Understanding Retirement Accounts

Investing in retirement isn’t always easy. Depending on your line of work, it can feel overwhelming and complicated.

What are retirement accounts? How can you invest in them? Do you have the right one, and are you using it properly?

Let’s take a look, so you can prepare for your future more effectively.

Taxes

No matter your job, you’ll have to pay taxes, either now, in retirement, or (more likely) a combination of both. It’s important to understand which category each of your retirement accounts falls into.

Later

Some accounts allow you to put untaxed money away for retirement, also known as “tax deferred.” You will, however, have to pay taxes on that money once you withdraw it during your retirement — including any earnings that have accumulated over the years.

Now

Other accounts are for money you’ve already paid taxes on. Specifically, it’s money that you’ve included as your income for that year and then saved in a tax-advantaged account. When you withdraw it during your retirement, you don’t have to pay tax a second time, including on any gains you’ve made.

Which is Right for Me?

You can, of course, select either type for your account, depending on your current situation — or both. If you expect to be in a higher income bracket when you retire, it may be better to focus on accounts that pay taxes now. That way, you’ll have plenty of tax-free income when you retire.

If you think you’ll be in a lower tax bracket when you’re no longer earning a full-time salary, it may be worth focusing your retirement savings on accounts that give you a tax deduction now.

It’s also possible to invest in both types of accounts if you qualify, in order to have different tax treatments on your retirement income.

Employer-Based

In an employer-based retirement account, your employer creates a plan for you, which you can make contributions in. Some employers even contribute funds – typically an amount that matches your own contributions.

401k and 403b

A 401k plan is the most well-known, because it’s very straightforward for both the employer and the employee. A 401k is issued to employees of a for-profit company, while a 403b is for non-profit employees.

For these, you choose to withhold up to $20,500 a year through payroll deduction. As this is handled by your employer, if you leave your job, you are required to take the initiative and roll the account over to your new employer.

Personal/Self-Employed

Other investment accounts can be obtained outside of work, or if you are self-employed.

Solo 401k

If you run your own business and have no other employees, you can set up a single 401k account for yourself. Here, you’ll act as both the employee and employer when making contributions. Unlike an employer-based 401k, you can make contributions of up to $61,000.

SEP IRA

This retirement investment account can also be used as a self-employed account. Since it’s meant for small businesses, this includes the owner, who is considered “self-employed.”

Taxable investment account

You can also invest in taxable investment accounts, which don’t offer any tax deductions on contributions or withdrawals. But there’s no limit to how much you can put into your account and any long term capital gains are taxed at a lower rate than income.

Bonds

Bonds aren’t just checks you receive from your grandparents on the holidays – they’re a well-established form of investment.

Typically, the kind you receive from family members are government bonds or “sovereign bonds.” It’s a form of credit, in which you give money to the government and they pay back a percentage every year. At an agreed-upon time, the full amount is then rewarded back to the bond owner. The longer this takes, the greater your interest – and the more money you earn in the final payment.

You can buy these personally, broadening your long-term savings, or customize your retirement account to include them.

Conclusion

Saving for your golden years is a very personal decision, influenced by your circumstances. Start by determining your options based on your employment. Then decide the best combination of accounts that meet both your long-term and short-term needs.