Saving for your retirement can be a little confusing, but I am here to break it down for you. Here is what retirement accounts to open first and why you should start saving now!

Retirement may sound like a dream come true. Without the bulk of your time spent working, just imagine what you could do with all that free time. Whether you want to sip margaritas on a white sand beach or spend more time with your family, retirement is not free. If you aren’t already saving, it is high time that you get started. 

Don’t waste valuable time – open an account with blooom to start taking control of your retirement

In fact, saving for retirement may be your single largest savings goal. The sheer amount of money you need to support yourself without work for your golden years can be fear-inspiring. But fear not!

Before you decide that saving for a comfortable retirement is absolutely impossible, know that it’s not. However, it will take determination and an understanding of where you should be stashing your retirement cash. Unfortunately, the coffee can you’ve stuck under the bed is not going to cut it. 

If you’re intimidated by the many options available, fret no more! Here is my guide to understanding what retirement accounts are and how to pick the best one for you.

Start saving now

The earlier you start saving for retirement, the more likely it is that you will be able to reach your retirement savings goals. The simple reason for this is the compounding effect. This happens when you choose to save your money and invest it early in your life – your money will have the chance to grow by itself over the course of your lifetime. 

If you’ve ever heard the phrase ‘make your money work for you,’ this is where it comes from. You want the money you earn and save to grow without your assistance, building you a solid nest egg for your retirement plans. Whether you want to retire early or at the traditional age of 65, investing your money early is key to your success. 

It is absolutely crucial that you move forward and open a retirement account soon. Do not let your fear of the unknown stop you from achieving your long-term financial goals. 

Retirement account basics

When you start looking for a retirement account, it can be overwhelming to see all of your options laid out in front of you. Unfortunately, the account names can start to blend together into a sort of alphabet soup of important choices.

It is important you don’t allow the three-letter acronyms overwhelm you into randomly picking a retirement account that isn’t right for you. Making the right selection for your retirement account, or retirement accounts is critical to the success of your retirement plan. 

As you build your retirement plan, be realistic about your risk tolerance, and choose your investment vehicles accordingly. This could make or break your retirement savings goals.

One of the best things to pay attention to is the fees. If you contribute to a retirement account that is taking a percentage of your earnings, then make sure that the cut taken will not derail your savings goals. An account with lower fees usually equates to a better return over the long-term. 

Your retirement account options

 How To Figure Out What Retirement Account To Open First - Options

Remember, it is okay to choose more than one retirement account. As you will soon learn, some retirement accounts have contribution limits which may force you to expand into another retirement account if you are able to save enough cash. 

No matter what your life looks like, there is a retirement account option that can work for you. Here are the basics:

IRAs

An IRA, or individual retirement account, is one of the best ways to stash money for your retirement. As an individual, you are able to set up an IRA account at many financial institutions, which can hold various types of investments for your retirement. 

Each year, the IRS sets a limit to the amount of money you can contribute to IRAs within a given year. For 2019, the contribution limit to an IRA was $6,000.

The main benefit to an IRA of any kind is that you have more control over these kinds of accounts. You are able to choose your brokerage firm and make all of the investment decisions without any oversight from your employer. 

If you decide on one of the IRA options below, you should check out J. P. Morgan Self-Directed InvestingGet up to $625 when you open and fund with $250,000 or more. Offer expires 1/19/2023. You’ll need to be a self-directed trader to open either a traditional IRA or a Roth IRA. But, since J. P. Morgan Self-Directed Investing has no fees associated with it, it’s one of the best investment account options out there!

Opening an account is quick and easy, and you’ll find tons of resources to help you determine which account is right for your retirement goals.

Disclosure – INVESTMENT AND INSURANCE PRODUCTS ARE: NOT A DEPOSIT • NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE

Traditional IRA

The contributions made to a traditional IRA can be written off on your taxes up to the annual limit set by the IRS, which was $6,000 for 2019 if certain income requirements are met. Plus, an extra $1,000 can be contributed if you are over the age of 50. With this, you may even be able to lower your taxable income for the year. 

As your retirement nest egg continues to grow within the account, you will not be taxed on those earnings until you withdraw the money. 

A traditional IRA is a great option for anyone that wants to take the tax break now. Although you will have to pay taxes on the money later, it can help to jump-start your savings.

It is an especially good account to have if you do not have a workplace sponsored retirement plan or have savings goals that exceed your employer-sponsored plan. 

Roth IRA

Roth IRAs have one key difference that sets them apart from traditional IRAs. The contributions you make to a Roth IRA are not tax-deductible. However, when you withdraw your contributions in retirement you will not have to pay taxes on that money. Of course, you will still have to pay taxes on the earnings at the time of withdrawal. 

The amount that you can contribute to a Roth IRA is based on your income. Plus, it is limited by contribution limits dictated by the IRS. 

The benefit of a Roth IRA is that you can pay your taxes now instead of in retirement. If you are a saver that anticipates being in a higher tax bracket at retirement, then you might as well pay your taxes upfront while in a lower tax bracket. 

Alongside J. P. Morgan Self-Directed Investing, Betterment is a great choice when it comes to opening an IRA. Betterment will even help you determine which IRA is right for you. Plus, you’ll have access to their Retirement Goal tool that can help you figure out how much to save each year, and which accounts to save in.

Spousal IRA

Anyone that wants to contribute to an IRA must have an earned income for the year. However, not all members of society have jobs that collect an income. This is where a spousal IRA could come in handy.

A spousal IRA is a great option for anyone that has taken time off from work but has a spouse that provides an income

For example, if you are a father that stays home with their children, then you will not have an earned income even though you have a demanding occupation. 

If you file a joint tax return with your spouse, then both of you will be able to fund a spousal IRA. The contribution limits will be based on the income of the working spouse. Although the money that funds the account can come from either spouse’s earnings, the spousal IRA account must be opened in the non-working spouse’s name. 

Employer-sponsored retirement plans

 How To Figure Out What Retirement Account To Open First - Employer sponsored

If you have an employer that offers retirement benefits, then you need to take a close look at your options. Some employers offer amazing match benefits for your retirement. Other employers offer a lackluster selection of plans that are completely self-funded. Whatever your options are, it is important to investigate. 

Take advantage of the plans that suit your needs and move on from less attractive offers. You will not have access to all types of employer-sponsored accounts from a single job. 

One distinction that needs to be made is between defined benefits plans and defined contribution plans.

  • Defined contribution – Most of the plans available today are defined contribution plans. This means that your employer sets up the accounts, but you have to contribute money to the account yourself. In some cases, the employer may match your contributions but in many cases, they do not. 
  • Defined benefit – On the other hand, a defined benefit plan is a guaranteed payment to you after you retire from the company. The payout amount was usually based on your position and number of years with the company. Unfortunately, defined benefit plans seem to be a thing of the past. However, if you happen to land a job opportunity with a solid defined benefit plan, then it may be worth taking. 

You will not have access to both types of plans through your employer, but you should be aware of both as you wade through your HR paperwork. 

401(k)

A 401(k) is one of the most common types of employer-sponsored retirement plans. If you contribute to a 401(k) for your retirement savings, then you will be able to enjoy a tax break on the money you are setting aside. 

The total allowable contribution to your 401(k) in 2019 was $19,000.  

The most important thing to look for in a 401(k) is the amount of match that your company is willing to put up.

Many companies offer a dollar-for-dollar or 50-cents-for dollar match up to a certain percentage. If you are able to contribute nothing else, make sure to receive any match that your employer offers. The match is basically a 100% return on your original investment which is almost impossible to find anywhere else. 

Another benefit of a 401(k) is that it allows you to collect your retirement savings, pre-tax, directly from your paycheck.

The money that goes into your 401(k) will not be taxable income for the year, so you are also lowering your current tax bill just by contributing. Of course, Uncle Sam will need his cut at some point, so expect to pay taxes on this money when you withdraw it from your 401(k).

403(b)

If you work for a non-profit, public school, or other tax-exempt organization, then you may be allowed to participate in a 403(b). Although this plan is similar to a 401(k) it is designed for the non-profit sector. 

