Your future self will thank you for stashing some money here.
Saving enough for retirement is a massive challenge, thanks to the rising cost of living, the scarcity of pensions, and Social Security’s declining buying power. As if all that wasn’t enough of a challenge, when you finally withdraw your hard-earned cash, the government comes along asking for its share.
Few people manage to avoid taxes in retirement, but you could reduce how much you owe by choosing the right home for your savings. Here are three accounts that could help you hold onto more of your money.
1. Roth IRA
The Roth IRA is one of the most popular accounts for those hoping to reduce their retirement tax bill because just about anyone can open one. Plus, they give you a lot of freedom to choose your own investments. Unlike most retirement accounts, Roth IRAs require you to pay taxes on your contributions in the year you make them. But then you’re able to withdraw your funds tax-free later on.
You can take contributions out tax-free at any age. However, you must wait until you’re at least 59 1/2 and have had your Roth IRA for at least five years before you can withdraw earnings tax- and penalty-free.
Roth IRAs are pretty common, so you can open one with just about any broker. But you’re only able to contribute to one as long as you fall below the income limits set by the IRS. High earners who hope to build up their Roth savings will have to do a backdoor Roth IRA where they first put money in a traditional IRA and then do a Roth IRA conversion.
But few encounter this issue. Most people can contribute up to $6,500 to a Roth IRA in 2023 or $7,500 if they’re 50 or older.
2. Roth 401(k)
An increasing number of employers are giving their employees the option of contributing to a Roth 401(k). Roth 401(k)s come with the high annual contribution limits and the possibility of an employer match found with a traditional 401(k) as well as the tax-free withdrawals of a Roth IRA.
Like Roth IRAs, Roth 401(k)s require you to pay taxes on your contributions in the year you make them and there are still age restrictions that limit when you can access your money tax-free. In addition, employer matches aren’t usually made with after-tax dollars, so you will owe the government a cut when you withdraw these in retirement.
These accounts don’t have income limitations, so they’re an option for high earners. And they’re a great choice for those who hope to set aside large sums for retirement. In 2023, you may contribute up to $22,500 to a Roth 401(k) if you’re under 50 or $30,000 if you’re 50 or older.
3. Health savings account (HSA)
Health savings accounts (HSAs) are a great place to stash money you’ve earmarked for retirement medical expenses. Your contributions reduce your taxable income for the year, like traditional retirement accounts. But in addition, you can make tax-free medical withdrawals at any age. And you can roll your extra HSA funds over from year to year as needed.
You can also make non-medical withdrawals from your HSA, although you will pay taxes on these. You’ll also face a 20% penalty if you’re under 65 at the time. But it’s still nice to have the option in case you don’t need all your money for medical care.
Those with eligible individual health insurance plans with deductibles of $1,500 or more may contribute up to $3,850 to an HSA in 2023. Those with family plans that have deductibles of at least $3,000 may contribute up to $7,750 in 2023. And adults 55 and older can contribute an extra $1,000 beyond the above limits.
If you hope to use your HSA as a retirement account, it’s important to choose your provider carefully. Look for one that enables you to invest your funds so you can grow your wealth more quickly over time. Otherwise, you may not earn much interest on your money.
The above accounts are all great choices if you’re looking to keep your retirement tax bill down. And you don’t have to limit yourself to just one. If you’re eligible for more than one of the accounts listed here, you could always open one of each type. Think about what makes the most sense for you, and then decide how much you’d like to contribute to each for the rest of 2023.
