How to Choose the Best Retirement Plans?

Roth IRAs, Traditional IRAs, and 401(k)s...Which One to Choose?

Simple were the days when Social Security and pension were enough to cover expenses during retirement. Today the cost of living has gone way up and we have to look at various retirement plans that offer tax breaks and other benefits.

Roth and traditional IRAs vary in how you pay taxes when you contribute, and when you withdraw in retirement. If you can only afford one retirement account, 401(k) may be the faster route to grow your money with an employer match. If you can invest in more accounts, consider how to get the maximum match and most favorable tax treatment.

401(k) Plans and Contribution Limits

401(k) plans are tax-advantaged accounts to save for retirement offered by employers. They are "Defined Contribution Plans," where these contributions are automatically deducted from your salary, and the employer matches.

How much you can contribute depends on what your salary is. The maximum contribution for a person under 50 can contribute $22,500 in 2023 while for those 50+ is $30000.

These high contribution limits are one advantage that 401(k) has over traditional and Roth IRAs.

Large corporations usually limit investment choices to mutual funds, bonds, and money market instruments.

Smaller corporations offer the same but are more likely to allow self-direction of investments, these include stocks, bonds, mutual funds, and other available investments. This self-direction of investments reassembles an IRA.

Contributions to your 401(k) reduce taxable income but are subject to income limits on how much of the contribution is deductible.

Roth IRAs vs. Traditional IRAs

These are known as "Individual Retirement Accounts" and are tax-advantaged accounts, holding chosen investments.

For 2022, you could've contributed up to $6,000 a year plus an additional $1,000 if 50+ by the end of the tax year. It rises to $6,5000 in 2023, plus an additional $1,000 for those 50+.

In a traditional IRA, you must take calculated annual withdrawals known as "Required Minimum Distributions (RMDs)." The SECURE ACT has increased the age when you need to begin taking RMDs from 70.5 to 72 years old as of 2020.

Roth IRAs have no RMDs during the owner's lifetime and can work as wealth transfers, meaning you can pass the entire account and its tax benefits to whomever you want.

The IRS recently made changes to the beneficiaries following the death of the IRA owner in 2019. All of the funds must be distributed by the end of the 10th year after the death of the IRA owner. There are certain exceptions for eligible beneficiaries, such as spouses.

Traditional IRAs get an upfront tax break but must pay takes on your withdrawals in retirement while Roth IRAs aren't tax deductible but qualified distributions are free of taxes and penalties.

To qualify as tax-deductible for Roth IRAs the first contribution must be at least five years and one of the following must be true:

• Reached the age of 59.5

• Disability

• Using the distribution to buy a first home (lifetime limit: $10,000)

• Death (beneficiary receives the distributions)

Roth IRAs are considered to be the better choice if you expect to be in a higher tax bracket in retirement, or if you expect to have significant earnings in the account. As long as the distributions qualify, you do not have to pay taxes on its earnings.

Can I have 401(k) and IRAs Together in my Retirement Plan?

Yes! We can have a 401(k), a traditional IRA, and a Roth IRA at the same time. If you can afford it and contribute the maximum to all the accounts, you can relax on how to allocate your savings.

If you cannot afford all of them you should consider the following.

Getting the Maximum Match

If there's a match for your 401(k), consider the maximum amount they need to contribute to the plan to receive the maximum available matching contribution.

Choosing Between IRAs

To decide, you must know how much of your traditional IRA contributions would be tax deductible and which IRA, if not both, is the best for your case. The total contributions to both IRAs cannot exceed the limit for that tax year.

Which to Fund First

Generally is best to contribute early in the year so the assets can start accumulating earnings as soon as possible or a little each month.

Some companies contribute the amount in one lump sum at the end of their tax filing deadline, while others contribute throughout the year. If your company does the lump sum at the end of the year, salary deferral contributions to the 401(k) early in the year are generally the best way to go.

Bottom Line

For those who can fund multiple types of retirement accounts, the choice is not an issue. For those of us who cannot fund all, picking the best option can be challenging.

It almost always boils down to whether you prefer to take the tax break when you retire with IRAS or while you're still contributing with traditional IRAs.

If you would like to know which one best fits your scenario, be sure to find a good retirement planning advisor who can aid you in making the best choice specifically for you.