As a young professional, it's tough to think about something that seems so far away. But here’s the truth: the earlier you start saving, the better off you’ll be. That's one thing everyone can agree on. Retirement planning might seem complex, but it’s all about getting your money to work for you. The good news is, there are key retirement accounts that can help you maximize your savings while benefiting from tax advantages. Whether you’re just starting out or looking to improve your strategy, here are the essential accounts to consider.
1. 401(k) or 403(b) – Employer-Sponsored Retirement Plans
If you’re working for a company that offers a 401(k) or 403(b), this is one of the most powerful tools you can use to build your retirement savings. Here’s why:
Why It's Important:
Employer-sponsored retirement plans allow you to save pre-tax money, reducing your taxable income for the year. Many employers also offer a matching contribution, which is essentially “free money.” Contributing at least enough to get the full match is a smart financial move.
Pre-Tax vs. Roth Contributions:
When contributing to a 401(k), you often have two options: pre-tax or Roth. Pre-tax contributions lower your taxable income now, but you’ll pay taxes when you withdraw the money in retirement. Roth contributions don’t offer a tax break now, but withdrawals in retirement are tax-free. Millennials, who may be in lower tax brackets now, can benefit greatly from Roth contributions.
2. Roth IRA – Tax-Free Growth for the Long Term
A Roth IRA is another essential retirement account, especially if you’re looking for flexibility and tax-free growth. You contribute after-tax dollars now, but the money grows tax-free, and you won’t owe taxes when you withdraw it in retirement. This is a big deal as your account grows over the years.
Why Millennials Should Love the Roth IRA:
You're likely in lower tax brackets now compared to later stages of life, making paying taxes upfront a smart move, allowing for tax-free withdrawals during retirement. Although, we don't have a crystal ball, current tax rates are historically low, many experts believe that tax rates could increase over time. Using a Roth allows you to lock in today's tax rates without having to guess what they might be in the future.
Income Limits and the Backdoor Roth:
If your income exceeds the IRS limits for Roth IRA contributions, there’s still a way to contribute through a backdoor Roth IRA, a strategy that allows you to convert Traditional IRA funds into a Roth IRA. A financial planner like me can help you make this move and file the correct tax forms to record the contribution correctly.
3. Traditional IRA – Flexibility with Tax Deferral
For those without access to an employer-sponsored plan, or if you want to supplement your 401(k), the Traditional IRA is a solid option. Contributions may be tax-deductible, and investments grow tax deferred. The deduction depends on a few factors including your income.
Why Consider a Traditional IRA:
The Traditional IRA offers flexibility in investment choices—stocks, bonds, mutual funds, and more. However, withdrawals in retirement are taxed as ordinary income, unlike Roth IRAs.
4. Solo 401(k) – For Self-Employed Individuals
If you’re self-employed or run a side business, the Solo 401(k) is a retirement plan designed just for you. It’s similar to an employer-sponsored 401(k), but you get to be both the employee and the employer, allowing for much higher contribution limits. As the name implies, only a solo business owner can use a solo 401k, however your spouse can contribute as well.
Why It’s Ideal:
For 2024, you can contribute up to $23,000 (as the employee) plus an additional 25% of your business earnings (as the employer), up to a combined total of $69,000. Solo 401(k)s also allow for Roth contributions and the ability to take loans against your balance, making them flexible for entrepreneurs.
5. Mega Backdoor Roth – Supercharging Your Roth Contributions
For high-income earners who’ve maxed out their Roth IRA and 401(k), the Mega Backdoor Roth strategy is a powerful way to get even more money into a Roth. It involves making after-tax contributions to your 401(k) plan and converting them into a Roth account.
How It Works:
Some employers allow after-tax 401(k) contributions (above the standard $23,000 limit for 2024). You can then convert these after-tax contributions into a Roth 401(k) or Roth IRA, essentially bypassing the contribution limits of traditional Roth accounts.
Why It’s Useful:
This strategy allows you to put up to $69,000 (in 2024) into a Roth 401(k) or Roth IRA, giving you an even larger pool of tax-free growth for retirement.
6. Cash Balance Plans – For High-Earning Entrepreneurs
A Cash Balance Plan is a defined benefit plan, similar to a traditional pension, but it’s designed for business owners and high-income earners who want to save significantly more for retirement than the limits of 401(k)s or IRAs allow.
Why Consider a Cash Balance Plan:
With a Cash Balance Plan, you can contribute hundreds of thousands of dollars per year, depending on your income, age, and plan rules. Contributions are tax-deductible, and they provide a predictable retirement benefit, which can be appealing to business owners looking for a way to save aggressively while reducing their tax burden.
7. Taxable Brokerage Accounts – Flexibility Without Limits
While most retirement accounts come with contribution limits, withdrawal restrictions, and tax advantages, a taxable brokerage account offers ultimate flexibility. You can invest as much as you want, access your funds at any time, and invest in nearly any asset.
Why Millennials Should Consider One:
Although you don’t get the tax benefits of retirement accounts, taxable brokerage accounts allow you to invest for medium- to long-term goals, like buying a house or even early retirement. You only pay taxes on dividends, interest, and capital gains when you sell investments. If these investments are held longer than 12 months, you'll only pay long term capital gains which is at more favorable rates than ordinary income tax rates.
8. HSA – A Hidden Retirement Gem
Although an HSA (Health Savings Account) is primarily designed to cover healthcare expenses, it also offers incredible retirement savings potential. If you have a high-deductible health plan (HDHP), you can contribute to an HSA and get a triple tax benefit: contributions are tax-deductible, the money grows tax-free, and withdrawals for qualified medical expenses are tax-free.
Why Use an HSA for Retirement:
After age 65, you can withdraw HSA funds for any purpose without paying a penalty (though non-medical withdrawals will be taxed). This makes an HSA a hybrid health and retirement account, giving you even more flexibility in retirement planning.
Start Putting Your Money to Work
Retirement might seem far off, but starting now can make all the difference. Whether you’re maximizing your 401(k), opening a Roth IRA, exploring a Solo 401(k), or using strategies like the Mega Backdoor Roth, there are plenty of options to set yourself up for the future. The sooner you start, the more you benefit from the magic of compounding interest and tax-advantaged growth. Take the first step today—your future self will thank you. Don't forget that you will need money from age 60-90. If you need help starting, schedule a consultation today, we specialize in working with young professionals.
Disclaimer: None of this should be seen as advice. This is all for informational purposes. Consult your legal, tax, and financial team before making any changes to your financial plan.: