Saving for retirement in a dedicated account is always a wise idea, but the best account to use will vary by age. That’s because your income tends to increase over time, so what makes more sense tax-wise at a lower income bracket may no longer be the best choice as your income increases. You might also want to make changes to where you keep your funds as you near retirement.
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“It’s best to use Roth accounts when you have a long time horizon or are in a low tax bracket,” said Scott Meyer, wealth manager and partner at Merit Financial Advisors. “The reason is if you are early in your career, then you have a greater chance of benefiting from tax-free growth on your account. And if you are in a low tax bracket, then you are paying tax on the contributions at a lower bracket.”
When it comes to a 401(k) versus an IRA, each has its distinct advantages.
“If you have access to a 401(k), there are some advantages: possible match dollars, ease of use by automatic deductions from your paycheck, higher contribution limits and no income restrictions,” Meyer said. “IRAs have some advantages as well: more investment options, less distribution restrictions and more options for tax withholdings in retirement.”
With these rules of thumb in mind here’s a look at the best type of retirement account to use at every age.
20s: Roth 401(k)
If you have access to a 401(k) through your employer, you should take advantage of this in your 20s.
“If your employer offers a 401(k) with a match, your first goal is to contribute up to the max of the match,” Meyer said. “This is essentially ‘free money.'”
If you have the option for a Roth 401(k), this can be advantageous versus a traditional 401(k) at this stage of life.
“Choosing the Roth option will allow you to potentially get tax-free growth on your account, and when you are young, your growth can exceed your contributions,” Meyer said.
If your employer does not offer a 401(k), then your best option is a Roth IRA.
“The Roth IRA will give you the same tax benefits on your growth as the Roth 401(k),” Meyer said. “There is a picture I once saw of a person standing under a large apple tree and the quote was, ‘Wow, and to think I only needed to pay tax on the seed.’ This is a great visual of the power of Roth accounts for a young investor.”
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30s: Roth 401(k)
A Roth 401(k) remains the best retirement account option for most people in their 30s.
“If you’re not already, try to contribute the maximum allowable amount to your 401(k), especially if you’re in your 30s and earning a higher income,” Meyer said. “If your employer offers a match, contribute at least enough to get the full match. I still like to see most investors in their 30s use the Roth option of the 401(k).”
If you don’t have access to a 401(k) plan, Meyer said to continue contributing to a Roth IRA. “You can still benefit from tax-free growth and withdrawals, which is valuable over the long term,” he said.
Some people in their 30s may not eligible for a Roth IRA due to income limits. (In 2024, the modified adjusted gross income limit is $146,000 for single filers and $230,000 for joint filers.) If this is the case, a traditional IRA may be a good option.
“Contributions to a traditional IRA are tax-deductible, lowering your taxable income for the year, but withdrawals in retirement are taxed as ordinary income,” Meyer said.
40s: Roth and Traditional 401(k) Plans
As you move into your 40s, you may have to start splitting retirement contributions among different accounts.
“Max out contributions to your 401(k),” Meyer said. “Your 40s is the decade you can start to split contributions from Roth to pretax if your income is high.”
If you are able to contribute more than the 401(k) max (the maximum contribution is $23,000 for 2024), you may want to put funds into an IRA.
“Continue contributing to a Roth or traditional IRA, but remember the contribution limits are relatively low compared to a 401(k),” Meyer said. (The maximum contribution is $7,000 for 2024).
“If you’ve maxed out your tax-advantaged accounts, consider opening a taxable brokerage account,” he said. “It won’t offer tax benefits like retirement accounts, but it provides flexibility in terms of withdrawals and investment choices.”
50s: Traditional 401(k), Roth IRA and HSA
Your 50s are typically your peak earning years. It’s also when you become eligible for “catch-up” contributions.
“If you’re 50 or older, you can take advantage of catch-up contributions — an additional $7,500 in 2024 — to your 401(k). This is a significant benefit, as it allows you to save more in a tax-deferred environment,” Meyer said.
“If you’re eligible, you can also make catch-up contributions to a Roth or traditional IRA — an extra $1,000 in 2024,” he continued. “Even if you’re in your peak earning years and phased out of Roth IRA eligibility, a traditional IRA still offers tax-deferred growth.”
If you have access to a health savings account (HSA) through your healthcare plan, contribute to this as well.
“An HSA is an excellent way to save for healthcare expenses in retirement, as it offers triple tax benefits — tax-deductible contributions, tax-free growth and tax-free withdrawals for qualified medical expenses,” Meyer said.
60s: Traditional 401(k) and Brokerage Account
In your 60s, you should continue contributing to your 401(k) if you’re still working.
“At this stage, you might want to focus more on protecting your savings and shifting toward more conservative investments, depending on your risk tolerance,” Meyer said. “This is also the decade to think about using the pretax option in your 401(k) since your timeframe for needing this money is shorter.
“If you’ve already maxed out your tax-advantaged accounts,” he continued, “this is a good time to focus on your taxable investment accounts to generate income for retirement.”
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This article originally appeared on GOBankingRates.com: Roth vs. Traditional, 401(k) vs. IRA: The Best Account To Use at Every Age
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