Which Retirement Account Should I Invest In?

By Eric Tyson

If you earn employment income (or receive alimony), you have options for investing money in a retirement account that compounds without taxation until you withdraw the money. In most cases, your contributions to these retirement accounts are tax-deductible.

Company-based retirement plans

Larger for-profit companies generally offer their employees a 401(k) plan, which typically allows saving up to $18,000 per year (for tax year 2017). Many nonprofit organizations offer their employees similar plans, known as 403(b) plans. Contributions to both traditional 401(k) and 403(b) plans are deductible on both your federal and state taxes in the year that you make them. Employees of nonprofit organizations can generally contribute up to 20 percent or $18,000 of their salaries, whichever is less.

There’s a benefit in addition to the up-front and ongoing tax benefits of these retirement savings plans: Some employers match your contributions. Of course, the challenge for many people is to reduce their spending enough to be able to sock away these kinds of contributions.

Some employers are offering a Roth 401(k) account, which, like a Roth IRA, offers employees the ability to contribute on an after-tax basis. Withdrawals from such accounts generally aren’t taxed in retirement.

If you’re self-employed, you can establish your own retirement savings plans for yourself and any employees you have. Simplified Employee Pension-Individual Retirement Accounts (SEP-IRA) allow you to put away up to 20 percent of your self-employment income up to an annual maximum of $54,000 (for tax year 2017). However, if you’re an employee in a small business, you can’t establish your own SEP-IRA.

Individual Retirement Accounts

If you work for a company that doesn’t offer a retirement savings plan, or if you’ve exhausted contributions to your company’s plan, consider an Individual Retirement Account (IRA). Anyone who earns employment income or receives alimony may contribute up to $5,500 annually to an IRA (or the amount of your employment income or alimony income, if it’s less than $5,500 in a year). A nonworking spouse may contribute up to $5,500 annually to a spousal IRA.

Your contributions to an IRA may or may not be tax-deductible. For tax year 2017, if you’re single and your adjusted gross income is $62,000 or less for the year, you can deduct your full IRA contribution. If you’re married and you file your taxes jointly, you’re entitled to a full IRA deduction if your AGI is $99,000 per year or less.

If you can’t deduct your contribution to a standard IRA account, consider making a contribution to a nondeductible IRA account called the Roth IRA. Single taxpayers with an AGI less than $118,000 and joint filers with an AGI less than $186,000 can contribute up to $5,500 per year to a Roth IRA. Although the contribution isn’t deductible, earnings inside the account are shielded from taxes, and unlike withdrawals from a standard IRA, qualified withdrawals from a Roth IRA account are free from income tax.

Annuities: Maxing out your retirement savings

What if you have so much cash sitting around that after maxing out your contributions to retirement accounts, including your IRA, you still want to sock more away into a tax-advantaged account? Enter the annuity. Annuities are contracts that insurance companies back. If you, the investor (annuity holder), should die during the so-called accumulation phase (that is, before receiving payments from the annuity), your designated beneficiary is guaranteed reimbursement of the amount of your original investment.

Annuities, like IRAs, allow your capital to grow and compound tax-deferred. You defer taxes until you withdraw the money. Unlike an IRA, which has an annual contribution limit of a few thousand dollars, an annuity allows you to deposit as much as you want in any year — even millions of dollars, if you’ve got millions! As with a Roth IRA, however, you get no up-front tax deduction for your contributions.

Because annuity contributions aren’t tax-deductible, and because annuities carry higher annual operating fees to pay for the small amount of insurance that comes with them, don’t consider contributing to one until you’ve fully exhausted your other retirement account investing options. Because of their higher annual expenses, annuities generally make sense only if you won’t need the money for 15 or more years.