Throughout your life, you’ve probably built up numerous pension plans, and you’ve likely given thought to numerous retirement tactics. The key now, if you have recently retired or you are about to retire, is to start putting those pillars together to form a complete structure of what you have and find out what you may need going forward.

The 401(k)

The 401(k) is one of the most common types of retirement accounts. It’s established by an employer for the benefit of employees and is funded with contributions from both parties. This account is comprised of stocks, mutual funds, and certain other limited investments. Money that goes into the plan is not subject to income tax and neither is the growth on that money. Only distributions from the account, usually at retirement, trigger any income tax.

You can withdraw your money from a 401(k) account at any time, but if you withdraw before you are age 59 ½, the withdrawal is subject to a 10% penalty tax in addition to your normal tax obligation at the time of withdrawal.^[1] Loans are allowed in some plans and so are hardship distributions, which can help by eliminating the 10% if you qualify.

The Traditional IRA

An Individual Retirement Account, or IRA, can be opened with any reputable financial institution. There are annual limits on how much you can deposit into your IRA, but you have the freedom to decide how much to contribute and when to make your payments. Additionally, IRAs can legally hold a broader variety of security types than 401(k)s and do not limit you to a narrow menu of preselected choices.

As with a 401(k), the contributions to a traditional IRA are often tax-deferred, though whether you qualify to deduct your contribution is determined by your tax filing status, level of income, and whether you or your spouse are covered by a workplace retirement plan:

You can still contribute to an IRA even if you aren’t able to take the deduction. The growth on your contribution is still tax deferred, which can make it more advantageous from a tax perspective than contributing to a taxable account. Just remember to track your basis in your IRA and to file form 8606 with your taxes for any year that you make a non-deductible contribution.

Any distribution of pre-tax money from an IRA, whether it is from a contribution you deducted or from growth in the account, is subject to income taxes. You could also face penalties if you distribute funds prior to age 59.5, just like you could with a 401(k).

The Roth 401(k)

Contributions to a Roth 401(k) are made from your salary deductions, just like a traditional 401(k). The major distinction between the two is that the Roth version is taxed at the time of deposit, yet no taxes are due when the funds are made as part of a qualifying distribution, which is most commonly at age 59.5 or later.^[3]

The Roth IRA

Much like a Traditional IRA, a Roth IRA is an individual account that can be opened through a financial provider. Both have yearly contribution limits and the same flexible investment options. However, the main distinction between the two is that contributions to a Roth IRA are taxed upon entering the account but not upon withdrawal. It’s a traditional IRA in reverse, but you need to follow two special rules specific only to Roth IRAs to qualify for the preferential tax treatment and avoid penalties.

Beyond that, Roth IRAs do not have required minimum distributions at age 72 like Traditional IRAs do. They can be a powerful tax tool to help you avoid large pre-tax distribution in retirement as well as a wonderful estate planning tool for the next generation. But, contributions to a Roth are limited based upon your income:

There are fewer rules on who can contribute to a Roth than there on who can deduct contribution to a Traditional IRA. Do note that while contributions are limited based on income level, conversions are unlimited. Anyone can do them! That makes the two-step process of a non-deductible Traditional IRA contribution followed by an immediate Roth conversion quite appealing. Everyone is eligible and money in the Roth grows tax free. Be mindful of the IRA aggregation rule as you complete these transactions.

The Pension

When an employer provides a pension to an employee, they commit to supplying them with a regular monthly income after they retire. These are sometimes called ‘defined benefit plans’ and require the employer to take on all the investment risk involved in supplying you with that monthly income. These plans have become less common over the last few decades due to the costs and risks employers take on.

The sum that the individual will get is calculated based on numerous factors, primarily their highest average salary over a 3- or 5-year period and the length of time they were employed at the organization.^[4]

Conclusion

As you can tell, taxes are a major part of retirement planning, and often making the right choice for your retirement involves being savvy about which tax-advantaged retirement savings vehicles to use. If you’re looking for advice on how to manage your accounts and which accounts might be right for you, contact us for a complimentary review of your finances.