With so many different types of retirement plans to choose from, you may be wondering which ones offer the best tax benefits. The simple answer is that the “best” benefits are tied to your individual situation. In this article, we’ll explore the different types of retirement plans so you can decide which plan might be the most beneficial option for you.
Some retirement plans are sponsored by employers, while other options are not. If you are looking to build a retirement plan that may receive tax benefits, some of the plans you may want to consider looking at are:
Keep in mind that your income-level and enrollment in employer-sponsored programs does affect how much you can save per year and the tax benefits available to you.
If you have the option of a 401(k) or 403(b) through your employer, you might wonder if those are better options than opening an IRA. If it is financially possible, you don’t have to choose. Your best option may actually be to have multiple retirement plans.
What Determines Tax Benefits On A Retirement Plan?
There are two main questions that you’ll want to consider when deciding which type of retirement plan works best for you.
- What is your income?
- Do you already have a plan through your employer?
What you can do to improve your tax benefits based on these questions:
- Your Income: Decide if you’d rather have an account where you can contribute funds pre-tax or after-tax. What income bracket are you in now? Will you be in a different bracket when you retire (higher or lower)?
- Note: Some types of IRAs usually have an “income limit”. Therefore, not everyone can make pre-tax contributions.
- Employer-Sponsored Plans: If you have a 401(k) plan or 403(b) plan through your employer – to receive the most benefit, you should make your own contributions up to the max of $20,500.00 (in 2022) so you can get the full match amount from your employer.
Types of Retirement Accounts And Their Tax Benefits
There are three account types that are the most popular among those saving for retirement:
401(k):
Employers usually sponsor this type of retirement plan. Through a 401(k), you can contribute a solid amount toward your retirement — $20,500 per year (as of 2022). In Traditional versions of the 401(k) plan, you contribute money before taxes. This means that you receive a lower tax liability on your current income. But, when the employee retires and begins withdrawing funds from the account, income taxes must be paid on the money withdrawn. If you try to withdraw your money before age 59.5, you must pay a 10% penalty.
403(b):
This plan is similar to the 401(k), and has the same limits. 403(b) plans are generally for State and non-profit employees. The administrative costs for 403(b) plans are lower. This allows organizations with very small budgets to help their employees save for retirement.
IRA:
An Individual Retirement Account is an account that can be opened by anyone that has earned income (including spouses). The downside to an IRA is that the contribution limit is lower – $6,000 per year, or $7,000 if you’re age 50 or older (as of 2022). But the upside is that if you decide to consolidate your retirement accounts, you can move all of your funds into one IRA. Rollover does not count toward your annual maximum contribution. However – your income will determine what kind of IRA you can open. Your income will also determine if you can deduct the contributions.
Types of IRAs –
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- Traditional:
- You make contributions to Traditional IRAs before or after tax. This can give you immediate tax benefits if your contributions are tax-deductible. With a Traditional IRA, your money can grow tax-deferred. However, you’ll pay ordinary income tax on your withdrawals. You must start taking distributions after age 70½ with a traditional IRA.
- Roth IRA:
- You make contributions to Roth IRAs after tax. In a Roth, there are no current-year tax benefits,. But, your contributions and earnings can grow tax-free. You’ll also be able to withdraw funds tax- and penalty-free after age 59½. (But the account has been open for five years). With a Roth IRA, there are no contribution age restrictions, nor do you have to take Required Minimum Distributions (RMDs). NOTE: there are income limitations to open a Roth IRA. Not everyone will be eligible for this type of retirement account. But, it can be a good savings option for those expecting to be in a higher bracket in the future.
- SEP IRA:
- These IRAs are for self-employed individuals, small business owners, and their employees. You fund a SEP IRA with pre-tax dollars. Which means that the money grows tax-deferred. Any withdrawals are taxed at ordinary income rates. Contribution limits are the lesser of 25 percent of income or $61,000 in 2022.
- Traditional:
See IRA Deduction amounts outlined by the IRS:
if you do have a retirement plan at work
or
if you do not have a retirement plan at work
What Are The Retirement Plan Tax Benefit Changes for 2022?
- The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan will remain $20,500.
- The limit on annual contributions to an IRA are still $6,000.
- The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.
- The income ranges for determining eligibility to make deductible contributions to traditional Individual Retirement Arrangements (IRAs), to contribute to Roth IRAs and to claim the saver’s credit all increased for 2022.
- Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. If during the year either the taxpayer or their spouse was covered by a retirement plan at work, the deduction may be reduced or phased out until it is eliminated. This depends on filing status and income. (If neither the taxpayer nor their spouse is covered by a retirement plan at work, the phase-outs of the deduction do not apply.)
2022 Phase-Out Ranges:
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- Single taxpayers covered by a workplace retirement plan, the phase-out range is $68,000 to $78,000.
- The phase-out range is $109,000 to $129,000 for married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan.
- For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $204,000 and $214,000.
- Married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
- The income phase-out range for taxpayers making contributions to a Roth IRA is $129,000 to $144,000 for singles and heads of household.
- For married couples filing jointly, the income phase-out range is $204,000 to $214,000.
- The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
- The income limit for the Saver’s Credit (also known as the Retirement Savings Contributions Credit) for low- and moderate-income workers is:
- $68,000 for married couples filing jointly
- $51,00 for heads of household
- $34,000 for singles and married individuals filing separately
Kate writes about retirement benefits for retirementinsurance.org. She has a Masters Degree in Social Work (MSW). She has over a decade of experience in assisting elderly and disabled populations navigate governmental and private programs to obtain the monetary assistance they need to lead better lives. As she watched her parents begin their own retirement journeys and navigate similar systems to obtain Social Security, Medicare and other retirement benefits, she gleaned a further personal knowledge about the topic and is eager to share what she has learned with others.