Know the Options
Consider the value of skimming through a well-designed menu in a nice restaurant. Seeing the available selection of dishes helps you get the most out of what this chef’s kitchen can offer. Even if you generally stick to your regular steak and fries, one evening you may be in the mood for something more exotic or just want to order some light appetizers. Being a knowledgeable patron and familiar with the panoply of available categories and options makes the experience more rewarding and enjoyable.
Loaded & Larger Savings Options
Similarly, most people stick to regular IRAs and 401k accounts. However, it is helpful to know about and understand the basics of the broader variety of retirement plan accounts that are out there. Maybe one day you’ll need to protect larger sums, fund a massive tax-free investing account, use retirement accounts to diversify into gold, real estate, or business startups, or build up a traditional pension fund for yourself and key employees. All of this (and more) is possible, but only if you know to ask your financial “chefs” about them.
Peruse this menu, and then, like a savvy waiter hoping for a hefty tip, I’ll circle back with some comments and suggestions.
Individual Retirement Accounts (IRAs)
- Traditional IRA: Allows tax-deductible contributions with taxes on withdrawals deferred until retirement.
- Roth IRA: Contributions are made with after-tax dollars; withdrawals are tax-free in retirement.
- Inherited IRA: For beneficiaries of IRA or employer-sponsored retirement plan assets, with specific rules depending on the beneficiary’s relationship to the deceased.
- Rollover IRA: Facilitates the transfer of assets from an employer-sponsored retirement plan to an IRA without losing tax advantages.
- Non-Deductible IRA: For after-tax contributions, suitable for individuals whose income exceeds the limits for deductible or Roth contributions.
- Self-Directed IRA (SDIRA): Permits a broad range of investments, including real estate, precious metals, and more. Available in both Traditional and Roth formats.
Employer-Sponsored Plans
- 401(k) Plan: Offers pre-tax and Roth options. Has significantly higher limits than IRAs and potential for loan options.
- 403(b) Plan: Similar to 401(k) plans, but for employees of public schools and certain non-profits.
- 457 Plans: Deferred compensation plans for state and local government employees.
- Thrift Savings Plan (TSP): The “401k” type plan for federal employees.
- SIMPLE IRA(Savings Incentive Match Plan for Employees): A hybrid between an IRA and corporate 401k. Designed for small businesses seeking to lower the technical complexity of a typical 401k plan.
Self-Employed Plans
- SEP IRA(Simplified Employee Pension): Enables small businesses and self-employed individuals to make employer contributions to an employee’s retirement account. Much higher limits than a typical IRA.
- Solo 401(k) Plan: For self-employed individuals, allowing the higher contribution limits and investment flexibility, including loans, of a corporate 401k.
- Self-Directed Solo 401(k) option. Combines the ultimate flexibility of a Solo 401k and Self-Directed IRA.
Defined Benefit Plans
- Pension Plans: Provides a fixed monthly benefit in retirement following complex actuarial rules. Can allow significant tax sheltered funding on top of 401k plans.
- Cash Balance Plans: Combines features of both pension plans and 401k plans, offering flexibility and additional funding options.
Other Retirement Options
- Annuities: Insurance-based products that provide a fixed income stream in retirement.
- Nonqualified Deferred Compensation Plans (NQDC): For executives and select employees, deferring income tax on a portion of their compensation.
- Taxable Brokerage Accounts: Due to capital gains treatment and step up in basis, can be very tax efficient.
- 529 Accounts: Primarily for education expenses, but with features that benefit retirement planning indirectly.
- Health Savings Accounts (HSAs): For medical expenses, offering triple tax advantages that can also support retirement savings if funds are accumulated for future medical expenses.
From Simple and Known
Regular IRAs are the most straightforward option that anyone can set up on their own, allowing thousands in tax-sheltered savings per person annually. Then you have employer sponsored plans (i.e., 401k, 403b, 457, and TSP plans (all of which are virtually identical except they are named differently based on the employer category). These plans depend on the employer’s whims, but approximately triple the amounts employees can defer out of their paychecks, and many 401ks offer company matches to boot. You also may be able to use a 401k to build up a significant tax-free investment account via expanded Roth features.
To Complex and Esoteric
Most are generally aware of IRA and 401k basics, but many entrepreneurs don’t know about the significant tax saving potential via self-employment retirement vehicles. Here too, massive Roth accounts are possible. And even some accountants and financial advisors may not fully grasp how pensions and cash balance accounts can be added on top of 401k plans to lower tax bills massively. For maximum effect, savers can also use HSAs, 529 plans, and annuities in a creative fashion. And thanks to capital gains rules, even taxable brokerage accounts can be utilized very tax efficiently to build, gift, and donate wealth.
Let’s Eat!
Just as you don’t need to be a professional chef to enjoy gourmet food, you don’t need to be a money geek to utilize the savviest tax and investing accounts. You do need to be a knowledgeable client though, to find the right “restaurant” and interact with the “staff” in a competent, confident manner. To do so, you need to take time to learn the basics. Hopefully, this article and future ones to come will help with that.
Don’t Obsess, Though
An important point is that perfect is the enemy of good. With so many retirement plan account options, some end up in analysis paralysis, always questioning if they and their advisors have designed the absolute best path forward. With so many pros and cons offsetting one approach or another, there is no one perfect approach. Remember that a solid financial plan you follow will always beat the “perfect” one that never happens!