How IRAs Work And Why They Are More Popular Than 401(k)s

are you one of the 60 million americans actively using a 401k plan to save for retirement how do you know that's the right choice for you despite their immense popularity 401k plans aren't the standard for all retirement accounts iras or individual retirement accounts are the most popular choice for those saving for retirement accounting for more than a third of all u.s retirement assets the ira provides a lot of autonomy and opportunity to invest in things that you feel are fit or work better for you first introduced in 1974 iras have seen explosive growth over the last five decades individual retirement accounts totaled an estimated 12.6 trillion dollars in assets during the first quarter of 2021 compared to just 2.6 trillion dollars back in 2000 in our research we've been able to see that the people who use the ira to make contributions do so year over year over year but an ira isn't the only account that future retirees should look out for more and more americans have been taking advantage of their hsa or health savings account to supplement their retirement savings despite the fact that the account was never intended to be used for that purpose contributions similar to traditional 401ks or iras they go in pre-tax but unlike traditional 401ks and iras they're also not taxed upon withdrawal if you're using it for qualified medical expense choosing the right retirement account that best suits your needs is a vital step in making sure you are well prepared for retirement so how do these alternative retirement accounts operate and which retirement plan will be best for you when it comes to choosing a retirement account that's best for you it all comes down to what financial situation you're currently in but most experts agree that employer-sponsored accounts should be utilized whenever possible these include 401k and 403b plans which are retirement accounts dedicated specifically for employees of public schools employees of tax-exempt organizations and certain ministers when thinking about the first best place to save for retirement for most people that will actually be their 401k or 403p plan at work and the reason is 9 out of 10 participants are in plans where the employer makes contributions i think 401ks are great because typically they have lower fees than other retirement accounts and especially if your company is offering a match then 401ks are the way to go iras are best for self-employed individuals and employers or employees who are not offered a 401k due to its limited matching and lower contribution limit in 2021 401k plans had a contribution limit of nineteen thousand five hundred dollars a year for employees younger than fifty while ira contribution limits were strictly set at six thousand dollars that goes back to what they were originally designed for right so the goal was to enable those without an employer sponsor plan to save a tax-severed fashion and typically people who are higher income working for large companies their company is going to offer a 401k so it's striking the balance between allowing people to save for retirement and offering them that tax advantage while also making sure that this isn't just a tax shelter for the very wealthy if you don't have a plan at work the ira has all the tax advantages of the plan at work and you fund it yourself so it's your contributions it will go in there won't be any employer money in a traditional or a roth it'll be your contributions going in but it's a great way for you to get those tax advantages that the folks are getting in the employer sponsored plans meanwhile financial advisors warn hsas should only be used to supplement your main retirement savings hsa should definitely not be a replacement for a 401k or an ira if you have a high deductible health insurance plan then hsas are great for setting aside money in case of medical expense to make the most of your retirement accounts you first need to understand how all the different plans work so traditional iras were first introduced as a part of arusa back in 1974 and the goal was to really enable those without an employer-sponsored plan to save in a tax-deferred way and so although eligibility initially was to those without pensions it eventually expanded to those with employer sponsor plans in the 1980s iras were also designed to play another vital role in our retirement market consolidation of rollovers when people change jobs and they don't want to keep the balance in their 401k with their old employer then they'll transfer it over to an ira because that is attached to them directly and rollovers have played a major role in fueling the growth of iras in mid-2020 more than half of all traditional ira owning households had accounts containing some amount of rollovers from their previous employment if you think about all the folks who change jobs in any given year or who are retiring and who want to consolidate that money into one spot put it into an ira a whole lot of the growth is because of those rollovers coming into the ira space so it's sort of a place to park retirement assets as well as a place to drive some real retirement saving ira holders enjoy a wide array of benefits that are unique to their account for instance like the 401k most iras have a 10 penalty for any early withdrawal before the age of 59 and a half but iras can give an exception to certain expenses such as higher education health insurance if you are unemployed and up to ten thousand dollars for a first home purchase but its biggest advantage over any other retirement account is its wide selection of investment options with the ira you have exposure to the public marketplace fully right so you can own etfs mutual funds individual stocks so i think that the popularity of the ira is that it does offer a place to build a retirement nest egg that has the tax advantages of a plan iras come in numerous different types but the most popular comes down to these four traditional roth sep and simple ira each one comes with its own set of rules as the industry evolved and you have different types of workers doing different types of things and that need different deferred vehicles you've seen the sep ira created you've seen the simple ira created so retirement industry has evolved quite a bit over the last 25 years to kind of meet what the market demand is traditional iras are the oldest and most common type of individual retirement account in 2020 36.8 million u.s households or 28.6 percent owned a traditional ira you can contribute cash and receive a tax deduction in return if you qualify the money inside the account is tax deferred meaning you can delay paying taxes on the amount until a later date while there technically isn't an income limit for contribution how much deduction you are eligible for depends heavily on whether you are already covered by a retirement plan at work a full deduction is only allowed if you and your spouse if you're married aren't covered by a retirement plan at work if you or your spouse is covered then your deduction eligibility depends on how much income you make if you're eligible for a deductible contribution you can save on your tax bill this year once the money is in that traditional ira it compounds so think of all those reinvested earnings and capital gains all just getting plowed back into the account without any taxes and then when you get to retirement