Just like a 401(k), you can have money taken directly from your paycheck and placed into your 403(b). The money in your 403(b) will be invested with growth in mind. Any money you place into the 403(b) will not be taxable until you withdraw funds in retirement. 

It is also possible for your employer to offer a match to your 403(b). If you are offered a match, then make sure to take it. You are basically walking away from free money if you refuse your match. 

457(b)

A 457(b) retirement plan is often offered to local government employees such as firefighters, police officers, and certain high ranking employees of nonprofits. 

The plan is similar to both a 401(k) and a 403(b) because it takes contributions directly from your paycheck and lowers your taxable income. The large advantage of a 457(b) is that the plan does not have as many withdrawal restrictions.

Most retirement accounts, including 401(k) and 403(b) plans, require you to wait to withdraw any money until you are 59.5. Otherwise, you will need to pay a penalty to access your money. 

Typically, 457(b) plans are offered in conjunction with other types of plans, such as the 401(k) or 403(b). If you are able to contribute the maximum amount to both plans, then you will be able to make a significant dent in your taxable income for the year. It is possible to use this tax deferment to supercharge your retirement savings now and deal with the tax consequences when you are ready to make withdrawals. 

TSP

The TSP, or thrift savings plan, is a retirement plan that is only offered to federal employees and members of the uniformed services.

The specifics of your TSP options will vary based on your position with the federal government and whether or not you are eligible for a separate pension. There are several types of TSP options available but they vary extremely widely which means that you will also have a wide variety of investment vehicles to choose from.

The TSP is a good option if you are able to contribute because it offers very low fees which can make a huge difference over your investment timeline. 

Pension

A pension is a defined benefit plan that provides a certain amount of monthly income in retirement. Unlike most modern employer-offered plans, a pension is a promise that you will be provided for in retirement whether or not you have other savings.

The amount of money you receive from your pension will be based on your years of service to the organization and your average salary throughout that time period. The longer you work for the company, the more money will be provided through your pension on a monthly basis. 

Options for the self-employed

 How To Figure Out What Retirement Account To Open First - Self-employed

If you have read through your options and noticed that many are geared toward people that work for an employer, then you may find yourself discouraged.

However, there are still many options available to you. Don’t worry, if you can hustle to make your own business a reality then you can make your retirement goals happen through one of these options. 

Also, keep in mind that you are able to fund traditional IRAs, Roth IRAs, and spousal IRAs as a self-employed individual. 

SEP IRA

A SEP IRA, or simplified employee pension IRA, is similar to other IRAs. You can fund the account yourself through several online brokerage firms but are limited by contribution limits. The contributions made to this account are tax-deductible for the year. 

One advantage of a SEP IRA is that there is very little paperwork involved and you will not have to file an annual report to the IRS. However, if you have employees, then the SEP IRA can become more complicated because you will be required to match the percentage of pay for your employees that you make for yourself. 

Solo 401(k)

A Solo 401(k) is essentially a 401(k) plan with a single participant. If you plan to save for retirement in good business years, but not so much in others, then the Solo 401(k) allows you to be flexible with your contributions.

If you want to open a Solo 401(k), your best bet is to go with a well-known firm like E*TRADE. They offer both individual 401(k)s and individual Roth IRAs. But what’s especially helpful with E*TRADE is the fact that they offer a Small Business Simulator tool that can help you find the best plan for your needs.

SIMPLE IRA

If you are the self-employed owner of a medium-sized business, then the SIMPLE IRA is a good option. The accounts within the plan are owned by the individual employee but you may be required to contribute to their accounts in some situations. 

One drawback to the SIMPLE IRA is that the withdrawal penalties are fairly rigid. If you want to withdraw money before age 59.5, then you will incur a 10% penalty.

However, if you want to withdraw money within two years of contributing it to the account, then the penalty is increased to 25%. The hefty penalty can make this option less attractive to many business owners. 

Which account is best for you?

Now that you have a better understanding of what types of retirement accounts are available, it is time to choose the accounts that will work best for you. 

Max out your employer-sponsored account first

A general approach that can’t steer you wrong is to start by maxing out the account you have access to at work. Whether you have a 401(k) or 403(b) offered through your employer, take advantage of that option.

