Here is your Retirement Accounts Guide for 2020, including updates for the CARES act passed in response to the Corona Virus Pandemic.
If you are new to retirement account, just started a career, or are just in need of a refresher, this Retirement Accounts Guide will bring you up to speed. We’ll review the most common account types and when they can and should be used.
If you are just in need of a summary, I’ve recapped the accounts in table form at the end. Check out the table of contents for “Summary Tables”
For the purpose of this guide, I’ll define a retirement account as a place to invest money that is tax-advantaged.
Tax-advantaged means that it will save you money on taxes either when you put money into the account, when you take money out of the account, or both!
To get things going, I’ll let you in on a little advice. Actually, it’s my best advice.
Table of Contents
START NOW!
If you want to have money for retirement, start saving now! The earlier the better because of compounding interest. Go check it out for yourself with a compound interest calculator. Bankrate has one of my favorites.
Types of retirement accounts
I’ve separated the account into three categories, based on where the money is coming from.
- Employer-Sponsored – You will receive a W-2
- Self-Employed
- Out-of-Pocket – Funded from money you already have
These categories are not mutually exclusive, meaning you may fall into one, two, or all three of the categories.
For example, you could have a full-time job, while making money with a side-hustle (such as Uber or Lyft), and have cash left over to further invest.
If you fall into multiple categories, don’t worry about where to put your money first, I’ll cover that after I cover the types of accounts.
How do retirement accounts work?
Understanding how retirement accounts work is an important step when planning for your future. Aside from knowing the differences between each type of account, here are two terms you should know.
Traditional vs Roth
I mentioned earlier that these tax-advantaged accounts will save you money on taxes either when you put money into the account, when you take money out of the account. These are the formal terms to describe that.
Traditional: The money you put in the account is not-taxed until you withdraw it. This is also known as putting money in pre-tax. Pre-tax means the money comes out of your paycheck before taxes are taken out.
Roth: The money you put in the account is after taxes, but is tax free when withdrawn.
Note: The SIMPLE IRA and SEP IRA are the only account types that do not have a Roth option. In essence, they are their own type.
This is just a brief summary. If you would like full details, check out:
Roth vs Traditional IRAs: A Complete Reference Guide
Is a Retirement Account Worth it?
If you’re wondering if a retirement account is worth it, it is! In my opinion, if you can keep your money from being taxed, you should.
Retirement accounts are one of the best ways to save your hard-earned money. Unless you think the government is a better manager of our money then you, yourself.
Retirement Accounts Guide for the Employed
401(k)
If you work for a large, public company, chances are you have a 401(k) option. This applies to most Americans.
Employers usually offer to match a certain amount of your contribution. (It’s a tax-advantage for them too!) For example, they may offer to match 50% of up to 8% of your salary. Meaning, they could potentially contribute up to 4% of your salary.
Who wouldn’t want free money?!
That’s just an example. Some companies may contribute less, but many companies have a higher contribution match!
The maximum contribution limit for 2020 is $19,500. If you are over 50, you can contribute an additional $6,500, for a total of $26,000.
It’s up to the employer if they offer a Roth 401(k) option. If your company has a 401(k), there will definitely be the Traditional 401(k) option.
The money invested in the accounts may be withdrawn starting at age 59 and a half. There is a 10% penalty if done before that age, with a few exceptions. (Now even more exceptions with the CARES Act!)
The last thing to note is that once you are retired and have reached age 70 and a half, you will be required to start withdrawing money from the Traditional 401(k). This is known as required minimum distributions or RMDs.
The government want’s the tax money, so they force you to take withdrawals or face steep penalties. (50% – Ouch!)
If you invested your money into a Roth 401(k), they are technically subject to RMDs. However, a Roth 401(k) can be rolled over to a Roth IRA with no penalty. The Roth IRA does not have RMDs.
CARES Act Overview
The CARES Act, passed by congress in March 2020, provides some relief for those effected by the Corona virus. The CARES act has relaxed loan provisions, an RMD waiver, along with what is being called Coronavirus Related Distributions (CRDs).
Eligibility for Benefits
In order to be eligible for the CRDs and relaxed loan provisions, you must meet one of the following three conditions:
- You have contracted COVID19.
- Your spouse or a dependent has contracted COVID19.
- You have lost a job, been furloughed or otherwise suffered a heavy financial burden because of COVID19 (including loss of childcare).
Coronavirus Related Distributions (CRDs)
If eligible, you can take up to $100,000 from employer-sponsored retirement plans and IRAs without the 10% early distribution penalty or the 20% mandatory tax withholding.
The CRD will be treated as regular income, but it can be spread over three years for tax purposes, and the distribution can be repaid within three years to avoid taxation.
CRDs are available for the entire 2020 calendar year. The means distributions made in 2020 prior to the enactment of the CARES Act may be still treated as a CRD.
Relaxed Loan Provisions
The available 401(k) loan amount has been increased to the lesser of:
• 100% of the vested balance (up from 50%) or;
• $100,000 (up from $50,000).
Participants with loan repayments due between 3/27/2020 and 12/31/2020 can elect to delay them for 1 year. Interest will continue to accrue, but the term of the loan will be extended accordingly.
Required Minimum Distribution (RMD) Waiver
The CARES Act waives all RMDs for 2020.
This includes first-time 2019 RMDs, which individuals may have been waiting until April 1, 2020 to make.
Any RMDs already taken in 2020 (including 2019 RMDs paid in 2020) are eligible for a 60-day indirect rollover (or 3-year repayment under CRD rules) and won’t be considered to have been taken as a distribution.
403(b)
If you work for a non-profit, or some other tax-exempt organization, you may have the option of investing in a 403(b). This is a common option among Teachers and Educators.
Aside from a few legal differences, they are equivalent to a 401(k). They both have the same contribution limits ($19,500 for 2020). They both offer Roth options. The age limits and RMD rules are the same as well.
457(b)
The 457(b) plan is offered by state and local governments. This is a common option among public servants, such at police and fire fighters, as well as anyone else you see driving a city-marked truck.
The contribution limits are the same as the 401(k), at $19,500.
The big difference is that you can withdraw your money before age 59 and a half free of penalty.
SIMPLE IRA
A SIMPLE IRA is for small businesses, those with 100 or less employees, so it is not the most common. The rules ARE different from a 401(k)
First, you must earn at least $5,000 for the last two years, plus the current year.
Second, the maximum contribution limit is $13,500. If you are over 50, you can contribute an additional $3,000, for a total of $16,500. (Don’t ask me what the logic is behind the difference.)
Third, there is no ROTH option available.
Fourth, the employer is required to make a dollar-for-dollar match of up to 3% of the employee’s salary.
The one similarity is that there is a penalty if you withdraw money before age 59 and a half.
Retirement Accounts Guide for the Self-Employed
Solo 401(k)
The solo 401(k), also nicknamed the one=participant 401(k), is for those who work for themselves, and only themselves. You can’t have employees working for you.
The contribution limits are fairly generous.
The maximum contribution limit for 2020 is $57,000, or 100% of your compensation, whichever is less. If you are over 50, you can contribute an additional $6,500, for a total of $63,500.
Caution: If this is a side job, employee 401(k) limits apply by person, not by plan. That means if you are participating in a 401(k) from your employer, the limit applies to contributions across all plans, not each individual 401(k) plan.
I suggest talking to a retirement professional and doing your own research if you fall into this category of having two income sources.
SEP IRA
The Simplified Employee Pension IRA is designed for the self-employed or small businesses (so it falls under the previous category as well.)
The maximum contribution limit for 2020 is $57,000, or 25% of your compensation, whichever is less.
The rest of the rules are similar to a Traditional 401(k).
The money invested in the accounts may be withdrawn starting at age 59 and a half. Also, required minimum distributions start age 70 and a half. Penalties apply if you break the rules.
Retirement Accounts Guide: Self-Directed
IRA
An individual Retirement Account, IRA, is available only to people with an earned income. This type of retirement account is designed to supplement other retirement accounts, such as a 401(k) from your employer.
