Just the other day, I read a seriously troubling statistic regarding Americans and their strategies for retirement.
According to an analysis of several studies by Time Magazine, approximately 1 in 3 American adults don’t have a retirement strategy at all.
Why? Because they haven’t stashed away a dime for their golden years.
As in, they haven’t saved anything. Zero. Nada. Zilch.
Worse…up to 56% of Americans have less than $10,000 saved for retirement.
Those are difficult statistics to believe, but I fear they are absolutely true. As Americans, we are amazing at so many things.
Unfortunately, saving money hasn’t been one of our strong points.
Fortunately, there is a silver lining around the retirement shortfall most Americans will likely face. Here it is:
Yes! You Can Have a 401(k) and an IRA
When the average person starts thinking about their own retirement savings, they automatically think of their work-sponsored retirement plan. For most people, that’s a 401(k) or 403b.
If you’re self-employed, on the other hand, you probably focus your retirement savings in a SEP IRA or even a Solo 401(k).
These tax-deferred plans are usually the best place to start – not only because you can generally lower your taxable income, but also because you might be getting an employer match. Always remember, an employer match on your retirement savings is free money – and you should never walk away from that.
If you’re not contributing to a work-sponsored plan by choice, your best bet is to contribute at least enough to get your employer match.
After that, you should research your work-sponsored plan to find out where and how your dollars are being invested. Just because your employer offers a plan doesn’t mean they offer a great way to invest your money!
If your employer does offer a stellar plan that makes the most of your dollars, you should also know you can contribute up to $19,500 to a 401(k) or 403b for 2020. If you are over 50 years old, however, the Internal Revenue Service allows for what is called a “catch-up contribution” each year.
Catch-up contributions up to $6,500 (up from $6,000 in 2018 and 2019) are permitted by certain retirement plans including the 401(k) and 403b.
For self-employed plans like the SEP IRA and Solo 401(k), the rules that govern maximum contributions are a little trickier and the amount you can contribute depends on your income that year.
For example, a SEP IRA allows you to contribute up to 25 percent of your compensation with a limit of $57,000 (but note there is no catch-up provision on this plan). Self-employed workers who use a Solo 401(k), on the other hand, can defer up to $19,500 of their salary for 2020 to their plan (up to 100 percent of their compensation), plus another 25 percent of compensation on top of that with the same overall limit of $57,000 (or $63,500 if they’re 50 or older).
Different Types of IRAs to Consider
But remember, you can contribute to an IRA on top of your traditional retirement accounts.
If you’re behind on saving for retirement like most Americans, it’s good to know you have some additional options to ponder.
There are two types of IRA to consider here, both of which are extremely different from one another:
A traditional IRA offers another tax-deferred option when it comes to retirement savings. For 2020, you can contribute up to $6,000 to a traditional IRA for 2020 provided you don’t also contribute to a Roth IRA. If you’re aged 50 and up, however, your maximum contribution to an IRA is limited to $7,000.
Note: You can contribute $6,000 (under age 50) or $7,000 (ages 50 and up) to an IRA each year, but that is the total amount you can contribute across all IRA accounts. You can’t, for example, contribute $6,000 to a Roth IRA then add another $6,000 to your traditional IRA account.
The advantage that comes with a traditional IRA is that your contributions might be tax-deductible dependent upon whether you also contribute to another tax-deferred retirement account and your income.
For married couples participating and filing jointly, the ability to claim a tax deduction for traditional IRA contributions begins to phase out when income is over $104,000 provided they also have access to a tax-deferred account such as a 401(k). Once your income exceeds $124,000, you can still make a traditional IRA contribution, but it won’t be tax-deductible. For single filers covered by a retirement plan at work, the full deduction is permitted up to an income of $65,000, where it begins to phase out up to an income of $75,000. The tax deduction on the contribution is no longer allowed if your income exceeds $75,000.
If you’re married filing jointly and your spouse is covered by an employer plan, you can make a tax deductible IRA contribution up to in income of $196,000, gradually phasing out at $206,000. If your combined income exceeds $206,000, the IRA contribution deduction is no longer allowed.
So yes, that places some limitations on the tax benefit that comes with saving in a traditional IRA – but, generally speaking, the limitations are only for high-earners. And even if you can’t deduct your contributions on your taxes, they can grow tax-free until you begin taking distributions.
So, all in all, a traditional IRA could be a smart way to save more money regardless of whether you can deduct your contributions or not. At the end of the day, it really depends on your specific situation and your retirement goals.
Who Should Consider a Traditional IRA:
- High income people who want more ways to save for retirement: Since there are no income guidelines that prohibit high earners from contributing to a traditional IRA, this can be a good option for people who earn more than average salaries. Just remember, an income over $104,000 for a married couple who files and participates jointly means your ability to deduct your contributions on your taxes might be limited.
- Mid-range earners who want to decrease their tax liability: Mid-level earners who pay a lot in taxes can lower their tax liability by contributing to a traditional IRA provided they can deduct the full amount.