and start taking the money out it gets counted as income because you're now finally taking that income that you put aside and taking it out in retirement so you can live on it and that's when you pay taxes on it roth iras are the second most frequently owned type of ira held by 26.3 million u.s households or 20.5 percent the major difference between the traditional and roth is when the owner is responsible for paying taxes on their contribution the roth ira is a little bit different where you're taking after tax money it grows tax free and then as long as you hold it for more than five years and your retirement after 59 and a half you could pull those assets tax free so if you think if you're young right now you think that you're going to be in a high wage trajectory and so in the future your your taxes are going to be higher then it might also be beneficial to have a roth now sep and simple iras are two employer-sponsored plans reserved for small businesses and self-employed individuals in 2020 8.6 million or 6.7 percent of u.s households owned some sort of an employer-sponsored ira plan they were designed to allow small employers to provide retirement account without having to deal with the administrative burden of providing a plan but second simple areas are kind of in a different category from roth and traditional iras they have different income limits and they have requirements on employer size the major difference between sep and simple iras lies in who can make the contributions for sep iras it's generally the employers who make the contributions for themselves as well as their employees but for simple iras both the employer and the employee can make the contributions the employer however is generally required to match the employee's contributions up to three percent of the employee's compensation or at least one percent for no more than two out of five years the simple is restricted to small employers so fewer than 100 participants and the idea there was that it would be easier for the employer to set up an ira for their workers rather than a full-blown 401k plan and so the employer makes contributions it's an ira the individuals choose the investments within the account and it pretty much is like an employer sponsored plan basically for people but in an ira structure there's a laundry list of different types suitable for every financial situation for instance self-directed iras can include investments such as real estate private company shares and even cryptocurrency iras definitely do offer a self-directed option when she can add in real estate and i'm sure a lot of people have heard the stories of some multi-billionaires who have you know a large amount of money in their iras that could not have come from contributions alone i think what's so important here is to do an assessment and to really kind of understand what do you need this tool for what are you trying to solve for and then ultimately figure out what's the best plan that works for you if you think about retirement savings plans such as 401ks and iras probably come to mind but there are other unexpected ways a working individual can save for retirement a health savings account is one of them i'm just as puzzled as you in terms of why hsas became another option for a retirement account i don't think they were designed to be a retirement account first introduced in 2003 hsas were originally created to incentivize saving for medical expenses for those with a high deductible plan i think it's been born out of folks with high premium costs health insurance has gotten expensive so i think you've seen a lot of participants move to these high deductible plans that are a little bit cheaper the idea is that you can put money pre-tax into hsa and set that aside so in the event that you need to spend money on your health care that would not be covered by your insurance plan the ones that i've seen that have been most popular are for folks that are getting close to retirement let's say 10 years out that are planning for their time and said hey listen i want to defer some assets for potential health care costs down the road and then they retire you know they get their medicare or medicaid or whatever it might be in their part b their supplementary plan and then on top of it they have an hsa plan that really makes sure they take care of all their health care needs what makes hsa such an effective tool for retirement isn't just the tax deduction but the fact that funds can be withdrawn at any time for health expenses however once you've enrolled in medicare you can't contribute to an hsa you still have access to the funds already put aside but you can't add more unlike traditional 401ks and iras they're also not taxed upon withdrawal if you're using it for a qualified medical expense so the plus side is that you're kind of getting a lot of tax benefits the downside is it only works if you're using it for medical expense however a majority of hsa holders are using their accounts to cover their expenses rather than using it to save for retirement despite the fact that an hsa balance can also be used to invest just seven percent of health savings accounts in 2019 held investments other than cash think about this i've deferred dollar for dollar ten thousand dollars into my hsa over five years and that ten thousand dollars has been invested into a portfolio that has now grown to fifteen thousand dollars you've had the capital appreciation of five grand because your cost basis was ten now you have 15 000 available to you to take care of medical expenses so it's not a dollar for dollar i think folks miss the investment component that's a major deal and being able to provide for health care expenses there's certainly a lot of different types of retirement accounts it is important to understand the options especially at the employer sponsored options you have available just because it's the best way to build up nest egg for retirement is to start saving early the biden administration is expected to propose several changes to the current retirement plan options during his campaign president biden called for an overhaul of 401k tax breaks that tend to skew towards higher income families by equalizing the tax benefits of retirement plans he also proposed the creation of automatic 401ks that would provide workers without a pension or a 401k type plan a chance to easily save for retirement at work despite these changes retirement accounts will continue to grow as more americans realize the importance of saving for retirement i think that really in looking at the u.s retirement system it's a system that is really accumulating we've got 35 trillion dollars earmarked for retirement and we are going to continue contributing and building that system so that people will have those nest eggs when they get to retirement to rely on

Channel: CNBC

Views: 371,088

Keywords: CNBC, business, news, finance stock, stock market, news channel, news station, breaking news, us news, world news, cable, cable news, finance news, money, money tips, financial news, Stock market news, stocks, business news, acorns, robinhood app, taxes, retirement benefits, investing, Retirement, roth ira, ira, 401k, hsa, 401(k), retirement plan, brokerage, how to retire millionaire, how to be a millionaire, compound interest, tax free millionaire, roth 401k

Id: DPnXJpDOAHI

Length: 15min 13sec (913 seconds)

Published: Thu Aug 12 2021