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Saving for retirement and investing for the future is something that we all know we should be doing. Yet, nearly half of American households struggle to put anything away. A major challenge to this issue is confusion over knowing how to participate, with all of the different types of accounts available, it can be hard to determine which retirement account is best for you.
Each account has its own special limits, income requirements, and tax penalties if used incorrectly. With consequences like that, how is a person supposed to know which of these plans to use to build their nest egg?
The best retirement accounts are those that help people avoid taxes and provide optimal growth potential. This includes the ability to automatically make tax-advantaged contributions into a mixture of investments. It also means minimizing fees and providing the owner with flexibility.
To help you find the ones that will be a good fit for you and your financial situation, we'll cover ten of the best retirement investing accounts allowed by the IRS today. With each one, we’ll cover how they work, what they can offer, and how you can use them to build your nest egg.
The 10 Best Retirement Investing Accounts For 2022
One of the most essential elements of a good retirement plan is choosing the proper tools to help you build your wealth. For that reason, it’s important to know the various retirement accounts and understand the differences between them.
In a nutshell, all retirement plans provide some sort of tax-advantaged savings opportunity over regular savings accounts with your local bank. This might be tax savings upfront when you contribute or avoiding taxes altogether when you retire. Either way, the less you owe to the IRS, the more retirement income you can enjoy someday.
But growth is also just as important. Some accounts will have more investment options than others, so it's critical that you pick the ones that give you a reasonable range of choices and minimize fees as much as possible.
Of course, every person’s financial and working situation is a bit different than the next. Some people might work for a private company, be self-employed, or not work at all. Since there are plans designed for a variety of scenarios, it will help to explore your options.
With that said, here are ten of the most commonly used retirement investment accounts and how they can be used to your advantage.
1. Traditional IRA
Just like the name implies, a traditional IRA is the classic style of retirement plan. Created under the Employee Retirement Income Security Act of 1974, a traditional IRA is an example of what’s called a tax-deferred plan.
Making tax-deferred contributions means the account holder will:
- Skip paying taxes on the year that they contribute to the plan
- Avoid paying taxes while their investments grow
- Pay the taxes when they retire someday (after age 59-1/2)
Traditional IRAs can be set up at just about any financial institution of your choice. This might be at a bank, full-service brokerage (like Vanguard or Fidelity), or even with a more modern investment app (like SoFi or M1 Finance). Once established, account owners will have a wide variety of securities and options that they can invest in.
In order for contributions to a traditional IRA to be considered tax-deductible, the account holder’s income needs to be below a certain limit. This will be measured by the MAGI (modified adjusted gross income) reported on their federal tax return. You can find the latest MAGI limits on the IRS’s website.
People who earn beyond these limits can still make what are called “non-deductible” contributions to a traditional IRA. These contributions won’t get a tax break when they go into the account. However, any growth they achieve will still be tax-deferred.
As of 2022, the IRS allows participants to contribute up to $6,000 per year to a traditional IRA. Participants who are age 50 and older are allowed to save an extra $1,000 of catch-up contributions.
The funds inside a traditional IRA are available for withdrawal after age 59-1/2. Once taken, they will be considered taxable income (hence why they’re called “tax-deferred”). Any early withdrawals before age 59-1/2 will not only be taxed but will also incur an early withdrawal 10 percent penalty.
2. Roth IRA
Even since its inception back in 1998, the Roth IRA has been a fan favorite among savers and financial planners alike. This is for plenty of good reasons.
Essentially, a Roth IRA works the opposite of a traditional IRA. Account owners don’t get a tax break on their contributions in the year that they’re made. However, they will get to withdraw them tax-free when they retire (after age 59-1/2).
Depending on how your financial situation and how you feel the tax code may change over the years, this could be a much more lucrative opportunity. To give you an extreme example, take PayPal co-founder Peter Thiel who invested $2,000 into a Roth IRA back in 1999. 20 years later, that account grew into a massive $5 billion – and none of it is taxable!
The contribution limits to a Roth IRA are the same as a traditional IRA: $6,000 as of 2022 (or $7,000 if you’re age 50 and older). However, the income requirements are relatively higher. Click here to find the latest ones from the IRS.
You are allowed to contribute to both a Roth IRA and a traditional IRA. However, the total combined contribution can’t exceed the IRS limit. For instance, you could put $3,000 into each type of account, but not $4,000 into each because the combination would exceed the $6,000 limit.
Just like a traditional IRA, you can set up a Roth IRA with virtually any financial institution of your choice. From there, you’ll be able to invest in basically any financial product that they offer.
3. 401k
A 401k is one of the most popular types of retirement plans in the U.S. today. Named after section 401k of the IRS tax code, these plans allow participants to contribute money to their accounts on a tax-deferred basis with every paycheck they earn (similar to a traditional IRA). Some companies have even adopted Roth-style options for their 401k plans.
To start a 401k plan, participants need to work for an employer that offers one. For this reason, you’ll often hear them referred to as employer-sponsored plans or defined contribution plans.