Who Should Pass:
- People who don’t want to take minimum withdrawals: Since traditional IRAs require you begin by taking minimum withdrawals at 70 ½ or pay a penalty, this isn’t the best account for people who want to leave their money invested longer.
- People who want to contribute well into old age: Because of the way traditional IRAs are set up, you can no longer contribute once you reach age 70 ½. A Roth IRA, on the other hand, lets you contribute for a lifetime provided you meet income requirements.
- Anyone who wants to diversify their tax liability in retirement: Traditional IRAs are like other tax-deferred accounts in that your money grows tax free, but you’ll pay taxes when you begin taking distributions. If you want to diversify your tax liability by paying taxes on some of your retirement savings now, consider a Roth IRA.
With a Roth IRA, contribution limits are the same – $6,000 for 2020, or $7,000 if you’re ages 50 and up.
The big difference is, the contributions you make are with after-tax dollars. Once you contribute, your money grows tax-free until you are ready to begin making withdrawals in retirement. The cool thing is, you don’t have to pay taxes on your distributions since you already paid income taxes upfront.
This can be good or bad – it really depends on your goals and outlook. By paying taxes on your contributions upfront, you can save some serious cash on your tax bill later in life. Then again, who knows what your tax rate will be when you retire years or even decades from now.
But, there are other benefits that come with a Roth IRA, including the fact that there are no forced withdrawals at any age and you can contribute as long as you earn an income – even if you’re over age 70 ½.
The biggest downside to using a Roth IRA is that there are strict income guidelines that govern who can contribute.
For married couples filing jointly, your ability to contribute to a Roth IRA starts phasing out with a MAGI (Modified Adjusted Gross Income) of $196,000 and phases out completely at $206,000. For single filers, the phase-out range starts at $124,000 and ends at $139,000.
Who Should Consider a Roth IRA:
- Anyone who wants to diversify their tax liability: Since you pay taxes on your contributions now, you won’t have to pay taxes on your distributions later. All the while, your money grows tax-free. If you’re worried how your tax bill might look in the future, contributing to a Roth IRA can be a smart way to diversify.
- Someone who wants access to their cash: Few people know this, but you can actually take your contributions (not your earnings) out of your Roth IRA at any time without paying a penalty. If you think you might need to access your funds before retirement, a Roth IRA offers some flexibility in that respect.
- People who want flexibility when it comes to contributions and withdrawals: Since people who qualify to use a Roth IRA can continue contributing past age 70 ½ and don’t have to begin taking distributions at any age, this is one of the most flexible retirement accounts out there.
Who Should Pass:
- Someone who wants to leverage retirement savings to save on taxes: Since Roth IRAs are funded with after-tax dollars, you can’t deduct your contributions on your taxes no matter how much or how little you earn. If you want to save money on taxes, tax-deferred retirement accounts might be a better bet.
- High earners who make too much money: Since phase-outs for who can contribute to a Roth IRA begin at $124,000 for single filers and $196,000 for married couples filing jointly, not everyone can contribute to a Roth IRA in the first place.
Where to Open a Traditional or Roth IRA
If you want to boost your retirement savings and plan to do so by adding an IRA to your portfolio, there are plenty of online brokerage firms that can help.
I’ve reviewed quite a bit of them in-depth, and I have a few favorites as a result.
Here are my top choices when it comes to opening a traditional or Roth IRA:
TD Ameritrade offers another great option for both beginning and experienced investors.
For starters, there are no commissions on stocks, exchange traded funds or options, plus have access to TD Ameritrade’s investing tools and data. The account minimum for IRA is also $0 with a TD Ameritrade account, making this option smart for beginners who just want to dip their toes in at first.
Read here to find out more about TD Ameritrade.
As a true robo-advisor, Betterment offers a slightly different approach to IRAs. With Betterment, your IRA will be invested across two baskets of investments: a bond ETF basket and a stock ETF basket.
Since Betterment will help make your investment decisions for you, you won’t have to worry over which individual investments to use. Plus, Betterment comes with no account minimums and relatively low fees that range from .15 percent to .35 percent depending on your account balance.
Make sure to check out my review of Betterment for 2019.
In addition to these options, we have covered a wide range of other firms you should consider for your retirement funds over the years. As you continue your research, make sure to check out these posts as well:
- Best Places to Open a Roth IRA
- Best Online Stock Broker Sign Up Bonuses
- Best Online Brokerage Accounts for Beginners
Will You Have a 401k and an IRA?
If the thought of saving for retirement has you feeling overwhelmed, remember that it’s perfectly okay to start small.
The good news is, there are all kinds of retirement accounts to choose from that might be perfect for your situation.
The list includes work-sponsored retirement accounts like a 401(k) or 403b to traditional IRAs and Roth IRAs – plus, every other type of retirement account you can think of.
If you want enough money to have an enjoyable retirement, the time to start saving is now. Don’t delay, and don’t make excuses. Time goes by much faster than we think, and retirement will be here before you know it.