Securing retirement in the USA - Part1

As you step into your 40s, a common question that arises is whether you're on right track for retirement. In this article, we'll explore various retirement accounts aimed at securing a comfortable retirement in the USA.

There are mainly two category of retirement accounts. One set of accounts funded with pre-tax money and another with post-tax money. For the accounts funded with pre-tax money, you are not paying taxes now but will pay when you are withdrawing money during retirement. Uncle Sam guarantees one-time taxes :-). For the accounts funded with post-tax money, you have paid taxes now and will not pay taxes during your withdrawal.

Let's review different types of accounts.

• Tax deferred
  • Employer 401k
  • Health Savings(HSA) account (really!)
• Tax deferred only up to certain income
  • Traditional IRA
• post-tax
  • ROTH IRAs

Employer 401k

Though it's not mandatory, 401(k) plans are a common retirement benefit offered by many employers in the USA, especially larger corporations. It's like provident fund in India. The contributions to 401k are tax-deductible. These contributions reduce your taxable income and reduces your tax liability. As of 2023, for individual under 50 years, the contribution limit is $22,500. The tax is paid when you withdraw the money from the account during retirement.

In addition to the contribution from the employee, it's common for employers to contribute towards employee 401k. Though different matching arrangements are possible, let's see couple of common employer matching arrangements.

Employer 1: Matches 50% of employee contributions.
Employer 2: Matches 50% up to 6% of employee contributions.

Recommendations

You should contribute enough to 401k so that you get your maximum employer contribution. Imagine your employer contribution as immediate returns on your investment. If you are not doing enough contributions to your 401k to get maximum possible contribution from employer, you are leaving free money on the table.

In the above example, while working for employer 1, you should max out your 401k. While working for Employer 2, you should contribute a minimum of 6%. Whether you should max out while working for employer 2, depends on other retirement vehicles you are considering.

Traditional IRA

Contributions to Traditional IRA are tax deductible based on the income. If you are married filing jointly, then the income limit for year 2023 is $129k. If the income is more than $129k, the contributions to traditional IRA are not tax deductible. You can still contribute but will not get tax benefit. If the tax is paid now on the contributions, then, during retirement you pay the taxes only on the earning portion.

Recommendations

If your employer is not providing 401k, then traditional IRA is alternate option. Also, the traditional IRA account will have more investing options than the employer 401k. So, if you have strong preference on the investing options or want to diversity in certain way, traditional IRA might be good choice.

Health Savings(HSA) account

The HSA account is eligible with high deductible health insurance plans. If the health insurance is from your employer, then, employer also might contribute some amount to the HSA account. HSA contribution limit for family is $7750 for year 2023. You can withdraw money from HSA account tax free for qualified medical expenses. This leads to the question, why is this a retirement account as we can withdraw against qualified medical expenses anytime. Some HSA providers do offer the option to invest your HSA funds in a range of investment options, such as mutual funds, stocks, bonds, and exchange-traded funds (ETFs). Let's see the recommendations below which gives an idea on how this account can be used as another retirement savings vehicle.

Recommendations

Contribute to your HSA and if the account has investing option, then, invest that money. If you can afford to pay the medical expenses now without touching the HSA account, then, do so. The advantage is, you have more money in HSA that is getting invested and generating more money. During your retirement, you can withdraw money from HSA tax free not only against that year medical expenses but also against any qualified medical expense occurred after opening HSA account. You just need to do extra work saving all the bills you are paying now without touching HSA account money.

ROTH IRA

Things get more interesting here. The contribution to ROTH IRA is done with post-tax money. So, you pay taxes now. But the earnings are tax free. You will not pay taxes while withdrawing money from these accounts during retirement.

As of 2023, the limit to IRA contributions is $6500 for individuals less than 50 years old. Also, there is an income limit that determines whether you can contribute to ROTH IRA. As of 2023, if you are married filing jointly, $228k is the income limit. Though this looks more than traditional IRA income limit, we need to observe a difference here. You can contribute to traditional IRA, even you exceed the income limit. It's just that you won't get the tax benefit. But for ROTH IRA, if you exceed the income limit, then, you can't even contribute to ROTH IRA.

Then, how to do we contribute to ROTH IRA if the income is more than $228k?

This question nicely leads us to part2 of the article where we discuss what backdoor ROTH and mega backdoor ROTH is.

That's a wrap for this week. Happy learning!

Please note that, I am not a financial advisor or tax consultant. I write based on my own research, experiences and interviewing the people done these things. So, be aware of the options and discuss with your tax consultant to make right decisions for your financial situation.