Understanding Retirement Plans
Everyone is told to save for retirement, but few have been told exactly how to do this or the different options available to them. Today we’re going to cover some retirement planning basics to be aware of.
To start off, the first point to be aware of is that there are primarily two types of retirement accounts: Traditional and Roth. Traditional accounts use pre-tax dollars to fund your investments in the account and taxes are paid once withdrawals are made during retirement. Roth accounts use after tax dollars and no additional tax is owed when withdrawals are made, thus leading to tax free growth.
The most common example of a traditional account is a 401k account. Employees will elect to have a certain percentage of their gross pay withheld and deposited into their 401k before taxes are taken out. This is a powerful way for employees to lower their taxable income while saving for retirement.
For example, if a person’s monthly gross income is $2,000 and they elect to have 10% withheld for a 401k contribution, $200 will be deposited into their 401k and taxes are assessed on the remaining $1,800 of gross income (assuming no other deductions). Fundamentally the employee is deferring tax payments on this income until retirement and allowing the investment to compound for many years before taxes need to be paid on the withdrawals.
With traditional accounts, the main consideration in retirement is known as Required Minimum Distributions (RMDs). While people can begin withdrawing from their traditional retirement account at age 59 ½ , the IRS mandates that withdrawals from retirement accounts begin no later than age 73. This is to ensure that investors eventually start paying taxes on the funds they saved over the years. The IRS uses a ‘life expectancy’ table to determine the amount that needs to be withdrawn. Fidelity investments has a useful, easy to read table here IRS Uniform Lifetime Table | Calculate RMDs | Fidelity
Roth accounts are much more straightforward: you put money in, invest that money, and withdraw from the account during retirement as you see fit (there are other instances where you are allowed to withdraw from a Roth account that is outside the scope of this article). This is generally considered ‘Tax-Free Growth’ whereas Traditional accounts are known as ‘Tax-Deferred’.
Now that we understand Traditional and Roth accounts, there are different types of these accounts from there. The two basic types we’ll cover here are 401k or 403b (i.e. workplace plans) and Individual Retirement Accounts (IRAs). Workplace retirement accounts, like the name suggests, are offered through your employer. The convenience of having a portion of your paycheck withheld and going automatically into your 401k or 403b helps many people build retirement savings. In most cases these contributions are ‘Traditional’, but some plans do allow for Roth contributions as well, so it is possible to have a Roth 401k or a combined 401k.
IRAs, also as the name suggests, is your personal retirement account that is completely separated from your workplace. A person can open an IRA with most brokers themselves or through a financial advisor and begin contributing to it. Simple enough.
Now that we have a basic understanding of the different types of accounts, let’s review some rules and potential strategies to utilize.
RULES TO BE AWARE OF
The number one rule to understand with these accounts and the money in them is that these funds are meant for retirement. People can begin withdrawing from them at age 59 ½ and, in the case of Traditional accounts, are required to take withdrawals by age 73. With few exceptions, withdrawing from these accounts prior to age 59 ½ will result in a 10% penalty and the withdrawals will be considered taxable income, so the person will receive only a fraction of the funds that they withdrew. With Roth IRA accounts, the rules are slightly less restrictive; a person can withdraw up to the amount they contributed without penalty or tax so long as the account has been open for 5 years. Unless absolutely necessary, this generally isn’t recommended.
For 401ks, be it traditional or Roth, a person can contribute up to $24,500 (not including employer matches, if any) from their salary. There are ‘catch-up’ contributions available to those aged 50-59 up to $32,500 and $35,750 for those ages 60-63. These funds will generally be invested in a mutual fund you select from a list of options available for your workplace plan, so there are fund and management fees along with performance to consider. In general, there are less investment options available inside a 401k vs an IRA.
For IRAs, be it Traditional or Roth, the maximum annual contribution is $7,500, with catch-up contributions up to $8,600 for those 50 and over. It’s important to note that if a person is contributing to a workplace retirement account at the max, it’s generally not advised contributing to a traditional IRA as well since they will not be allowed to claim the tax deduction, thus defeating the purpose of the account. For Roth IRAs, there are maximum income limits that need to be followed, meaning if you make over a certain amount of money you cannot contribute to one. For 2026, if a single person makes over $168,000 in Modified Adjusted Gross Income (MAGI), they cannot contribute to a Roth. A complete table can be found on Fidelity’s website here Traditional and Roth IRA Contribution Limits | Fidelity Investments
SIMPLE RETIREMENT STRATEGIES
While everyone’s individual situation is different and one should consult a financial advisor to discuss their personal financial state, here are some basic strategies to consider when savings for retirement.
Use a mix of Traditional and Roth accounts: When a person begins working, one option to consider is contributing to your company’s 401k or 403b plan and subsequently opening a Roth IRA to add some of your discretionary income into. This will allow you to have more options when it comes to retirement. For example, if you’ve amassed enough wealth to truly retire at 59 ½, you can begin withdrawing from your Roth IRA (tax-free) while you let your traditional 401k continue to compound until RMDs are mandatory at age 73.
Contribute at-least up to your employer match: Some employers will match your contributions up to a certain amount so long as you’re contributing at least a certain percentage. Say it’s 5%, then make sure to contribute at least 5%.
For IRAs, make sure the funds are actually invested: IRAs do not work like 401ks where the funds are automatically invested into a mutual fund (of your choosing). If you simply make a deposit into an IRA, it’ll sit there as cash until it’s invested. While you can automate the amount you deposit and how each deposit is invested, you’ll need to choose those investments for yourself. IRAs do provide many more investment options vs 401ks, but it is on the individual to ensure it’s invested the way they want.
When you leave your job, roll-over your 401k into an IRA: Doing this will allow you to track you total retirement funds and ensure it’s invested the way you want. Assuming you’re only making traditional contributions into your 401k, you can setup something called a ‘roll-over’ IRA in which each old 401k can be transferred into with no tax consequences once you leave a job. This way you have more autonomy over your investments and avoid paying mutual fund management fees.
While there are other types of accounts and items to consider when it comes to retirement planning, the above is the basics in terms of account types and general rules to follow.
If you’re interested in having your retirement plan reviewed by a financial advisor, click the link at the bottom of this page to contact us and work with EVCM.
Happy investing!