A Guide to Retirement Accounts for Young Families
By starting retirement savings at age 30 instead of 40, young families can more than DOUBLE what they’ll have at retirement.
Age 30 scenario: $2,994,527 at retirement (see chart)
Age 40 scenario: $1,416,000 at retirement
Time is your Superpower with money.
Assumptions for chart (left): $100k income, 15% savings rate, 7%/year return, age 70 retirement
For young families, saving for retirement can be extremely confusing…
What accounts do I save to? How much to each account? Do I save to a Roth IRA or Traditional IRA?
The good news? Young families have time on their side which is a huge win when it comes to saving for retirement.
Figuring out a plan for retirement now, not later, is a decision that will pay for itself many times over. The chart above speaks for itself.
What Retirement Accounts Are Young Families Eligible for?
Depends… Some retirement plans are available to everyone, some are only through an employer, and others only for the self-employed.
Personal Retirement Accounts:
Examples: Traditional IRA, Roth IRA, Health Savings Accounts (HSA)
Eligibility: Anybody can open one!
Employer Sponsored Retirement Accounts:
Examples: 401k, 403b, Pensions, ESPP, ESOP, Deferred Comp plans, 457, and more
Eligibility: Must be an employee of a company
Self-Employed Retirement Accounts:
Examples: SEP IRA, Solo 401k, Simple IRA (if you own a company with employees, employer sponsored accounts may be options too)
Eligibility: Must be self-employed (think freelancers and small business owners)
How Much Should Young Families Save for Retirement?
The typical “rule of thumb” is to save 15% for retirement. Unfortunately, rules of thumb are quick and easy but often are inaccurate.
When the 15% rule of thumb doesn’t work:
You have higher priorities to compete with (i.e. paying off high interest debt, save for down payment on a home, creating an emergency fund, etc)
You can save more than 15% (talk about lost opportunity! If it’s not saved, it’s usually spent, 15% when you could save 30% will be a huge hit to your net worth over time)
You want to retire earlier or later than 67
You want a specific plan for your family that gives reassurance and confidence in your family’s financial security (not a generic prescription for society as a whole)
How much you save for retirement should not be a “one size fits all” suit, but a custom fit suit based on your income, expenses, goals, etc.
Should Young Families Save to Roth or Traditional Retirement Accounts?
“Traditional” retirement accounts:
Examples include Traditional IRA or Traditional 401k). “Traditional” means contributions to the account are done on a “pre-tax” basis. You save $6,000 to a Traditional IRA and you get to deduct that $6,000 from your income, which reduces your taxes, which leaves more dollars in your account to compound and grow over time. So no tax paid today, but you do pay tax when the money is withdrawn in retirement.
“Roth” retirement accounts:
Examples include Roth IRA or Roth 401k). “Roth” means contributions to the account are done on an “after-tax” basis. You save $6,000 to a Roth IRA and you get no tax deduction today (like a Traditional IRA), but what you lose in tax benefits today you gain over time since Roth contributions grow “tax-free”. So, $1 invested today grows to $10 tomorrow. Well, you paid tax on the first $1, the other $9 of that $10 is tax-free growth!
So Which Do I Choose? Roth or Traditional?
Traditional accounts can be great when you’re in a high tax bracket, have tight cash flow, or have student loans and are seeking forgiveness as a few examples.
Roth accounts are usually what I recommend to my clients for a few reasons:
Roth contributions (but not growth) can be withdrawn at anytime without penalty (unlike Traditional 401k’s where it’s locked up)
Account grows tax free (this is huge for young people with decades until retirement)
Tax rates are historically low right now. Saving to Roth locks in that potentially lower tax rate today
Behavior. You save more to Roth without realizing it. $6,000 to a Roth IRA is worth more (after taxes) than $6,000 to a Traditional IRA (since tax will be due when withdrawn)
Ultimately, it depends on a number of factors, some in your control, some out of your control, in deciding which option makes sense for you.
Pro’s and Con’s of Different Retirement Accounts
In this blog post, we will explore various retirement account options and help you determine which might be the best fit for your family's needs.
1. 401(k) Plans & 403(b) Plans
401k and 403b plans are pretty similar to one another so I lumped them together here. 401k’s tend to be for private companies while 403b’s are more for government, teachers, hospital workers, etc. These are employer-sponsored retirement accounts that allows employees to contribute a portion of their salary on a pre-tax, after-tax, or Roth basis.
Pros:
Employer Matching: Many employers offer matching contributions, which can significantly boost your savings.
High Contribution Limits: For 2024, the contribution limit is $23,000, with an additional $7,500 catch-up contribution for those aged 50 and above.
Tax Benefits: Traditional 401k contributions are made pre-tax, reducing your taxable income. Roth 401k contributions are made after-tax, so no tax benefits on contributions made today but they grow tax free over time which can save you tons on taxes over your lifetime.
Cons:
Limited Investment Options: Investment choices are usually limited to the funds offered by the employer and those options can sometimes have high fees.
