Saving money for your golden years is crucial. Without a solid nest egg, you’ll risk struggling to pay the bills once your career ends.
Most seniors need about 70% to 80% of their former income to live comfortably in retirement, and Social Security will only provide around half that amount, if you’re an average earner. As such, you’ll need to save independently during your golden years, and the good news is that you have a number of tax-advantaged retirement plans to help you accumulate wealth.
IMAGE SOURCE: GETTY IMAGES.
Types of retirement savings accounts
If you’re saving for retirement in 2020, here are the plan choices that may be available to you:
Here, we’ll review each of these options to see what the annual contribution limits entail and whether you’re eligible to fund each account, as different plans have different rules.
Traditional 401(k)s
Employer-sponsored 401(k)s come in two main varieties: traditional and Roth. The upside of a traditional 401(k) is that your contributions are made with pre-tax dollars, saving you money each year you fund your retirement plan.
Imagine you fall into the 24% tax bracket and put $6,000 into a traditional 401(k) in 2020. That alone will shave $1,440 off your 2020 tax liability.
Once your traditional 401(k) is funded, your money can be invested for tax-deferred growth. This means you don’t pay taxes on your investment gains on a yearly basis, as you would with a traditional brokerage account. Rather, you pay taxes when you take withdrawals in retirement.
You’re allowed to access the money in your 401(k) penalty-free once you turn 59-1/2. Then, you’ll need to start taking required minimum distributions, or RMDs, from that account once you turn 70-1/2.
The annual contribution limits for traditional 401(k)s are quite generous in 2020: $19,500 for workers under 50, and $26,000 for those 50 and over. This represents a $500 increase for younger workers compared to 2019, and a $1,000 catch-up increase for older workers.
In addition, you may be entitled to matching dollars in your 401(k) if your employer offers such a program. The exact match you’ll get will depend on what that program looks like and how much you contribute to your 401(k) yourself. But the money you get from your employer does not count toward your annual limit, so if you’re 40 years old and decide to max out at $19,500, and then get another $3,000 in matching dollars from your employer, that’s totally fine.
Roth 401(k)s
Though not every 401(k) plan offers a Roth savings feature, a growing number of plans are starting to incorporate this option. With a Roth 401(k), your money goes in on an after-tax basis, so there’s no immediate tax break for making contributions. But once your account is funded, your invested savings get to grow tax-free, and withdrawals in retirement are tax-free as well.
The annual contribution limits for Roth 401(k)s are the same as those of traditional 401(k)s, as are the rules — you can access your savings penalty-free once you turn 59-1/2, and you must start taking RMDs once you turn 70-1/2. The primary difference, however, is that RMDs from a traditional 401(k) result in more taxes for you as a senior, whereas RMDs from a Roth 401(k) don’t increase your tax burden in retirement, since all Roth withdrawals are tax-free.
Furthermore, whereas there are income limits that come into play with regard to funding a Roth IRA, Roth 401(k)s don’t impose earnings-related restrictions. As such, you can fund a Roth 401(k) even as a higher earner.
403(b)s
A 403(b) works just like a 401(k), only it’s a savings plan available to specific types of workers — educators, nonprofit employees, and those employed by religious institutions. The annual contribution limits for 403(b)s mimic those of 401(k)s: $19,500 for workers under 50, and $26,000 for those 50 and over.
Workers with at least 15 years of service may, if their plans allow for it, be entitled to an additional catch-up on contributions. This special catch-up is calculated as the lesser of:
- $3,000
- $15,000, reduced by the amount of extra contributions made in previous tax years
- $5,000 times the number of years you’ve worked for your employer minus total extra contributions made during previous tax years
Note that this special catch-up is not the same catch-up as the one workers 50 and older are entitled to. If you’re entitled to both catch-ups, 403(b) contributions that exceed the standard $19,500 limit are first applied to the 15-year catch-up, and then to the catch-up for being 50. Let’s say you’re over 50 and are eligible for an additional $3,000 under the special catch-up provision for putting in 15 years of service. If you contribute a total of $25,000 to your 403(b) in 2020, the first $19,500 will count as your regular contribution. Then, your next $3,000 will count as your special catch-up, and your final $2,500 will count as an age-related catch-up.
Traditional IRAs
If you’re self-employed, or don’t work for a company that offers a 401(k) plan, you can save for your golden years in an individual retirement account, or IRA. The annual contribution limit for traditional IRAs in 2020 is much lower than that of 401(k)s — $6,000 for workers under 50, and $7,000 for those 50 and older. These limits are the same as the limits for 2019 — there was no increase.
Otherwise, the rules are the same as those of a traditional 401(k) — your money goes in on a pre-tax basis, investment growth is tax-deferred, and your withdrawals in retirement are taxed. You can access your money penalty-free once you turn 59-1/2, and RMDs come into play starting at age 70-1/2.
Roth IRAs
The annual contribution limits for Roth IRAs are the same as the limits for traditional IRAs: $6,000 for workers under 50, and $7,000 for those 50 and older. Roth IRA contributions are made with after-tax dollars, so there’s no immediate tax savings for funding an account. But investment gains in a Roth IRA are completely tax-free, and withdrawals in retirement are tax-free as well.
One major benefit of Roth IRAs is that they’re the only tax-advantaged retirement savings plan to not impose RMDs. As such, you’ll have the option to leave some or all of that money to your heirs if you so choose.
One drawback of Roth IRAs, however, is that higher earners are barred from contributing to one directly. Here’s where the Roth IRA income limits stand for 2020:
|
Tax Filing Status |
Contributions Phase Out Once Income Exceeds: |
Contributions Are Barred Once Income Exceeds: |
|---|---|---|
|
Single, head of household, or married filing separately (and you didn’t live with your spouse during the year) |
$124,000 |
$139,000 |
|
Married filing jointly or qualifying widow/widower |
$196,000 |
$206,000 |
|
Married filing separately (and you lived with your spouse at any point during the year) |
$0 |
$10,000 |
DATA SOURCE: IRS.
Note that with the exception of tax filers who are married and file separate returns, the Roth IRA income limits have all increased from 2019, thereby opening the door for more workers to…