Retirement Plans Inside and Outside of Work

Saving enough for a comfortable retirement is one of most people’s greatest financial goals—and challenges. Fortunately, there are tax-advantaged accounts available at work—and outside of it—specifically designed to help you save for your golden years. Let’s get to know them.

Workplace-based Plans

In the late 1970s, U.S. legislation paved the way for the 401(k) plan—the traditional version of which allows employees to contribute a certain percentage of their pre-tax pay to an account that is specifically earmarked for retirement. That money is typically invested in a mix of securities, like mutual funds, stocks and bonds. The funds in a traditional 401(k) grow tax-deferred throughout your career and then are taxed upon withdrawal in retirement.

A 403(b) plan can function similarly but is specifically for employees of nonprofit or other tax-exempt organizations, such as schools, hospitals and government agencies. There are a few distinctions between 403(b)s and 401(k)s, but the principle of tax-deferral still applies.

One of the advantages of these workplace retirement plans is that many employers will also contribute to them on their workers’ behalf. The structure of this "employer match" varies from organization to organization, but the idea is that for every dollar the employee contributes up to a set percentage of their salary, the employer will match it with specific amount. An example of a formula is a match of 50 cents on the dollar up to 6 percent of the employee’s salary.

Because these accounts come with tax advantages, the Internal Revenue Service (IRS) will only allow you to contribute up to a specified amount each year (and a higher amount in "catch-up contributions" if you are age 50 or older and therefore closer to retirement).

Pre-tax or Roth 401(k) or 403(b) Contributions

Many employers allow pre-tax and Roth contributions to their workplace retirement plans. Deciding between making pre-tax and Roth contributions can depend on factors like your current and anticipated income and tax bracket at retirement. Making pre-tax contributions lowers your immediate taxable income, deferring the taxes on your contributions and potential earnings until retirement. Roth contributions are made after taxes are taken out of your paycheck, but the potential investment gains are tax-free, as long as you have held the account for 5 years from your first contribution and are at least 59 ½ when you take the withdrawal.

Generally speaking, Roth contribution may make sense for younger workers who expect to retire in a higher tax bracket than the one in which they began their careers.

Some savers may choose to diversify their tax strategy by making both Roth and pre-tax contributions. Using both types of accounts allows you to "mix and match" pre- and post-tax contributions now, and likewise, pre- and post-tax distributions in retirement. (It’s important to note that unlike a Roth IRA, there are no income limits for Roth contributions into a 401(k).)

Retirement Accounts Outside of Work

For those who don’t have access to a retirement plan at work—or those who do and either want to save even more or want access to additional investment options—there are Individual Retirement Accounts (IRAs). These are held at financial institutions and are completely funded by the individual, with a lower contribution limit than a 401(k). Any potential investment gains in Traditional IRA accounts grow tax-deferred. If you are covered by a retirement plan at work and your income is below a certain threshold, traditional IRA contributions may be tax-deductible. If neither you nor your spouse is covered by a retirement plan at work, your contribution will be deductible.

You may also consider a spousal IRA, whereby a working spouse may contribute to an IRA in the name of a spouse who doesn’t work, or makes little to no income.

Traditional vs. Roth Accounts

If your adjusted gross income falls below a certain threshold, you may qualify to contribute to a Roth IRA. Contributions are not income tax-deductible, but distributions are not subject to federal income taxation if certain conditions are met. Unlike a traditional IRA, Roth IRAs don’t require the owner to withdraw money by a certain age.

It’s important to keep in mind, though, that your ability to contribute to a Roth IRA depends on your income. Higher earners may be subject to reduced contribution limits or may not be able to contribute at all.

The Bottom Line

There is plenty more to understand about the types of accounts discussed above—and how to make the most of them. Speak with your workplace representative or financial advisor to learn about these options and what’s what works best for your financial situation.