401k plans have much higher contribution limits than IRAs. Participants can save up to $20,500 (as of 2022). Those who are age 50 and older can make an additional $6,500 catch-up contribution.
One of the most exciting things about a 401k plan is employer contributions. Companies that make employer contributions will put an extra $0.25 to $1 for every $1 you contribute. It will be the easiest money you’ll ever earn.
Participants will be limited to the financial institution and whatever investment options the plan has defined. This can range from a relatively small handful of funds to a full spectrum of securities. Unfortunately, if the plan doesn’t have a specific type of investment they’re looking for, then they won’t be able to invest in it.
Similar to IRAs, the funds inside of a 401k are not available for withdrawal until after age 59-1/2. Early withdrawals will be subject to a 10 percent penalty. However, 401ks do offer the chance to take out a loan if the plan administrator allows it.
If the participant leaves the employer, then they get to keep their 401k. This includes the present value of all the money they’ve contributed plus some of the employer’s contributions (according to the plan’s vesting schedule).
4. 403b and 457b
401ks aren’t the only employer-sponsored or defined contribution plans available. Whereas a 401k was meant for private corporations, there are also two other types of similar plans: the 403b and 457b.
- 403b plans are designed for employees of public schools, churches, and other tax-exempt organizations.
- 457b plans are used by government entities (such as local and state employees) and non-profit organizations.
For all intents and purposes, a 403b and 457b work nearly the same as a 401k plan. They have the same rules and contribution limits. However, there are some subtle differences:
- Although employer contributions are allowed, they are rarely offered.
- Whereas withdrawals from a 401k or 403b plan made before age 59-1/2 are subject to a 10 percent penalty, withdrawals from a 457b are not subject to this penalty.
- Participants of 401ks and 403bs who are age 50 and older can make catch-up contributions. However, 457b participants have double this catch-up contribution limit.
5. Thrift Savings Plan (TSP)
A thrift savings plan (TSP) is a special type of employer-sponsored retirement plan that is only open to federal employees and members of the uniformed services.
By all measures, a TSP basically works the same as a 401k plan. Participants will make tax-deferred contributions, and the employer can also contribute on behalf of the employee. Participants can also choose to set up a Roth-style account if they wish.
The major difference between a TSP and 401k is in how participants can invest. With a 401k plan, your employer can choose to work with any financial institution in the world and limit the plan to the investment options they choose.
A TSP is limited to just six basic options consisting mainly of index funds for stocks and bonds. The idea behind this is to make investing as simple as possible. Because of the use of index funds, account fees are also significantly reduced.
6. SEP IRA
People who are one-hundred percent self-employed will not have access to employer-sponsored retirement plans like a 401k. Therefore, the IRS allows them to choose from one of three types of plans designed specifically for the self-employed.
For many people, the preferred choice is the SEP IRA. SEP stands for “simplified employee pension” and it’s designed for people who either work alone or have a small number of employees.
From a single-employee perspective, SEP IRAs are great because participants get to take on two roles: employee and employer.
- As the employee, they can contribute up to $6,000 (or $7,000 if they’re age 50 and older). Note: If they’re already using a traditional or Roth IRA, then no employee contribution can be made.
- As the employer, they can also contribute the lesser of 25 percent of their earnings or $61,000 (as of 2022).
All of these contributions are considered to be tax-deferred. Therefore, the more the participant contributes to a SEP IRA, the less they’ll owe to the IRS on their income.
Beyond the contribution rules, a SEP IRA works just like a traditional IRA. Account-holders cannot make withdrawals until age 59-1/2 unless they pay a 10 percent penalty.
Participants can open a SEP IRA with any financial institution that offers them. They’re then allowed to invest in any securities that the institution offers.
7. Solo 401k
A solo 401k (also known as an individual 401k) is another type of self-employed retirement account. It's created for business owners with no employees.
Similar to a SEP IRA, solo 401k account holders will make contributions as both the employee and employer.
- As the employee, you can save up to $20,500 (as of 2022) or 100% of compensation, whichever is less.
- As the employer, you can make additional contributions up to 25 percent of your compensation.
The total contribution from both parts cannot exceed $61,000 (as of 2022).
Since Solo 401ks are not as common as SEP IRAs, they’re not as easy to set up. You’ll likely have to look beyond investment apps and check with traditional brokerages like Vanguard, Fidelity, Charles Schwab, etc.
8. Rollover IRA
A Rollover IRA is when someone with funds from a former employer moves them from that company's plan into an IRA.
For example, let's say you worked for a company and had a traditional-style 401k. You decide to leave that company and go work somewhere else. What do you do with your 401k?
You could:
- Leave the money right where it is inside your ex-employer's 401k plan. However, there might be high fees and limitations on how you can invest it.
- Roll the money into your new employer's 401k plan. However, there's no guarantee that the new employer’s 401k plan will be any better in terms of fees and investment options.
- Withdraw the funds. However, this is the worst option because it would then trigger taxes and a 10 percent early withdrawal penalty.
