Today’s guest post is by Jenna Rodrigues, financial coach and founder of Allocate, where she teaches mission-driven millennials how to spend their values and build their future, so they can serve the world without sacrificing their own stability.
Today’s post is on investment accounts available for US-investors looking to save for retirement.
It can be confusing to know where to start, which is why I created this flowchart:
Clear as mud? Here’s more information:
Start with investing in your employer-sponsored retirement plan Also called: 401(k), 403(b), 401(a), SIMPLE IRA, or a SEP IRA
Things to know:
● Your employer gives you access to this type of account.
● If your employer offers a retirement account as part of your benefits package, ask if they offer a matching contribution. If they do, ask what you need to do to take full advantage of the match.
● If you have a small business (even if it’s a side hustle), you can open a SEP IRA. Work with a CPA to figure out how much you can contribute to a SEP IRA account, because it’s fairly complex to calculate. You also have the option of a solo 401k and a SIMPLE IRA if you are self-employed.
● As an incentive to invest, the government gives you a tax break when you contribute to traditional retirement plans. Let’s use an example to explain what I mean:
○ If you make $45,000 per year and contribute $5,000 to your 401(k), your reportable wages will actually be $40,000 because $45,000-$5,000 equals $40,000. That $5,000 is not included when you file your tax return.
● When you take money out of this type of account in retirement, you will pay taxes on any withdrawals.
● If your employer offers a Roth 401(k) option and you use it, that means that you won’t get a tax break in the year you contribute money into the Roth account. However, the money will grow tax-free. When you take the money out, you will not be taxed on it.
Action Step #1: If you have access to an employer-sponsored retirement account, contribute enough so that you get the full employer match.
Next, open an IRA (Individual Retirement Account) Also called: Traditional IRA, Roth IRA, Spousal IRA (which can be Roth or Traditional)
Things to know:
● If you have earned income (or if you are the spouse of someone with earned income), you can contribute to an IRA.
● This a great option for folks who work at an employer without a retirement plan, but want to invest for retirement.
● IRAs are also great for people who DO have a retirement plan, because it’s a second place where you can invest for your future. You can (and should) have both.
● You can open a Traditional IRA or a Roth IRA (so long as your income is below the Roth IRA income limits).
● Taxes on a traditional IRA are paid when you take money out in retirement, whereas taxes on a Roth IRA are paid before you contribute the money into the account.
● Click here for more information about the income limitations for taking a tax deduction on traditional IRA contributions. If you are a higher-income earner and have access to an employer-sponsored retirement plan, things get a little more complicated.
● In 2020, folks under age 50 can contribute $6,000 per year to an IRA. If you have BOTH a traditional IRA AND a Roth IRA, you can put in $6,000 total to these accounts in 2020 (not $12,000). Make sure you are careful if you are contributing to both to stay within the annual contribution limit.
● Folks over age 50 can put in an additional $1,000 per year. This is called the “catch-up” contribution.
● You have until April 15th of 2020 to contribute to an IRA for 2019, and until April 15th of 2021 to contribute to an IRA for 2020. Kinda weird, but good to know!
● If you have an old 401(k) from a previous employer, you can roll it to an IRA to have more control over what you’re invested in. When you do this, it doesn’t count against your yearly $6,000 limit.
Action Step #2: Open a Traditional or Roth IRA and work on contributing up to the annual max into this account.
If you still have more money you can invest, bravo! Consider increasing your contribution to your employer-sponsored retirement plan, because the annual contribution limits are quite high.
Action Step #3: Consider upping your contributions to your employer-sponsored retirement plan if you like the investment options available.
If you’re looking for more investment accounts where you can sock away money, here’s an additional option that few people talk about:
A Health Savings Account Also called: HSA
Things to know:
● If you have a High Deductible Health Plan, you can open an HSA to help save for healthcare expenses.
● To give you an incentive to save for healthcare, the government gives you a tax break on contributions you put into an HSA.
● If your HSA reaches a certain balance, your HSA company will let you invest a portion of the money.
● When you spend this money on healthcare expenses, you won’t have to pay any taxes on the money.
● After you turn 65, you can spend this money on anything after paying taxes on it. This account becomes another traditional IRA at age 65.
Action step #4: If you are eligible for an HSA account, consider opening one up for a tax-free way to pay for healthcare expenses, and a potential place to invest money as well.
Where can I open an IRA or HSA?
Great question. You open an investment account at a brokerage firm.
Brokerage firms employing digital applications have become quite popular for millennial investors. These are called robo-advisors, and they ask questions and make investment choices for you based on your responses.
If you are eligible for an HSA, it’s likely that your employer has a bank that they work with for setting up the account and making contributions via a deduction from your payroll. You could also choose your own HSA provider (but will have to put your contributions in on your own).
If you made it this far into the article, great job! What questions do you have about investing? Judy and I will both respond to comments, so fire away!