How to Choose a Retirement Account

The most universal goal to save for is retirement, or as I like to call it, a “work-optional lifestyle,” so determining how to choose the right retirement account is crucial. Despite this type of investing account being the most prominent and the most talked about, the complexities of the types of accounts and the rules that come with them make them the hardest to navigate. My goal for you is to feel educated and confident on how to choose and start a retirement account by the end of this post.

The Basics

First, let’s define what it means to be a retirement account. It is a type of financial account designed to help individuals save and invest money for their retirement years. It is a crucial tool for building long-term wealth and achieving financial security during your post-employment years. It’s important to note that while retirement accounts offer significant tax advantages, they also come with certain restrictions and penalties to encourage long-term savings for retirement.

Now let’s talk about the difference between an account and your money that goes into it. No matter what type of retirement account you choose, the account itself is just a shell, or a bag, if you will. They need to be funded and then invested in order to work for you! Think of the account as your bag and the investments are your phone, keys, wallet, etc…the things that make your life work easier.

Next, let’s differentiate between “contributing” and “investing.” Similar to the last paragraph, it’s important to make this distinction because I have heard too many horror stories of people contributing to their accounts for years, only to discover it’s been sitting in cash–not invested. So once you contribute to your retirement account (or any investment account for that matter), you must make sure those funds are being used to purchase investments, whether you have to do that manually or you can set that up automatically.

Now let’s get into the different types of retirement accounts. You may or may not have access to all of these accounts. It all depends on what kind of benefits are available to you at your workplace and what your income is. Also, there are many types to go over, but I will go more in-depth for the most popular ones and give a brief description for the less popular ones.

Common Types of Retirement Accounts:

1. Individual Retirement Accounts (IRAs): These are personal retirement accounts that individuals can open on their own and will be in the individual’s name only. IRAs can be established with financial institutions such as banks, brokerage firms, or mutual fund companies. Contributions to IRAs are typically made with pre-tax income (Traditional IRA) or after-tax income (Roth IRA). The growth of investments within an IRA is tax-deferred or tax-free, depending on the type of account.
   • Traditional IRA
     • Contribute pre-tax income, which means that when you contribute money to it, you’ll get a (typically) dollar for dollar tax deduction at tax time. Another way to put this is that contributions are tax deductible.
     • Grows tax-free
     • Pay income tax when taken out at in retirement (after 59 1/2 years old)
     • Pay a 10% penalty and income tax if you take money out before you are 59 1/2
   • Roth IRA
     • Contribute post-tax income; so no tax advantage when you contribute
     • Grows tax-free
     • Qualified withdrawals in retirement are tax-free
     • Income limits that determine your eligibility to contribute directly to a Roth IRA, so it’s best to take advantage before your income is too high to contribute.
   • Employer-Sponsored Retirement Plans: These retirement accounts are provided by employers to their employees as part of their benefits package. The most common types include:
     • 401(k): Offered by private companies, a 401(k) allows employees to contribute a portion of their salary to the account, often with the option of employer matching contributions. The contributions are tax-deferred, meaning they are deducted from your taxable income in the year of contribution. Withdrawals are generally taxed as income during retirement.
     • 403(b): Similar to a 401(k), but available to employees of nonprofit organizations, schools, and certain government entities.
     • 457(b): Available to employees of state and local governments and some tax-exempt organizations.
     • Thrift Savings Plan (TSP): Specifically for federal employees and members of the military.

In order to take advantage of retirement accounts, you need have clarity on your unique situation. Here are a few scenarios and suggestions when it comes to retirement accounts that can help.

Sample Scenarios

1. Meredith is 27 years old, is a successful online influencer with unlimited earning potential, single and wants to live a work optional lifestyle by the time she is 45.
   • Max out a Roth IRA each year if income isn’t too high.
   • Start a solo 401(k) or SEP IRA and work towards maxing them out each year.
2. Katie is 31 years old, has moderate income and great benefits with her employer, is engaged to be married and has dreams of owning a home and starting a family.
   • Contribute up to the company match within the company 401(k).
   • Contribute to Roth IRA, especially if household income once married will make them ineligible to contribute to a Roth IRA.
   • After maxing out Roth IRA, work towards contributing 10% within the 401(k).
3. Jess is 39 years old, married with two children, she is a stay-at-home-mom and her husband has a good salaried job with great benefits.
   • Make sure husband is contributing up to company match within his 401(k).
   • Start a spousal IRA in Jess’ name and max it out each year.
   • Start contributing to his Roth 401(k)
   • Work towards maxing out 401(k) to reduce taxable income.
4. Elizabeth is 45 years old, divorced and owns a successful small business.
   • Contribute to both Roth IRA and Traditional IRA (max amount cumulatively is $6,500 for 2023.)
   • In years when taxes are owed, contribute to Traditional IRA more.
   • Start a 401(k) or SIMPLE IRA for business if you are able to contribute more for yourself than a Traditional IRA and want to provide access for employees.
5. Carla is 52 years old, single, with a steady salaried job but not great benefits, multiple old 401(k)s that need to be consolidated and wants to retire by the time she turns 60.
   • Roll over old 401(k)s into one traditional IRA (consolidate!)
   • Max out Roth IRA contributions at $7,500/year (50+ year olds get an extra $1,000 catch up amount.)
   • Contribute to a Traditional IRA instead if you need a tax deduction for that year.

How to Invest a Retirement Account

Once you know how to choose a retirement account, you need to know how to invest the money you put into them. So how do you invest the funds inside your retirement accounts? Start by considering the time horizon of the account.

Any account that has a time horizon of 10 years or longer can generally be invested for growth with a heavy holding in stocks aka equity (70%-100% depending on individual time horizon, risk tolerance and goals.) The longer the time horizon, the more stock-heavy the account should be. Try to stick with mutual funds or Exchange Traded Funds (ETFs) that allow you to have a diversified portfolio.

Pro Tip: Most 401(k)s have a “target date” fund that automatically rebalances your stock exposure as you near retirement. That’s usually a great, simple investment to start with.

Lastly, here are some reminders and tips to keep in mind from a birds eye view.

1. Yes, time is the most important asset you have when it comes to investing, and you should start saving & investing into retirement accounts as soon as you can, HOWEVER, there are other foundational parts of your financial plan that should be steady first. For example, if you don’t have sufficient Emergency Funds or if you have high-interest debt, then you shouldn’t be contributing to a retirement account yet. The only exception here is if you have access to a 401(k) with a company match; in that case, you should contribute up to that match only so you don’t leave any free money on the table.
   • Learn about those foundational elements here.
2. Look at the types of retirement accounts the same way you look at your individual investments within them: it’s best to diversify.
   • By the time you get to retirement, you want to have all options on the type of income you can start withdrawing. For example, if you want to delay paying taxes on your withdrawals for as long as possible, you will want to have a Roth IRA and a non-retirement account to be able to pull from at the beginning of your retirement.
3. It’s listed in the scenarios above, but I want to re-iterate it here. If you are not earning income, but your spouse is, then you should start and contribute to a Spousal IRA.
4. Do not be discouraged if you do not have access to a 401(k). Having a livable wage, a job that you enjoy and saving what you can through the vehicles available to you are enough. The key is getting started and automating it so you don’t have to think about it every month.
5. Consulting with a financial advisor or doing further research can help you understand the specific details and options available to you based on your individual circumstances.

For more on how to choose a retirement account that’s best for you (and other basic financial planning pro-tips), grab my free 5-Step Roadmap Towards Building a Solid Wealth Foundation here.

This blog post was written on 6/12/23 by Danielle G. Nava, CFP®

Disclosure: ​The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss.