A lot of people have spent the past few weeks glued to their TV screens watching elite athletes from all over the world compete. And while many of those superstars have taken home their share of medals, we at The Fool think there’s another category deserving of recognition — retirement plans.
Hear me out. Without tax-advantaged retirement plans, a lot of people would have a much harder time socking away funds for their senior years. And so with that in mind, here are the awards for the best retirement accounts out there.
The bronze medal goes to…
The traditional 401(k). The reason? These plans allow you to contribute up to $19,500 a year on a pre-tax basis if you’re under 50. If you’re 50 or older, you get a generous $6,500 catch-up contribution that brings your total to $26,000. All told, you get to shield a lot of your immediate income from taxes while getting to sock away a lot of money for the future.
Now there’s a reason the traditional 401(k) falls short of winning gold, and it’s that you generally get limited investment choices in these plans. But, a lot of 401(k)s these days off low-cost index funds, and those are a great choice for long-term investors.
The silver medal goes to…
The Roth 401(k). These plans have the same contribution limits as traditional 401(k)s. And while they don’t offer an immediate tax break on contributions, they offer something better — tax-free withdrawals during retirement.
Now some people would rather get the tax break up front, and that’s understandable. But think about it this way — would you rather not have to deal with the IRS taking some of your money now, or when you’re older and your options for earning more may be limited? Not having to worry about taxes could make for a more relaxed, stress-free retirement, which is the Roth 401(k) comes in a notch higher than its traditional counterpart.
The gold medal goes to…
The Roth IRA. Roth IRAs have their drawbacks. They only allow you to contribute up to $6,000 a year ($7,000 if you’re 50 or older) and higher earners can’t fund one directly. Rather, they have to put money into a traditional IRA and convert it to a Roth afterward.
But here’s why the Roth IRA takes the gold. First, gains in a Roth account are tax-free, and withdrawals are tax-free in retirement. And as we just discussed, shedding that IRS burden is nice.
On top of that, the Roth IRA is the only tax-advantaged retirement plan to not impose required minimum distributions, or RMDs. What RMDs do is effectively force you to spend down your savings in your lifetime, so if your goal is to leave behind money to your heirs, that’s a problem.
Roth IRAs don’t have RMDs. That means you can leave your money to sit and grow — in a tax-advantaged fashion — for as long as you’d like. Roth IRAs are also flexible in that you can withdraw your principal contributions at any time without penalty. And while you should ideally be leaving that money alone for retirement, some people open a Roth IRA for the express purpose of saving for college.
Which plan will you choose?
Well, it was a fierce competition, but ultimately, the Roth IRA is going home with the gold. Meanwhile, if you’ve yet to open a retirement plan, it pays to explore all of these options. The sooner you get started, the greater your chances of accumulating a substantial pile of wealth that will serve you well once your time in the workforce comes to a close.
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