Three Retirement Accounts to Consider in 2022 for Long-Term Wealth

If you are young and just starting your career, retirement might not be your primary concern at the moment. However, there is no time better than now to start preparing for your retirement. The earlier you start saving for retirement, the better are your chances of being financially independent during the non-working years of your life. For long-term financial security, it may be wise to create a plan early in life, or right now, if you have not already begun your retirement planning journey. By redirecting a portion of your income towards a tax-free retirement account, your wealth can grow significantly, enabling you to achieve peace of mind and financial security during the golden years of your life. If you wish to learn about the pros and cons of different retirement accounts, how to open one, its taxability, its rules concerning withdrawal and penalties, and more, try consulting with a professional financial advisor who can guide you on the same.

However, the state of retirement in America is not healthy. As reported in a 2020 survey, nearly 41% of Americans had less than $100,000 in retirement savings. The diminishing pension rates and Social Security checks coupled with the increased life expectancy rates are leaving future generations in a vulnerable position without sufficient funds to support their lifestyle during retirement. In another study, nearly three-quarters of Americans agreed the country is facing a retirement crisis, and it is critical, now more than ever, for people to become aware of retirement planning. According to Annuity.org, the median retirement savings for all workers is only $97,000. But the retirement savings expectations increased 10% to 1.04 million in 2021. Such a gap in retirement savings will cause approximately 55% of workers to work even during retirement.

Fortunately, you can avoid being financially unstable during retirement by making the right moves and commitments in the present. There are ample opportunities to help you start saving for retirement, supporting you to retire comfortably or even retire early, if everything works out well.
The most effective way to begin your retirement savings journey is by making the most of the tax-free retirement accounts. There are different types of retirement accounts that you can use to reach your retirement goals. These accounts allow you to build wealth and profit from the various tax benefits. As per a 2021 study, about 71% of the participants rely on retirement accounts, such as 401(k)s, Individual Retirement Accounts (IRAs), 403(b) accounts, etc., to fund their retirement expenses. Whether you are several years away from your retirement or getting closer to your retirement age, there are plenty of opportunities to build your retirement savings today with these options.

Here are three of the best retirement accounts you can consider to create your retirement corpus:

1. Roth IRA

The Roth IRA was introduced in 1997 but was not a preferred investment choice for wealthy retirement planners. However, due to the rising tax rates and superior tax advantages of a Roth IRA, retirement savers are now using the Roth IRA to reduce their tax bills and amplify their retirement savings for the future. Roth IRA is an individual retirement account where you can contribute after-tax dollars and earn tax-free returns on your funds. Apart from tax-free growth, the withdrawals from your Roth IRA are also tax-free, subject to some conditions. You pay taxes on your Roth IRA contributions upfront and allow your savings to compound tax-free to get tax-exempt distributions during retirement. However, to get penalty-free drawings, you should hold your Roth IRA for a minimum of five years and be at least 59.5 years old at the time of withdrawal. If you meet these conditions, the withdrawals are categorized as qualified and tax-exempt. You can open a Roth IRA account with a brokerage firm, bank, or a registered investment company. A Roth IRA is also one of the best retirement accounts for self-employed people. However, like other tax-free retirement accounts, the IRS (Internal Revenue Service) limits your Roth IRA contributions. For 2022, the maximum Roth IRA contribution is $6,000 if you are under 50 years of age. However, if you are older than 50, the IRS allows you to contribute $7,000 in your Roth IRA for 2022. These are collective limits for all IRAs in your name. If you contribute above the upper ceiling, you would be liable to pay a 6% penalty every year until you rectify the error. Further, the IRS mandates that the Roth IRA contributions come only from earned income, including salaries, wages, business earnings, disability retirement benefits, commissions, bonuses, assignment work, etc. But interest, dividend, child support, rental income, Social Security benefits, unemployment benefits, pension, and annuity earnings are not earned income and cannot be saved in a Roth IRA. If your earned income is lower than the maximum contribution limit, you can only contribute a sum up to your earned income. For example, if you can contribute $6,000 in 2022 in your Roth IRA, but your earned income is only $5,000, then you can only save $5,000 in your Roth IRA for 2022. Your Roth IRA contributions are also restricted by your income eligibility and tax filing status. Hence, it may be advised to study the Roth IRA contribution limits along with income limitations and the tax filing status.

Overall, a Roth IRA is one of the most efficient types of retirement accounts if you expect yourself to be in a higher tax bracket during retirement. In a Roth IRA, you pay taxes in the present and do not owe any taxes to the IRS at the time of withdrawal if you meet the qualifying distribution criteria.

2. 401(k):

