If you missed part one of the Phippen Tax & Financial Services Financial Accounts Series and want to work on your financial organization, start here. The accounts outlined below are the three accounts we recommend opening next. While the previous accounts organized your finances and prepared you to weather financial emergencies, these help you start saving for retirement and targeted savings goals:
1. 401(k)/403(b)/457/TSP
Your 401(k), 403(b), 457, or TSP* is a tax-advantaged retirement account that allows you to save a large amount of money for your future self. These accounts are typically offered by your employer, and your employer may even pitch in with an employer match. An employer match is when your employer agrees to contribute the same amount you do, or a percentage of it, usually up to a certain percentage. In other words, the employer match is free money! If you do not contribute at least enough to maximize your employer match, you are effectively throwing away this free money. If you are self-employed, you can still contribute to a solo 401(k) and offer yourself a “match” of up to 25% of your business profits.
Traditional 401(k)s allow the contributor to invest pre-tax dollars, decrease their taxable income, and push back taxes until the money is withdrawn at or after age 59.5 years old. Roth 401(k)s are taxed initially, but they grow tax free, and both the principal and gains may be withdrawn tax-free at age 59.5. (In either case, substantial tax penalties apply if you withdraw funds before age 59.5.)
Why do I need a 401(k)? The 401(k) is your biggest retirement account if you are employed by someone else, and it is still a powerful investment tool for the self-employed. If you are an employee with an employer that offers an employer match, a 401(k) provides you both tax advantages and free money.
2. Roth IRA
A Roth IRA is a retirement account that can be opened by anyone who earns income (or has a spouse who earns income), regardless of whether you are employed or self-employed. Since it is a Roth account, money is contributed after-tax, but it grows tax-free and can be withdrawn tax-free once you are 59.5 years old. There are income limits on Roth IRAs, meaning folks that make too much money cannot contribute to them. For traditional IRAs – where you contribute money pre-tax, but all withdrawals (including the growth) are subject to tax – income limits do not exist for contribution eligibility, but there are deductibility limits, meaning folks with a high enough income cannot realize all the tax deductions that IRAs typically provide.
It is still worth having a traditional IRA if you exceed any of these income limits since you can roll money over from a traditional IRA to a Roth IRA to foster tax-free growth over time. Additionally, the IRA (whether Roth or traditional) serves as a retirement consolidation point: If you leave a job where you have a 401(k), you can roll that 401(k) into an IRA to consolidate your retirement investments and make your financial planning easier.
Why do I need a Roth IRA? The Roth IRA is a tax-advantaged account where you can save for retirement regardless of employment status. It also provides a consolidation point for any employer retirement accounts that you need to roll over after leaving a job. While a traditional IRA is often better in the short-term, a Roth IRA is generally the better long-term investment.
3. High-Yield Savings Accounts
High-Yield Savings Accounts (HYSAs) are first where you keep your emergency fund, but they are also where you can set aside money for multiple savings goals while still receiving some interest to keep up with inflation. HYSAs allow you to have different “buckets” of funds where you can contribute money towards specific categories. Common savings accounts goals may be saving for a down payment to buy a home or saving for a large annual vacation.
For large annual expenses, like a property tax bill or holiday gifts, saving a little bit each month makes them less surprising for your budget. Additionally, setting up HYSAs for targeted emergencies can provide a wider safety net than having one emergency fund. For example, if you contribute a small amount to a car fund each month, you prepare yourself for future maintenance your car needs. If you contribute to a furniture fund, you can immediately replace a chair when it breaks.
On the more fun side, HYSAs are the place to save for potential events that give you joy so you can say “yes” when they arise. Vacations, concerts, the big game: This is your place. You can pay the steep ticket price for that Taylor Swift concert if your “Concerts” HYSA has enough money.
Why do I need multiple High-Yield Savings Accounts? HYSAs allow you to organize your money to address various mid-term to long-term savings goals while still receiving interest on your money.
*I subsequently use “401(k)” to discuss factors that are true for all of the accounts. In any case where there are differences, they are specified. The specific type of account available to you is based on your employer type. For example, only federal government employees can participate in the Thrift Savings Plan.
About the Financial Accounts Series: The Financial Accounts Series is a four-part series discussing financial accounts that can improve the health of your finances. Over the next three weeks, the Phippen Tax & Financial Services team will provide a deep dive on each of the accounts listed above before releasing Part 3, Accounts You Want. If you would like to seek additional guidance about your personal finances or the specific organization and composition of your financial accounts, please contact Patrick Phippen or complete a new client form if you have not worked with Patrick in the past.
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