An IRA is step two

After you have maxed out your work-sponsored account, the next logical step is an IRA. Choose the type of IRA based on your personal situation.

If you think you will earn more in retirement, then choose a Roth IRA. If you think you will earn less in retirement than you do now, then choose a traditional IRA. 

Your self-employed options summed up

If you are self-employed, you have a gamut of options available to best suit your individual needs. 

I broke down the best retirement accounts in the table below to help you find the best place to start. 

Retirement accountHighlightsLowlightsBest for
401(k)If your employer offers a match to your contributions, then you can take advantage of essential free money.Your investment choices within your 401(k) account may be limited based on your employer.If your employer offers a 401(k), then it is an easy way to save for retirement directly from your paycheck.
403(b)The employer match can be higher in a 403(b). The investment choices within your 403(b) may be limited based on you employer. If your employer offers a 403(b), then it is an easy way to save for retirement directly from your paycheck.
Thrift Savings Plan (TSP)Typically these plans are associated with lower fees. You may need to remain in your position for a predetermined length of time in order to see real benefits. If you are also eligible for a federal pension, then your pension could be affected by your TSP.
457(b)Can work in tandem with a 401(k) or 403(b) to supercharge your retirement savings if your employer offers both.Not offered to most private sector employees. If you have the ability to save enough to max out both your 401(k) or 403(b) and 457(b), then you should consider opening a 457(b) if you employer offers that option.
Traditional IRAYou can deduct your contributions from your taxable income for the year to ease your tax burden.The amount you can contribute is based on your income.If you have reached your contribution limit for an employer sponsored plan, an IRA should be your next step.
Roth IRAThe contributions are made after your taxes for the year, so you lower your tax burden in retirement.You may not be eligible to contribute based on your income.If you have reached your contribution limit for an employer sponsored plan, an IRA should be your next step.
Spousal IRAIf you are a non-working spouse, then you are able to contribute to an IRA in this way. You are limited to the same contribution rules based on your working spouse’s income. A married couple with one spouse not working.
Defined benefit planStable and predictable retirement benefit.Very rarely offered by modern employers.If you have the option and want a guaranteed retirement benefit, then this is a good way to go.
SEP IRAIt is easy to set up this kind of an account for your small business, plus, as an employer you will get tax deductions on your contributions to employee accounts.The contribution limit for a sole proprietor is less than the limits for a Solo 401(k).If you are self-employed with a few employees, this is a good option.
Solo 401(k)You will be able to make both employer and employee contributions for yourself. The process to open a Solo 401(k) is more complicated and a SEP IRA.If you are self-employed without any employees.
SIMPLE IRAThe administrative costs for a SIMPLE IRA are low compared to other options.If you need to withdraw money within 2 years of putting it in before age 59.5, then you will be required to pay a 25% penalty. If you are self-employed with up to 100 employees.

Carefully consider your options and map out your retirement strategy with purpose. 

After you’ve set up a retirement account, monitor and optimize it

Optimizing your retirement account is an important step in making sure your money is being put to the best use. It’s also a step that most people ignore.

Optimization means not paying unnecessary fees. It means rebalancing your portfolio to accurately reflect your retirement goals.

So, if a 401(k) or an IRA are your top retirement accounts, I recommend taking a look at a company called blooom.

They’ll take care of the boring (but vitally important) tasks that most people don’t want to deal with. For example, blooom will periodically rebalance your portfolio if your company adds investment options that may be better suited for your risk level.

Read our full Blooom review to learn more. 

Summary

Now that you have a better understanding of your retirement account options, it’s time to start saving! Saving money in your 20s for retirement may not seem worthwhile, but it is essential if you plan to ever stop working.

A good place to start is your employer-sponsored plan, which your employer’s HR department should be able to talk you through. Or, choose your own plan from the options above.

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About the author

Total Articles: 60
Sarah Sharkey is a personal finance writer covering retirement, investing, debt, savings, credit cards, mortgages, and student loans. Additionally, she is the founder of Adventurous Adulting, a personal finance blog dedicated to helping readers tackle their money and take control of the adventure of life. You can connect with her on LinkedIn or Twitter.