Looking at Investment accounts is like looking down at a bowl of Campbell’s Alphabet soup.
To begin, you have Roth’s, IRA’s, SEP’s, 401(k), 457 etc.... Most of it is nonsense until you have a quick reference guide to help you along.
In this post I thought it would be helpful to go over the basics of the top 10 accounts, how much you can contribute and an overview of each one. It is important to remember that these are just investment accounts, not the investments themselves. This is where a lot of confusion starts.
Think of an investment account like a NASCAR race. Each car is a different investment account, such as Honda for a 401k, Ford is a ROTH IRA, etc.... The investments themselves are the drivers, who determine the speed of the car. Speed is the risk taken i.e., stocks vs bonds vs crypto.
Individual Retirement Accounts Outside of Work
Individual Retirement Account (IRA)
What is an IRA?
An IRA is a pre-tax retirement account meaning you don’t pay taxes until retirement. These IRAs are available to anyone that makes an earned income. With IRA’s you must wait until you are 59.5 to pull any funds and to avoid penalties.
How much can I contribute?
As of 2023 the contribution limit is $6,500 a year for an individual and an additional $1,000 for catch-up contributions if you are above the age of 50. Keep in mind you must have earned income. An example is, if you make $5,000 this year, you will only be able to contribute $5,000 to your IRA.
There is an exception and that is if you are married you can contribute to your spouses through a spousal contribution. This allows a non-working (or little income) spouse to piggyback off the others earned income.
Is there an income limit?
There is no income limit to open and fund an IRA however, there is an income limit to take advantage of the tax deductions if you are covered by a retirement plan at work. Make sure to check out this link to see if you qualify.
ROTH IRA
What is a ROTH IRA?
Like an IRA, this retirement account follows the same rules except for your contributions are POST-TAX. This means that once you contribute to the account, you will never be taxed again.
A ROTH must be open for at least 5 years, and you must be 59.5 to make withdrawals on the earnings from the account however, you can make withdrawals on YOUR contributions at any time. This isn’t recommended as this account should only be used for the long run.
How much can I contribute?
For 2023 you can contribute up to $6,500 into your ROTH, and same rules apply for “Catch-up contributions”.
Is there an income limit?
Unlike the IRA, a ROTH has income limits that prevent you from contributing to the account. This is based on your Modified Adjusted Gross Income (MAGI)
Single - <$153,000
Married Filing Jointly - <$228,000
If you are above the income limit you can do what is called a BACKDOOR ROTH CONTRIBTUION. This allows you to make contributions into your IRA and then immediately convert it into a ROTH.
Health Savings Account (HSA)
What is an HSA?
An HSA is a powerful tool that combines both the IRA and the ROTH, together to make a tax deductible, and tax-free growth account. An HSA is meant for health care costs but a good way to use it is to cash-flow your healthcare needs now and let it build for your healthcare expenses in retirement.
How much can I contribute?
The limit is $3,850 for self-coverage and $7,750 for family coverage. Unlike the ROTH and IRA, catch up contributions start at 55.
Is there an income limit?
The best part about an HSA is there is no income limit. However, you do have to be enrolled with a High Deductible Health Insurance Plan (HDHP). Remember an HSA is triple-tax advantaged meaning it reduces your taxable income, growth is tax deferred, and then tax-free on health care costs.
Employer Sponsored Retirement Accounts
401 (k)
What is a 401(k)?
A 401(k) is an employee sponsored plan meaning that you can only have one if your employer offers it. Contributions into the plan are pre-tax, so when you pull them out at retirement you will be taxed on what you draw from. With a 401(k), your employer has an option to match the dollars you contribute into the plan, this translates to FREE MONEY!
How much can I contribute?
With a 401(k), you can contribute $22,500 a year plus employer contributions. This money must stay in the plan until you are 59.5 otherwise if you take an early withdrawal, you will be penalized with a 10% penalty plus taxes.
Is there an Income limit?
There is no income limit, just remember that you can only make contributions to a 401(k) if your employer offers one.
ROTH 401 (k)
What is a ROTH 401 (k)?
This account has the same exact rules as the above 401(k). The only difference between the two is this account is post-tax not pre-tax. This means once contributions are made you will never be taxed on the money again. The only stipulation is that money contributed by the employer will ALWAYS be pre-tax so you will owe taxes on employer contributions in the future.
How much can I contribute?
$22,500 plus employer contributions
403 (b)
What is a 403 (b)?
Same as 401(k) except the only difference is that it is used by tax-exempt or non-profit organizations. Some organizations offer pre-tax or ROTH options.
457(b)
What is a 457(b)?
Same as 401(k) but these are used for people who work for local and state governments. The advantage to these plans is that once you are separated from service you can pull the funds at any age unlike the above employer plans where you must wait until 59.5 years old.
Solo 401(k)
What is a solo 401(k)?
This plan is only available to an individual (and spouse if applicable) business owner(s). To qualify for a solo 401(k), you cannot have any employees. With a solo 401(k), contributions are pre-tax, and they also have options for a ROTH Solo 401(k).
How much can I contribute?
As an owner of a Solo 401(k) you must think of yourself as the employee and the employer. The max contribution to a solo 401(k) is $66,000 subject to the below limits.
The EMPLOYEE can contribute up to $22,500 or 100% of compensation, whichever is less.
The EMPLOYER (also you) can make an additional contribution up to 25% of your compensation.
Simple IRA
What is a simple IRA?
A simple IRA is for small business owners under 100 employees. This account is similar to a 401(k) with contributions pre-tax and reducing your taxable income. An employer with a Simple IRA must choose either a 3% matching contribution or a 2% nonelective contribution (a contribution whether or not the employee contributes).
How much can I contribute?
Employees can contribute up to $15,500
Simplified Employee Pension IRA (SEP IRA)
What is a SEP IRA?
A SEP IRA is an employer contribution plan only, meaning that only the employer can make contributions, not the employees. This can be beneficial to companies that have a cyclical nature with up and down months. Any company size can open a SEP IRA, and funds are pre-tax.
How much can I contribute?
Those who qualify can contribute up to 25% of their employee’s compensation or $66,000, whichever is lesser.
With all these accounts you can see that it gets overwhelming with all the info overload. Please come back and use this as a resource or download the picture below as a cheat sheet to Retirement accounts.
Five Pine Wealth Management is a registered investment advisor offering advisory services in the State(s) of Idaho and Washington and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training.
The information in this blog is for informational purposes only and should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security or advisory service in any jurisdiction where such solicitation, offer, or recommendation would be unlawful or unauthorized.
The information provided should not be relied upon as the sole factor in an investment making decision. Past performance is no guarantee of future results.