The maximum contribution limit for 2020 is $6,000, or 100% of your compensation, whichever is less. If you are over 50, you can contribute an additional $1,000, for a total of $7,000.
The remainder of the rules match the 401(k) rules. For full details, again I suggest reading: Roth vs Traditional IRAs: A Complete Reference Guide
Self-Directed IRA
The self-directed IRA has all the same rules as the IRA we just covered, but opens up more investment options. You may be able to put money into alternative investments such as cryptocurrencies, precious metals and real estate.
Self-directed IRAs can be set up like a Traditional IRA or like a Roth IRA, so technically, self-directed IRAs are a subset of the IRA category.
The account custodians of a self-directed IRA are not allowed to give financial advice because it’s “self-directed”. Therefore, traditional brokerages, banks, and investment companies usually don’t offer a self-directed IRA.
You will have to do your own homework. Plan on talking to a financial adviser as well.
Retirement Account Guide: Alternatives
Here are some alternatives for if you still have extra money to invest, and/or if you don’t qualify for some of the accounts previously mentioned.
Brokerage Account
This is just a plain investment account, earmarked for retirement if you so choose. The benefit of this account is that there are no income limits, contribution limits, age limits, or any of the other rules that apply to retirement accounts.
You are free to handle the money as you choose.
Of course, the downside is that you will pay taxes on the money you invest, as well as any earning it generates.
However, another plus is that the capital gains tax rate is generally lower than the income tax bracket a person is in.
HSA – The Surprise Bonus Retirement Fund
The HSA is the ultimate retirement savings account, although, it’s not technically a retirement account.
The Health Savings Account, HSA, is designed for…. well…. your health. It’s made to save you money on medical expenses.
However, money inside the account can be invested like a 401(k) or IRA.
Also, HSA savings are never taxed. Completely tax-free money. I’m pretty sure it’s the only place you will find such a deal.
Unfortunately, there is a contribution limit. The limit for 2020 is $3,550 for an individual or $7,100 for a family.
There are some more rules, but for all the details, check out $500,000 + 6 Reasons you need a Tax-Free HSA Today
What is the best retirement account to consider in 2020?
The two most popular retirement accounts are the 401k and the IRA.
If your fortunate enough to have a 401(k) through your employer, you may be eligible for a matching contribution. Take advantage of that free money!
How much is good for retirement?
If you’re like me, one of the first questions you ask yourself is, “How much do I need?” The second question is, “How fast can I get there?”
The general rule of thumb is that you are able to live off 4% of your total retirement saving in one year. I argue that the risk on 4% is too high, and that you should be able to live off 3.5% a year.
To learn about my math and my logic, go read about how I determined my number:
4 Steps to Determine Your FI Number
What order should I invest the money?
To the extent that each of these accounts are available to you, here is the best order to invest your money.
1. 401(k) – Max out the matching contribution
Take full advantage of that free money!
If you are self-employed, start with the HSA.
2. HSA – Max it out
The money you put into the HSA is completely tax free. It’s the next best thing to being given free money!
3. Traditional or Roth IRA – Max it out
Here is where you start to have options. IF you expect your income will be higher in retirement (I do!), then max out your Roth IRA. Otherwise, it is more advantageous to max out your Traditional IRA.
4. 401(k) – Finish maxing it out
Finish taking advantage of tax-savings offered through your 401(k)
If your self-employed, this would be the time to max out your solo 401(k).
5. It Depends: You Choose the Next Step
If you still have money to invest, congratulations!
You’re doing pretty well for yourself. You have already invested over $30,000 for the 2020.
You may want to consider diversifying by investing in Real Estate
If you’re comfortable with the stock market, consider opening a brokerage account.
Another option is to consider doing a backdoor Roth Physician on Fire covers the details in his post Backdoor Roth IRA 2020: Step by Step Guide with Vanguard
My Personal Investment Strategy
Are you wondering where I invest my retirement savings? Well, I follow the same guidelines that I just suggested you to follow!
For the year 2020, I will
- Fully fund my 401(k).
- Max out our HSA.
- Max out our Roth IRAs.
- Save extra money to invest in real estate.
