The road to retirement is paved with a myriad of savings account options. In fact, there are so many options you may find it difficult to choose.
While the task may be daunting, there are strategies that can be employed to make sure you are maximizing your returns and remaining within your risk comfort zone at the same time. On that same note, there are savings account options that are peddled that could do you more harm than good.
When going over the options, you should start with clearly identifying your goals. Whether you want to build a nest egg that will allow you to live lavishly in your Golden Years, or you simply want to live comfortably, there are ways to accomplish your goals.
Savings accounts for retirement include those you've likely already heard of, such as individual retirement accounts, or IRAs. Many people also find Roth IRAs to be viable options. Then there are health savings accounts, which are growing in popularity as a means to build up your financial coffers for retirement.
The go-to IRAs
The most popular individual retirement accounts are traditional IRAs and Roth IRAs.
Traditional IRAs allow you to direct your income towards investments before taxes are withheld. Roth IRAs allow you to withdraw earnings on a tax-free basis when you retire, or any time for that matter. However, you must remember there could be tax consequences to making withdrawals.
Make sure you find out if the contributions you make to a traditional IRA are tax-deductible. The IRS notes that depending on factors like your income and tax-filing status, they may be tax-deductible. This could keep the dollars you're saving for retirement out of the hands of the tax regulator.
Any strategy you employ to maximize your returns with either of these accounts must start with you looking at your income and your potential to earn more over the course of your life. That's because there are income limits for Roth IRAs. If your income is above those limits, "then it's a no-brainer: a traditional IRA is the only one for you," according to CNN Money. It adds that, generally speaking, you're better off in a traditional if you expect to be in a lower tax bracket when you retire.
Understand that by deducting your contributions now you stand to lower your current tax bill. When strategizing over Roth IRAs, timing is everything. So is your tax bracket.
Those who are just starting off in their careers are more than likely earning the lowest incomes of their lifetimes. This means they are in low tax brackets. As they move further along their career paths, their incomes will likely increase, putting them in higher tax brackets.
If you're in this situation, expecting to be in the same or higher tax bracket when you retire, a
Roth IRA may be best for you.
Your strategy in taking advantage of these accounts is also to clearly understand the difference between contributions and earnings.
Earnings are what those contributions make from your Roth IRA investments. If you withdraw the account's earnings after reaching age 59½ (assuming the account is at least five years old), the earnings are tax-free. These tax-free withdrawals are one of the biggest benefits of a Roth IRA compared to a 401(k) retirement plan.
The potentials of the 401(k)
With 401(k) plans your taxable income is reduced through deductions based on your contributions to it. The catch relates to timing. If you withdraw when you're at the highest level of your career or when you are close to retirement, you may have to pay taxes on your contributions as well as your earnings.
The employer-sponsored 401(k) account typically entails employee matches where the employers match contributions to a certain percentage. The best strategy for using a 401(k) to maximize the returns for your nest egg is to take full advantage of it.
Be careful if you have a 401(k), a traditional IRA, and an employer-sponsored retirement plan. That's because the IRS could limit the amount of traditional IRA contributions you can deduct from your taxes.
Take advantage of auto-enroll if your employer offers it for their plans. The option may come with a low contribution rate, and if it does, you should increase it to as much as possible. It's thought that people who start saving early can sock away 10 percent of their income. On the other hand, those who are approaching their golden years will likely have to save 15 percent or more to make up for the years they went without investing.
Saving your health, and money
Another option entails health savings accounts. Like traditional and Roth IRAs, these accounts have plenty of tax advantages. They are designed to help people who have high-deductible health plans (HDHPs) with paying for out-of-pocket medical expenses, Investopedia notes.
They are like 401(k)s and traditional IRAs, but their tax advantages literally give them an advantage. Some even think they are the most tax-preferred accounts available.
To qualify for a health savings account, you must have a high-deductible health plan. If you're eligible for Medicare or someone else can claim you as a dependent on their tax return, you are not eligible for a health savings account.
With that in mind, be sure to start making contributions to the account before you turn 65. That's because they are no longer tax-deductible after you turn 65 – the qualifying age for Medicare.
If you have an HSA and you're 55 or older, you can make an extra "catch-up" contribution of $1,000 per year and a spouse who is 55 or older can do the same, provided each of you has his or her own HSA account. Your family's total annual contribution cannot exceed $8,750.
Make sure your investment strategy for HSAs entails maxing out contributions before you turn 65 so you can save for general retirement expenses beyond those for medical issues.