Retirement Accounts
Tax-Advantaged Wealth Building
Introduction
Retirement accounts are special investment accounts that offer significant tax advantages. Understanding and utilizing these accounts is one of the most powerful wealth-building strategies available. The tax benefits alone can add hundreds of thousands of dollars to your retirement savings over a career.
This lesson covers the major types of retirement accounts, their tax advantages, and how to use them effectively.
Why Retirement Accounts Matter
Retirement accounts offer two major advantages:
1. Tax Benefits
Depending on the account type, you either:
- Don't pay taxes on money going in (tax-deferred)
- Don't pay taxes on money coming out (tax-free)
- Or both (in the case of employer matching)
2. Forced Long-Term Thinking
Penalties for early withdrawal encourage leaving money invested for decades, allowing compound growth to work its magic.
The Impact of Tax Advantages:
$500/month invested for 30 years at 8% return:
| Account Type | Approx. Value at Retirement |
|---|---|
| Taxable account (25% cap gains tax) | ~$550,000 |
| Tax-advantaged account | ~$680,000 |
That's $130,000 more from tax advantages alone!
401(k) Plans
What It Is:
An employer-sponsored retirement account that allows pre-tax contributions directly from your paycheck.
Key Features:
| Feature | Detail |
|---|---|
| 2024 Contribution Limit | $23,000 ($30,500 if 50+) |
| Tax Treatment | Pre-tax contributions; taxed at withdrawal |
| Employer Match | Many employers match a percentage of contributions |
| Investment Options | Limited to employer's chosen funds |
| Withdrawal Age | 59½ without penalty |
Employer Match = Free Money:
If your employer offers matching (e.g., 50% match on first 6% of salary), not contributing enough to get the full match is leaving money on the table.
Example with $60,000 salary:
- You contribute 6%: $3,600
- Employer matches 50%: $1,800
- Total contribution: $5,400
That's $1,800 of free money annually—a 50% immediate return!
Always contribute at least enough to get the full employer match.
Traditional IRA
What It Is:
An Individual Retirement Account you open yourself, separate from your employer.
Key Features:
| Feature | Detail |
|---|---|
| 2024 Contribution Limit | $7,000 ($8,000 if 50+) |
| Tax Treatment | Contributions may be tax-deductible; taxed at withdrawal |
| Investment Options | Nearly unlimited (stocks, bonds, funds, etc.) |
| Withdrawal Age | 59½ without penalty |
| Required Distributions | Must begin at age 73 |
Deductibility Rules:
- No employer retirement plan: Fully deductible regardless of income
- With employer plan: Deductibility phases out at higher incomes
- Spouse rules: Additional considerations if spouse has employer plan
Roth IRA
What It Is:
An IRA funded with after-tax dollars that grows tax-free forever.
Key Features:
| Feature | Detail |
|---|---|
| 2024 Contribution Limit | $7,000 ($8,000 if 50+) |
| Tax Treatment | After-tax contributions; tax-free withdrawals |
| Investment Options | Nearly unlimited |
| Withdrawal Age | 59½ for earnings (contributions anytime) |
| Required Distributions | None during owner's lifetime |
Income Limits:
You cannot contribute to a Roth IRA if your income exceeds certain limits (around $161,000 single, $240,000 married in 2024). The "backdoor Roth" strategy may be available for high earners.
Why Roth IRAs Are Powerful:
- Tax-free growth for decades
- No required minimum distributions
- Contributions can be withdrawn anytime without penalty
- Tax diversification in retirement
Roth 401(k)
What It Is:
A 401(k) with Roth tax treatment—after-tax contributions with tax-free growth.
Key Features:
| Feature | Detail |
|---|---|
| Contribution Limit | Same as traditional 401(k): $23,000 ($30,500 if 50+) |
| Tax Treatment | After-tax contributions; tax-free withdrawals |
| Employer Match | Goes into traditional 401(k) (pre-tax) |
| No Income Limits | Available regardless of income |
Many employers now offer both traditional and Roth 401(k) options. You can split contributions between them.
Traditional vs. Roth: Which to Choose?
The decision depends on whether you expect higher taxes now or in retirement.
Choose Traditional (Tax-Deferred) If:
- You're in a high tax bracket now
- You expect lower taxes in retirement
- You want the immediate tax deduction
- You're maximizing contributions (pre-tax dollars go further)
Choose Roth (Tax-Free) If:
- You're in a low tax bracket now
- You expect higher taxes in retirement
- You're early in your career with growth ahead
- You want tax diversification
- You value the flexibility of no RMDs
Best Strategy:
Many people benefit from having both types—tax diversification gives flexibility in retirement to manage taxable income.
Other Retirement Accounts
SEP IRA (Self-Employed):
For self-employed individuals and small business owners. Higher contribution limits (up to 25% of compensation or $69,000 in 2024).
SIMPLE IRA:
For small businesses with 100 or fewer employees. Lower limits than 401(k) but simpler to administer.
403(b):
Similar to 401(k) but for non-profit organizations, schools, and government entities.
457(b):
For state/local government employees and some non-profits. Can be withdrawn at any age upon leaving employer without penalty.
Retirement Account Strategy
Step 1: Get the Full Employer Match
Contribute at least enough to your 401(k) to get the full employer match. This is free money with an instant 50-100% return.
Step 2: Consider Roth IRA
If you're in a lower tax bracket or want tax diversification, max out a Roth IRA ($7,000).
Step 3: Max Out 401(k)
After Roth IRA, go back to 401(k) and try to reach the maximum ($23,000).
Step 4: Taxable Investing
After maxing tax-advantaged accounts, invest in regular taxable brokerage accounts.
Key Takeaways
- Retirement accounts offer significant tax advantages worth hundreds of thousands over time
- Always contribute enough to get the full employer 401(k) match—it's free money
- Traditional accounts: pre-tax contributions, taxed at withdrawal
- Roth accounts: after-tax contributions, tax-free withdrawals
- Choose traditional if in a high tax bracket now; Roth if in a low bracket
- Having both account types provides tax diversification in retirement
- Contribution limits reset annually—use them or lose them
Summary
Retirement accounts offer powerful tax advantages that can add significantly to your wealth over time. The 401(k) allows pre-tax contributions from your paycheck—always contribute enough to get any employer match. Traditional IRAs offer similar tax-deferred growth. Roth IRAs and Roth 401(k)s are funded with after-tax dollars but grow tax-free forever. Choose between traditional and Roth based on whether you expect higher taxes now or in retirement; having both types provides flexibility. Maximize these accounts before investing in taxable accounts.