I cover my progress each month in my net worth reports. Be sure to check out my latest Net Worth Report. There is also a link available in the menu at the top of this page (and every page).
Side note:
The IRS lists more options on their “Retirement Plans” page, but not all are listed here. Only the best!
Also, some of them aren’t really retirement plans, just retirement supplements, such as employee stock purchase plans.
Summary Tables
Retirement Accounts Guide for the Employed Summary Table
| | 401(k) plan | 403(b) plan | Governmental 457(b) | SIMPLE IRA |
|---|---|---|---|---|
| Which type of employer can offer the plan? | For-profit or nonprofit organizations. (Most Common) | Non-profit organizations and tax-exempt organizations | Any state or local government entity | For-profit, nonprofit or government organizations with fewer than 100 employees |
| Who is eligible to participate? | Employees may be required to meet minimum age and service conditions | All employees are eligible, with very few exclusions. | Eligibility is generally at the employer’s discretion | Employees with at least $5,000 of compensation in any two previous years of service and who anticipate compensation of at least $5,000 in the current year |
| How much of your salary can you contribute for 2020? | $19,500, or $26,000 if you are age 50 or above | $19,500, or $26,000 if you are age 50 or above | $19,500, or $26,000 if you are age 50 or above | $13,500, or $16,500 if you are age 50 or above |
| Additional considerations | Roth 401(k) contributions may be allowed | Roth 403(b) contributions may be allowed | Roth 457 contribution may be allowed | No Roth contribution option |
| Employer match may be available | Employer match may be available | Employer match may be available | Employer contributions required | |
| 10% IRS penalty on early withdrawals (exceptions apply) | 10% IRS penalty on early withdrawals (exceptions apply) | No penalty on early withdrawals | 25% penalty on early withdrawals for the first two years, 10% penalty thereafter (exceptions apply) |
Retirement Accounts Guide for the Self-Employed Summary Table
| Solo 401(k) | SEP | |
|---|---|---|
| Which type of employer can offer this plan? | Self-Employed: Those who work for themselves, and only themselves | Self-Employed, For-profit, nonprofit or government organizations |
| Who is eligible to participate? (Some employers may be less restrictive) | Self-Employed persons that have no employees | Employees age 21 or above who perform service in at least three of the prior five plan years, and who receive at least a required minimum amount of compensation in the current year ($600 in 2020) |
| What is the maximum that can be contributed for 2020? | 100% of compensation, up to $57,000, or or $63,500 if you are age 50 or above | 25% of compensation, up to $57,000 |
| Additional features | Loans are available | No loan provisions |
| You are considered the Employer and Employee | Employer contributions are discretionary |
Traditional vs Roth IRA Summary Table
| Traditional IRA | Roth IRA | |
|---|---|---|
| Who is eligible to make contributions? | Individuals of any age with earned income* Non-working spouses of individuals with earned income *As of 2020, there is no age limit for contributions due to the SECURE Act changes | Individuals of any age with earned income Non-working spouses of individuals with earned income |
| What is the maximum you can contribute for 2020? | Lesser of $6,000 ($7,000 if you are age 50 or above) or 100% of earned income | Lesser of $6,000 ($7,000 if you are age 50 or above) or 100% of earned income |
| How are contributions and distributions (withdrawals) taxed? | Contributions may be tax-free, depending on your income Any growth from contributions will be tax-deferred until withdrawn. Distributions of pre-tax contributions and earnings are taxed at your ordinary income tax rate the year you withdraw the money. | Contributions are non-deductible Earnings are tax-free if: Distributed five years or more from the first day that funds were first contributed or converted to any Roth IRA for the individual,and you are age 59½ |
| Additional considerations | Required minimum distributions start at age 72. Early withdrawals of taxable amounts prior to age 59½ are subject to a 10% IRS penalty (exceptions apply). | No required minimum distributions. Early withdrawals of earnings may be subject to tax and a 10% IRS penalty if distributed prior to age 59½ (exceptions apply). |
Hopefully this guide is some help to you on funding your retirement. If you have any questions, you can shoot me an email, or leave a comment below.
FIRE Away!