Retirement accounts are a cornerstone of financial planning for the future, yet they can often feel like a maze of acronyms and options. What exactly are 401(k)s, IRAs, and Roths, and how do they benefit us? Let's break it down.
In the past, pensions were the norm, providing employees with a safety net for their elder years. However, for companies, these plans became increasingly costly and unpredictable. Consequently, many have phased out pensions, ushering in a new era of retirement planning that offers both challenges and opportunities for employees.
Unlike pensions, which typically required lengthy tenure with one employer to fully vest, retirement accounts offer flexibility. We have the freedom to contribute to our own accounts, independent of our employment status, empowering us to take control of our financial futures. Of course, this also means shouldering the responsibility of saving enough to meet our retirement goals.
Taxation plays a significant role in incentivizing retirement savings. Congress has introduced tax code adjustments, such as the popular "401(k)," to encourage individuals to save for retirement. Consider a simplified example for the tax year 2023: assuming a single individual with a $100,000 salary, contributing to a 401(k) plan offers tax deductions, except in the case of a Roth designation.
No 401(k) | $10k to 401(k) | $10k to Roth | |
Salary | $100,000 | $100,000 | $100,000 |
Less Standard Deduction | ($13,850) | ($13,850) | ($13,850) |
Taxable Income before Other adjustments | $86,150 | $86,150 | $86,150 |
Less 401(k) Contribution | $0 | ($10,000) | $0 - Not deductible |
Taxable Income | $86,150 | $76,150 | $86,150 |
Tax | ($14,360) | ($12,160) | ($14,360) |
After-tax Cash | $71,790 | $63,990 | $61,790 |
While contributing to a Roth account may seem like forgoing immediate income, it offers tax-free withdrawals upon retirement, unlike traditional 401(k) plans where withdrawals are taxed.
Investment options within retirement accounts provide further advantages. 401(k)s offer diverse investment options, typically including mutual funds or index funds. These investment vehicles allow individuals to own fractions of multiple companies, mitigating the risk associated with single-company ownership. Additionally, the tax-deferred growth within retirement accounts enhances long-term investment returns compared to taxable brokerage accounts.
The retirement landscape has evolved significantly, necessitating a shift in how we prepare for our later years. Retirement accounts offer numerous advantages and serve as essential tools for financial security. For personalized advice, contact us to schedule a 15 minute introductory meeting.