Early Withdrawal Penalties: Withdrawals before age 59½ typically incur a 10% penalty plus taxes. Exceptions can apply.
Best For:
Individuals whose employers offer matching contributions.
Young families looking to reduce their taxable income and maximize their retirement savings.
2. Roth IRA
A Roth IRA is an individual retirement account where contributions are made with after-tax dollars, allowing for tax-free growth and withdrawals in retirement.
Pros:
Tax-Free Withdrawals: Qualified withdrawals are tax-free.
Flexible Withdrawals: Contributions (but not earnings) can be withdrawn anytime without penalties.
No Required Minimum Distributions (RMDs): You are not required to start taking distributions at age 72.
Cons:
Income Limits: High-income earners may not be eligible to contribute directly.
Lower Contribution Limits: The contribution limit for 2024 is $6,500, with an additional $1,000 catch-up contribution for those aged 50 and above.
Best For:
Young families expecting to be in a higher tax bracket in retirement.
Individuals looking for flexibility in their retirement savings.
3. Traditional IRA
A Traditional IRA allows individuals to contribute pre-tax income, with taxes deferred until withdrawals are made in retirement.
Pros:
Tax Benefits: Contributions may be tax-deductible, reducing your taxable income.
Wide Investment Options: Offers a broader range of investment options compared to employer-sponsored plans.
Rollover Flexibility: Can be rolled over into a 401(k) or another IRA.
Cons:
Early Withdrawal Penalties: Withdrawals before age 59½ typically incur a 10% penalty plus taxes.
RMDs: Required to start taking distributions at age 72.
Best For:
Young families looking for immediate tax benefits.
Individuals who prefer a wider range of investment options.
4. SEP IRA
A Simplified Employee Pension (SEP) IRA is a retirement plan designed for self-employed individuals and small business owners.
Pros:
High Contribution Limits: Contributions can be up to 25% of compensation, with a maximum of $66,000 for 2024.
Tax Benefits: Contributions are tax-deductible, reducing taxable income.
Easy Setup: Simple to establish and maintain compared to other employer-sponsored plans.
Cons:
Employer-Funded Only: Only employers contribute to SEP IRAs; employees cannot make contributions.
Early Withdrawal Penalties: Withdrawals before age 59½ incur a 10% penalty plus taxes.
Best For:
Self-employed individuals and small business owners looking for high contribution limits and tax benefits.
Young families running small businesses who want to save for retirement efficiently.
5. SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is another retirement plan option for small businesses and self-employed individuals.
Pros:
Employer Matching: Employers are required to match contributions up to 3% of the employee's salary.
Ease of Setup: Simple and inexpensive to establish and maintain.
Employee Contributions: Employees can contribute up to $15,500 in 2024, with an additional $3,500 catch-up contribution for those aged 50 and above.
Cons:
Lower Contribution Limits: Compared to 401(k) plans and SEP IRAs, contribution limits are lower.
Early Withdrawal Penalties: Withdrawals within the first two years incur a 25% penalty, and after that, a 10% penalty before age 59½.
Best For:
Small business owners and self-employed individuals seeking a straightforward retirement plan.
Young families employed by small businesses that offer SIMPLE IRAs.
6. Health Savings Account (HSA)
While not a traditional retirement account, an HSA offers unique benefits that can be advantageous for retirement planning, particularly for medical expenses.
Pros:
Triple Tax Advantage: Contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free.
Rollovers: Funds roll over year to year if not used.
Investment Options: Can invest in stocks, bonds, and mutual funds.
Cons:
Eligibility: Must be enrolled in a high-deductible health plan (HDHP).
Penalties: Non-medical withdrawals before age 65 incur a 20% penalty plus taxes.
Best For:
Young families with high-deductible health plans (i.e. “high deductible” meaning $1,600+ for self-only coverage or $3,200+ for family coverage for 2024).
Individuals looking to save for future medical expenses now or in retirement.
Conclusion
Time is your superpower. The compounding interest chart says it all. Starting your retirement savings adventure now, not later, is a decision that will pay for itself many times.
If you’re a young family or professional looking to get started saving for retirement, schedule a free 30 minute introductory call with me here. Together we’ll get a detailed savings plan in place for retirement and any other goals you have. We’ll define how much you need to save, to which accounts, and why, then we’ll track your progress to make sure you’re on track, giving you piece of mind around you and your family’s financial security. Let’s save you thousands on taxes, speed up your path to financial freedom, and get a plan in place.
If you’re a young family or professional looking to get started saving for retirement, schedule a free 30 minute introductory call with me here. Together we’ll get a detailed savings plan in place for retirement and any other goals you have. We’ll define how much you need to save, to which accounts, and why.
Getting a plan in place could save you thousands on taxes, speed up your path to financial freedom, give piece of mind, and will ensure you’re taking advantage full advantage of the years in front of you to maximize your net worth!
San Diego Financial Advisor | Fee-only Fiduciary
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