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If you’ve contributed as much as you’re allowed in a year to your Roth individual retirement account (IRA), are there other tax-advantaged ways to put additional money to work building your retirement savings? The answer is yes.
As long as you’re eligible, you can save extra money for retirement in various accounts: a 401(k), a Simplified Employee Pension (SEP), a Savings Incentive Match Plan for Employees (SIMPLE) IRAs, or a Health Savings Account (HSA). Investment-only annuities are another option and don’t have the high fees associated with regular annuity products.
Here’s an important tip: Be sure to take full advantage of the savings power of your 401(k) before putting money in your Roth IRA by contributing enough annually to get the (free) extra money offered by your employer through the full employer match.
Read on to learn more.
Key Takeaways
- If you max out your Roth IRA, save even more by contributing to a 401(k) and by getting extra funds with the employer match.
- Simplified Employee Pension (SEP) IRAs permit contributions up to 25% of compensation for self-employed individuals.
- Health Savings Accounts (HSAs) offer tax-free withdrawals for medical expenses and tax-free growth of deposits.
- Annuities can provide additional retirement savings options with tax-deferred growth, although they often come with higher fees.
- Contributions to SIMPLE IRAs are tax-deductible, with options for matching contributions by employers.
Maximizing Contributions to 401(k) and Other Employer Retirement Plans
The first option to explore is a 401(k), 403(b), or 457 retirement plan at work. You can contribute sizable amounts to these plans annually. They normally increase annually to account for inflation, so every year be sure to check the maximum contribution allowed.
Many employers provide matching contributions, which is one of the best perks around—employers contribute extra funds on your behalf to your retirement account. So the value of your account can really grow. It’s important to contribute at least enough money to your account to receive the full match amount before you put even a penny into your Roth IRA.
Contributions to these accounts are generally tax deductible for the year when you make them. This means that your money will grow tax deferred and you’ll pay tax only when you take withdrawals during retirement. If you choose the Roth version of one of these plans, you won’t get any up-front tax break, but your withdrawals in retirement will be tax-free, much like a Roth IRA.
Important
If you have any self-employment income, consider funding a SEP or SIMPLE IRA.
Understanding SEP IRAs for Self-Employed Income
A Simplified Employee Pension (SEP) IRA is a retirement account that offers tax breaks for small business owners, including those who are self-employed. If you have self-employment income, whether it’s from a full-time job or a part-time gig, you can contribute up to 25% of your compensation or a certain maximum dollar amount, whichever is less. Again, the maximum can change every year, so be sure to look for the latest allowed figure.
If you’re self-employed, you’re considered to be both employer and employee. Keep in mind that if you employ others, you generally have to contribute on their behalf, too. And it has to be the same percentage of compensation that you contribute to your own account. So, if you contribute 15% of your compensation, then you also have to contribute 15% on behalf of any employees who:
- Are age 21 or older,
- Have worked for you for at least three of the last five years, and
- You’ve paid at least a certain salary amount (check this figure annually).
Similar to a traditional IRA, SEP IRA contributions are tax deductible for the year when you make them, but you’ll have to pay tax when you withdraw the money in retirement.
SIMPLE IRAs: A Retirement Savings Solution for Small Businesses
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is like a 401(k) plan geared for small businesses with 100 or fewer employees. As with a SEP IRA, if you are self-employed, you’re considered to be both employer and employee.
If you have other employees, you have to contribute for them, too, using one of two options:
- Make a dollar-for-dollar match of up to 3% of an employee’s pay, or
- Contribute a flat 2% of compensation, whether or not the employee contributes.
As with SEP IRAs, your contributions are tax-deductible for the year when you make them, and your withdrawals in retirement will be taxed as ordinary income.
Benefits of the SECURE Act for Small Business Retirement Plans
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in late 2019, making broad changes to retirement legislation. Under the act, if you have employees, then as a small business owner, you receive some benefits for establishing retirement plans for your employees. This applies to 401(k)s, 403(b)s, SIMPLE IRAs, and SEP IRAs, as mentioned above.
Small businesses receive an increase in tax credits for establishing a retirement plan. For adopting an automatic enrollment process, they also receive a tax credit. These credits apply for up to three years.
Under the act, a small business is a business that has no more than 100 employees receiving at least $5,000 in total compensation. The bill also broadened access to multiple employer plans.
Exploring Annuities as a Retirement Income Option
If you’ve exhausted all of the tax-deferred and tax-exempt retirement accounts for which you qualify, you might want to look into annuities. These are insurance products that make periodic payments of income during retirement.
Annuities have a justly deserved bad reputation for high fees and poor investment options. However, a newer class of annuities, called investment-only annuities, have lower costs. These annuities are created for tax-deferral purposes rather than insurance benefits. It’s essential to pay close attention to any additional features and ensure that the annuity provides enough value to justify the extra fees.
Your contributions to an annuity aren’t tax deductible, but they will grow tax-deferred, and there’s no limit on the amount of after-tax money that you can contribute. You’ll have to pay tax on the gains when you make withdrawals, but you won’t owe tax on the principal.
Using Health Savings Accounts for Retirement Medical Expenses
Health Savings Accounts (HSAs) are designed for healthcare costs, and withdrawals are tax-free only if they go toward approved medical expenses. Still, most of us have those, particularly as the years roll by. You contribute after-tax money to the HSA, and it grows tax-free while in the account.
Fast Fact
You can’t contribute to an HSA once you enroll in Medicare, but you can continue to use the funds in the account.
If you have a high-deductible health plan (HDHP), you may be eligible to contribute to an HSA. The HDHP must have maximum annual out-of-pocket expenses that do not exceed certain amounts for self-only coverage and for family coverage. Out-of-pocket expenses include deductibles and co-payments, but not premiums.
What Investment Vehicle Should I Invest in First?
If you are employed and your employer offers a contribution match on a 401(k) or a 403(b), these are the plans to take advantage of first. Employer matches are essentially free money invested on your behalf, so contribute to those before moving on to other tax-advantaged accounts like a Roth or a traditional IRA.
Can I Use Health Savings Account (HSA) Funds for Any Purpose in Retirement?
Health Savings Account (HSA) funds are specifically earmarked for healthcare costs, even in retirement. You can withdraw the funds for other uses, but you will incur taxes.
Can I Have Both a 401(k) and an Individual Retirement Account (IRA)?
Yes. Employer-sponsored plans like a 401(k) or a 403(b) count as direct contribution plans. An individual retirement plan (IRA) is a tool that you can use to increase your retirement savings beyond employer-sponsored plans.
The Bottom Line
You have many valuable savings options to choose from after you’ve maxed out your contributions to your Roth IRA. These include 401(k)s, SEP IRAs, SIMPLE IRAs, HSAs, and annuities. How much you can save may be limited by the amount and type of income you have earned as well as your contributions to other accounts. To be safe, it’s worth checking on your additional savings opportunities with a tax professional.