For these reasons, the IRS allows a fourth option where account holders can take their retirement savings and “roll” them into a new traditional IRA with a brokerage of their choice. Not only does this preserve its retirement fund status and not incur any taxes, but it also gives the owner a wide range of investment choices.
Once funded, a rollover IRA will work essentially the same as a traditional IRA. Withdrawals can be made after age 59-1/2 and will be considered taxable income. Any withdrawals before then will be subject to an additional 10 percent penalty.
9. Spousal IRA
For every type of retirement account we've mentioned so far, there is always one common theme: the account owner was working and has earned income.
So, what happens when someone isn't working or has no earned income? The classic example is a family where one of the parents has chosen to stay at home and take care of the children. Shouldn't they also be allowed to save for retirement?
Absolutely! For this reason, the IRS allows what's called a spousal IRA.
This will be an IRA in the non-working spouse's name. Essentially, it can be set up as either a traditional or Roth IRA, and it will have the same rules and contributions limits.
To qualify, the couple has to:
- File their federal taxes as “married filing jointly”
- Meet the income requirements for the style of IRA they'd like to have (traditional or Roth)
Most traditional brokerages are happy to offer a spousal IRA.
10. Pensions
Yes, some people still get pensions. This classic “defined benefit” retirement plan that your parents or grandparents had is still offered today to many working Americans such as:
- State and local employees
- Servicemembers
- Union workers
Although the participant can't actively choose the investments it contains, pensions do offer the advantage that they'll provide guaranteed monthly payments for life. This is a huge relief for the account owner (and their spouse) because they don't have to necessarily worry about how the account is invested. They get to sit back and passively receive the income.
Choosing the Right Retirement Investing Account
With so many different types of retirement accounts available and their tax implications, it can be difficult for an investor to know which ones they qualify for and how they can be optimized for maximum growth potential.
Although every situation is different, most financial experts will generally recommend taking the following approach:
1. Plans with Employer Matching
People who work for a company that offers employer matching incentives should start here first. This is because a matching contribution from the employer is like getting free money for nothing. All the investor has to do is save, and they might get a 50 to 100 percent return automatically.
Contribute enough to get the full employer match and then stop. For instance, if the employer matches you up to 6 percent of your contributions, then make 6 percent your goal.
2. Roth IRAs
Because of the future tax avoidance that a Roth IRA can provide, most middle-class Americans would be wise to make use of this account now. Despite having to pay taxes on the contributions you make now, the future growth potential and ability to create tax-free income in the future will be invaluable by the time you’re ready to retire.
The target should be to make a full Roth IRA contribution for the year. Remember as of 2022, that amount is $6,000 (or $7,000 if you’re age 50 and older).
3. Self Employed Plans
For people who have a side hustle and earn extra money outside of their normal job, they’ll want to consider funding a SEP IRA or Solo 401k. Not only is this an additional opportunity to save more for retirement, but it will also significantly reduce their taxable business income which will lead to a lower tax bill with the IRS.
4. Go Back to Your Employer Plan
After fully funding a Roth IRA and a self-employed plan (if applicable), the investor can then turn back to their employer-sponsored plan and continue to make additional contributions until they hit the IRS max for the year. This is usually accomplished by diverting raises and bonuses to the plan, or by tightening up the household budget to find some extra cash.
5. Double-Down on Spouses
If your spouse also works, don’t forget that you can essentially duplicate this entire strategy for them as well. Even if they don’t work, at a minimum you can use a spousal IRA to ensure that they will have something set aside for the future.
Pick The Best Retirement Investment Account For You
Everyone knows that they should be saving and investing their money for the future. But given the number of different options available, contribution requirements, and tax consequences, it can be confusing to navigate and know which one is the right tool for the job.
Fortunately, there are a few great retirement investment accounts you can focus on.
IRAs are a staple in retirement planning. Account owners can set them up with any financial institution of their choice and invest in nearly any security they offer. Owners can also designate them as either traditional or Roth-style based on how they believe it will benefit their current and future tax situation.
Employer-sponsored plans like a 401k, 403b, 457b, and TSPs are also very popular. Not only do these investment plans have higher contribution limits, but they also may include employer matching contributions which are essentially free money. You can only participate in one of these types of plans if you work for an employer that offers them.
For those people who are self-employed or have freelance income, two of the three available plans I'd recommend are a SEP IRA and Solo 401k. Both are great for individuals, and the more a person contributes to their plan, the less they'll owe in business taxes.
IRAs can also be used for other special purposes. People who have changed jobs can move their old 401k balance into a rollover IRA. Also, spouses who don't work might qualify for a spousal IRA.
Finally, some workers still receive pensions. Although you can't dictate how pension funds get invested, the fund is designed to be hands-off for account holders and provide them with monthly income payments for life.
Strategically, most people would benefit to get the full employer matching from their workplace plan first, max out a Roth IRA next, and then fund their other retirement plans as much as possible.
Of course, every person's financial situation is unique, so you may wish to consult with a financial planner who can help tailor a roadmap to your specific needs.
