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How to Save for Retirement: 5 Essential Accounts to Consider

Saving for retirement can seem daunting and complicated, but it doesn’t have to be. If you are wondering where to squirrel away money when it comes to saving as tax-efficiently as possible, consider these five essential retirement account types.

Articles by Fred Egler, CFP®
By Fred Egler, CFP® Financial Planner, Betterment Published Nov. 07, 2014 | Updated Jul. 01, 2020
Published Nov. 07, 2014 | Updated Jul. 01, 2020
5 min read
  • You can contribute to a 401(k), an IRA, and a Health Savings Account all in the same year.

  • The annual contribution limits for each type of retirement account are subject to change from year to year.

Saving for retirement can seem daunting and complicated, but it doesn’t have to be. If you are wondering where to squirrel away money when it comes to saving as tax-efficiently as possible, consider these five essential retirement account types.

Traditional 401(k)

  • The most common type of workplace retirement account for investors is a Traditional 401(k). Contributions to a Traditional 401(k) are made with pre-tax dollars, and the money is normally deducted directly from your paycheck before the paycheck reaches you. The result is that Traditional 401(k) contributions reduce your amount of taxable income for the current year. This holds true for Traditional 403(b)s, too.

Money in a Traditional 401(k) grows tax-free, and the distributions are taxed when you withdraw the money during retirement. Therefore, it may be smart to contribute to a Traditional 401(k) if you think you will be in a lower tax bracket in retirement than you are currently in now.

Another good reason to contribute to a Traditional 401(k) is the possibility of an employer match. Your employer may match the contributions you make to your Traditional 401(k) plan up to a certain percentage. That’s free money—and no one should pass that up.

In 2019, the maximum amount you can contribute to a Traditional 401(k) is $19,000 if you are under age 50. If you are age 50 or above, you can contribute an additional $6,000, bringing your total limit to $25,000.

For 2020, the contribution limits have increased to $19,500 for those under age 50. For those age 50+, the catchup contribution is now $6,500, meaning that your total contribution limit is up to $26,000.

The IRS generally requires you to start taking required minimum distributions from your Traditional 401(k) either when you reach a certain age, or, when you retire from your job—if you are older than the age requirement.

Roth 401(k)

  • A less common but increasingly popular workplace retirement account is a Roth 401(k). These accounts have the same contribution limits as Traditional 401(k)s. The main difference is when the funds in Roth 401(k)s are actually taxed. Unlike Traditional 401(k)s, Roth 401(k)s are funded with contributions that have already been taxed. This means that Roth 401(k) contributions do not reduce your taxable income.

The money in a Roth 401(k) grows tax-free, and when you withdraw the money in retirement, the distributions are also tax-free. If you think you are going to be in a higher tax bracket in retirement—or generally think tax rates are going to increase in the future—Roth 401(k) contributions may be the right choice for you.

If your employer offers a 401(k) match then you will still get the match if you make Roth 401(k) contributions, however, the matches will be placed in a Traditional 401(k) account.

Keep in mind, the contribution limit across Traditional and Roth 401(k)s is a combined limit. For example, you could not contribute $19,500 to both a Traditional and a Roth 401(k) in 2020—you can only contribute $19,500 total across both. You can split your contributions so that a portion goes to the Traditional and a portion goes to the Roth.

Contributions are made on a calendar year basis.

Traditional IRA

  • IRAs (Individual Retirement Accounts) are not offered by an employer, which means you have more control and flexibility with the investments and the provider you choose. As long as you earn taxable income you can contribute to a Traditional IRA, and the maximum contribution you can make for 2019 and 2020 is $6,000. If you are over age 50, you can contribute $7,000.

Money in a Traditional IRA grows tax-free, and is normally taxed when you take distributions in retirement. Additionally, the IRS generally requires you to start taking distributions from a Traditional IRA starting at a certain age.

You can also get a tax deduction on your Traditional IRA contributions in the year you make them. Your ability to deduct, though, can depend on if:

Some investors choose to roll over their 401(k)s to a Traditional IRA in order to consolidate their investments at the provider of their choice, or to switch to a provider with a lower fee. For investors looking to make backdoor Roth conversions, it is wise to move an old 401(k) into a current 401(k) if that option exists, instead of a Traditional IRA.

Roth IRA

  • Unlike Traditional IRAs, Roth IRA contributions offer no ability to receive a tax deduction. You contribute to a Roth IRA with after-tax dollars, and when you take distributions from your Roth IRA in retirement they are tax-free.

Similar to Roth 401(k)s, making Roth IRA contributions is beneficial if you think you will be in a higher tax bracket in retirement than you are now. Another perk is flexibility. Roth IRAs do not require you to take minimum distributions like Traditional IRAs do. Additionally, you can withdraw your contributions to a Roth IRA at any time without taxes or penalties.

If you make over a certain amount of income, you cannot contribute to a Roth IRA directly. Roth IRAs have the same contribution limits as Traditional IRAs ($6,000 or $7,000, depending on age), but that limit is the maximum amount total across both types—meaning you cannot contribute the maximum amount of $6,000 (or $7,000) to both a Roth IRA and a Traditional IRA in the same year.

Unlike 401(k)s, you can contribute to an IRA up until that year’s tax filing deadline. So for example, you contribute to an IRA for the 2019 tax year up until April 2020.

Health Savings Account (HSA)

  • Health Savings Accounts (HSAs) should be used as an option to set aside money for retirement if you have already filled up all your other retirement account options. Contributions to an HSA are tax-deductible, and distributions from an HSA are tax-free if you use the money for medical expenses or related costs.

If you allow your HSA to invest and grow over time you can withdraw the funds at age 65 without triggering a penalty. Distributions from your HSA at age 65 or over would be treated similarly to distributions from a Traditional IRA.

In 2019, you can contribute up to $3,500 to an HSA if you are a single tax filer, and up to $7,000 if you have a family HSA. For 2020, the limits are $3,050 for single tax filers and $7,100 for families.

Keep in mind that you can only contribute to an HSA if you are enrolled in a high-deductible health plan through you or your spouse’s workplace.

HSA contributions are made on a calendar year basis.

Try our Retirement Savings Calculator

Need Advice?

Within a Betterment account, we can provide additional advice regarding which accounts you should consider funding and in what order. You can even sync up your 401(k)s and other financial accounts to see an overall picture of your finances. Get started or log in to complete your retirement plan and see personalized savings advice.

Our licensed financial experts also offer advice packages for retirement planning and more.

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