A 401(k) is one of the most popular retirement savings mediums for U.S. workers. In 2020, there were over 600,000 401(k) plans with 60 million and above active participants, former employees, and retirees. A 401(k) plan is an employer-sponsored, tax-advantaged account that allows you to contribute pre-tax dollars and earn tax-free returns over time. In 2022, if you are under 50, you can contribute up to $20,500 per year in your 401(k) account, $1,000 higher than in 2021. If you are over the age of 50, you can make a catch-up contribution of up to $6,500 in 2022 (a total of $27,000 annually) in your 401(k) account. In some cases, employers make matching contributions to your 401(k). The total employer and employee 401(k) contributions cannot exceed $61,000 for 2022 for employees under 50 and $67,500 for those aged 50 or more. According to Vanguard, nearly half of the employers make matching contributions (an average of 3% of the salary). The account allows you to invest your money in stocks, bonds, mutual funds, etc., allowing your funds to grow over time. The returns are tax-deferred, adding to the attractiveness of a 401(k). However, the distributions you take from your 401(k) account are treated as ordinary income, and you pay income tax for the amount withdrawn. Further, if you take any distributions from your 401(k) before reaching 59.5 years of age, you will pay a 10% penalty unless the IRS exempts the case like loss of employment, permanent disability, etc. In early withdrawals, you pay the IRS penalty plus the income tax on the sum withdrawn. That said, you can only keep your money in a 401(k) account until the age of 72. The IRS mandates you to take RMDs (Required Minimum Distributions) by April 1 of the year you turn 72. Your RMD amount depends on your life expectancy and 401(k) balance. If you do not take the RMD within the deadline or fail to withdraw the entire RMD sum, the amount pending is taxed at 50%. The RMDs were waived off under the CARES Act, 2020. However, they are now applicable for all concerning retirement accounts.

You can invest in a 401(k) account if you think you will be in a lower tax bracket during retirement. By contributing pre-tax dollars in the present, you can defer your tax payment until funds are withdrawn during retirement, a period when most likely you would expect yourself to be in a lower tax bracket. However, if your employer does not provide you with a 401(k) account, you can invest in a traditional IRA, which gives you the same benefits as a 401(k) but with a lower contribution limit. For 2022, you can contribute up to $6,000 in your traditional IRA if you are younger than 50 years and $7,000 if you are 50 years old or above.

3. Health Savings Account (HSA):

Another type of retirement account you can use to secure your golden years is a health savings account (HSA). An HSA is not a regular tax-free retirement account. It is a specialized account that allows you to make tax-deductible contributions every year. It is advisable to invest in an HSA for 2022 to cover the steeply rising medical costs during retirement. As reported by a recent study on the estimated health care costs for retirees, an average 65-year-old retired couple in 2021 might require nearly $300,000 (after taxes) to cover their healthcare costs during retirement. This sum will be higher if the retiree has an underlying health concern, such as diabetes. However, the exact amount spent will depend on the retiree’s health, the retirement age, retirement state, and life expectancy. With such enormous health costs, it is critical for you to plan your retirement years with an HSA, helpful during your working and non-working years. This account works like your personal savings account, but the money you save in this account is used to pay for your medical expenses. You own and control the money in your HSA; there is no involvement of any insurance company or your employer. Even if you choose an HSA funded by the employer, you retain control over your HSA funds. The money you deposit in your HSA is tax-free, and the earnings from HSA are also exempt from taxes. The objective of the account is to help you get tax-free earnings to cover your future healthcare costs. The rationale is that if you have a separate medical expense account, your other retirement savings can last longer. Some HSAs also pay you interest on the unused money or invest your funds in mutual funds, ETFs (Exchange Traded Funds), and other financial products, enabling your savings to grow in the long term. It is beneficial to invest your HSA funds per your risk tolerance.

The unused sum in your HSA after the year-end is carried forward to the next year. In case of withdrawals, if you take funds for medical use, your distributions are tax-free. However, if you withdraw money from your HSA for a non-medical purpose, the IRS levies a tax penalty. Further, if you take out money from your HSA before your official retirement age, assuming 65 years, you will owe a 20% penalty on the sum withdrawn. Like other tax-free retirement accounts, even an HSA has annual contribution limits. For 2022, the IRS has set the annual contribution limit for self-only HSA at $3,650 ($50 up from $3,600 in 2021) and $7,300 for family coverage (self + one or more), which is $100 higher than the 2021 contribution ceiling of $7,200. If you are 55, you can increase your HSA contributions by availing the catch-up contribution of $1,000 to cover increasing healthcare costs. If you have a self-only HSA plan, you can contribute up to $4,650, and if you have a family HSA plan, you can collectively contribute up to $8,300 in 2022. It is advised to make the most of your HSA contributions and start investing at the earliest to accumulate a large sum for your medical expenses. However, be mindful that once you enroll in the Medicare plan, by 65 years, you can no longer contribute to an HSA. But you can use the money from this account to cover your Medicare premiums, deductibles, and more. The IRS permits you to keep your funds in the HSA for as long as you want. There is no mandatory distribution clause. Hence, ideally, by waiting to draw out your funds, you allow it the time to grow exponentially by maximizing investment returns. When you want or need to withdraw your HSA savings, it is best to ensure that you use the money for qualified medical expenses to avoid penalties. Further, be careful about your withdrawal timing and avoid withdrawals during a market downturn because that would force you to sell your investments at a lower cost.

To summarize

These three different types of retirement accounts are a wise consideration for retirement planners in 2022. Use a retirement account calculator to assess how much you need for a financially secure retirement. You cannot accumulate higher savings by having multiple retirement accounts. The maximum ceiling of a retirement account is a blanket figure and collectively applies to all specific retirement accounts in your name. For instance, if you can invest only $6,000 in your Roth IRA, then this is a collective limit applicable for all Roth IRAs in your name. Irrespective of how many accounts you have, you cannot invest more than $6,000. However, you can maximize your contributions in each of these three retirement accounts individually. If you want in-depth guidance on how to best use these retirement accounts, consider engaging with a professional financial advisor.

To get in touch with a fiduciary advisor who may help you understand the pros and cons of the retirement accounts discussed in this article, along with their contribution limitations, income limitations, tax filing status and more, use the free advisor match service. Based on your requirements, the platform scans through registered and qualified advisors to match you with an advisor suited to your financial needs and goals.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. In addition, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.