One-Participant 401(k)”) | None | $61,000 | Pre-tax or After-tax (via “Roth Solo 401(k)”) | You must be at least part-time self employed to open and maintain this account. The contribution limit is a true maximum based on $20,500 as the “employee” and up to an additional $40,500 or 25% of the total income – whichever is less – as the “employer.” RMDs are required. |
| SEP IRA | None | $61,000 | Pre-tax | The contribution limit is the lesser of $61,000 or 25% of the total employee income. RMDs are required. |
* You may have a 401(k) that allows for both traditional pre-tax contributions and after-tax contributions via a Roth 401(k). But the combined total contributions cannot exceed these amounts.
** If you have both a Traditional IRA and a Roth IRA, your combined total contributions cannot exceed $6,000 annually (or $7,000 annually for those over 50). Additionally, since there are income limits for a Roth IRA, the amount you can contribute will be less the closer you are to the income limits. Search for “Roth IRA phase-out limits” to get the most up-to-date information for this year.
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