What Are The Best Tax Free Retirement Account Types?

When starting your career, the last thing on your mind might be retirement. This makes sense because about a quarter of the U.S population does not have retirement accounts. Even so, it is best to plan for this eventuality early. You’ll want to save as much as possible so that you have enough cash to enjoy your retirement. If you feel you’re starting late, check out our other article on the best tax-free retirement strategies, no matter your age. This is where a tax free retirement account comes in.

With this type of account, you will pay taxes for the money deposited into your account but will not pay taxes on its growth. This means you will grow your savings faster than you would when using a non-tax-free retirement account. There are also no IRS regulations on when or how you can access the money in a tax-free retirement account.

Below are the best tax-free retirement account options for you.

DEFINED CONTRIBUTION PLANS

In defined contribution plans, you deposit a portion of your pay into your retirement account, thus automating your savings plan. At times, your employer matches your contribution up to a specified amount, like 50%. In your retirement, you access the money you and an employer invested. Some examples of defined contribution plans are Roth 401k, traditional 401k and the 403b.

Most companies offer the traditional 401k plan to their employees. It allows the contribution of pre-tax dollars, unlike the Roth 401k that accepts after-tax contributions. With pre-tax contributions, you reduce your taxable income. In both 401k plans, your money grows without being taxed, and you only pay taxes on its withdrawal when you retire.  The difference between the two is that the growth on the Roth isn’t taxed, making it an ideal option for a tax-free retirement account.

The 403b plan works much like the 401k but is offered by churches, charities, and public schools. In it, you contribute pre-tax income to your retirement account.

Though beneficial, you are at an employer’s mercy with a defined contribution plan.  You have no guarantee that an employer will match your contribution.  You also don’t have a say in the types of accounts you can invest in.  Besides, you do not determine the investment plans for your savings, and there are penalties if you withdraw your cash before you are 59.5 years old. Nonetheless, some groups like specific public employees are exempted from these penalties.

IRA PLANS

An individual retirement account (IRA) is managed by its policyholder. You will open and fund the account yourself rather than through an employer. The government created IRAs to help employees save for their retirements outside of their workplaces. The limit for contribution in 2020 and 2021 is $6000 and $7000 for policyholders above fifty years old.

The common types of IRA accounts include SIMPLE, SEP, Roth, traditional, and rollover. The traditional IRA plan allows you to invest in almost all options, but it might be costly to withdraw your cash because of high penalties and taxes. The Roth IRA accepts after-tax contributions and voids taxes on your withdrawals in retirement.  

Are you noticing how the Roth is a great option for your tax-free retirement account?

The spousal IRA allows your unemployed spouse to contribute to your IRA.  This works provided your taxable income is more than the IRA contributions. This way, your spouse does not have to be employed for him/her to have a retirement plan. In a rollover IRA, you move money from another retirement account into an IRA to access the latter’s benefits.  Consider the tax consequences of this though, as you will owe taxes.

The SEP-IRA is designed for small business owners and the self-employed.  The business owner contributes to their own plan. This contribution is distributed to an employee’s SEP IRA instead of a trust fund such that the worker somewhat has a free retirement account. Nonetheless, employees do not have a specific amount of how much they can accumulate.

In a SIMPLE IRA, all employees get the same employer contributions to their retirement plans irrespective of their ranks. The employee does not have to contribute to the account, unlike in the defined contribution plan.

SOLO 401K

This is also called the Uni-k or one-participant “k” plan. It’s another option meant for business owners and their spouses. Since the account’s owner is an employer and employee, you can have a maximum elective deferral of $19500.  You can also have a maximum non-elective compensation contribution of 25% for up to $57000 for companies excluding catch-up payments.

The solo 401k is better than the SIMPLE IRA when you run a business alone because you can contribute more money towards your retirement. But, it is more complicated than the latter to set up, and you have to file a report yearly when your assets exceed $250,000.  Always review Roth options, if available, as they’re the easiest tax-free retirement account to identify.

FEDERAL THRIFT SAVING PLANS

This is like the 401k, but available to those in the uniformed services and government employees. In it, you will choose from multiple low-cost investments, including an international stock fund, bond fund, S&P index fund, small-cap fund, and a fund that invests in special securities issued by the treasury. Also, federal workers can pick from many lifecycle funds that have diverse retirement dates for the investment of their core funds, thus easing their investment choices.

While the TSP isn’t exactly like a 401k, they share some characteristics.  The main trait to look for is whether there is a Roth option.  Because future withdrawals are not taxed, this is the kind of tax-free retirement account you’ll want to set up.

Under federal thrift saving plans, your employer can contribute 5% to your retirement plan, including a 1% non-elective contribution. Furthermore, the plan’s investment fees are low. But, there is no specific account balance for you when you retire, unlike in the defined account balance account.

Choosing a tax-free retirement account from the above might seem overwhelming.  You do not have to be an accounting expert to use these retirement accounts because they are quite easy to open and manage. They are also open to almost all employees.

The employer-offered plans like the defined-contribution are portable, have high return potential, and are not reliant on the success of your employer. Furthermore, you do not have to manage your investments yourself, and the accounts pay you until your death. This means you do not worry about outliving your retirement benefits.

But, individual contribution plans like the IRA and solo 401k have minimal regulations, high contributions, and varied investment alternatives. Moreover, you can invest your contribution to higher-return assets like stock funds and stocks so that you get better profits.  Just remember to look for tax-free retirement account options when they’re available.  These types will allow you to realize tax-free growth, making your retirement years much more comfortable.