Retirement accounts: 401(k), Roth IRA & HSA explained

The Street

Bob Powell, Editor, Retirement Daily, joined TheStreet to break down the different retirement plan options.

Transcript

00:00Now, Bob, real quick, walk me through some of the options for retirement savings, because

00:05a lot of people start scratching their head.

00:07It's like alphabet soup, 401K, Roth IRA, all these numbers, all these letters.

00:12But there are tax implications, not just for the money that you're putting in, but when

00:17you're ready to retire, the money that you're going to take out.

00:21So can you talk a little bit about how those different plans work, especially when it comes

00:26to taxes?

00:27There are three basic types of accounts.

00:30There would be the taxable account, where you might be investing in stocks and bonds

00:34and mutual funds.

00:35And the money that's going in is after tax.

00:37And then when it comes out, it'll be taxed in some form or fashion, or it'll be taxed

00:41along the way.

00:42So if you're investing, say, in a CD, that could be taxed as current interest income,

00:49as ordinary income.

00:51It could be maybe if you have stocks in your taxable account and you're buying and selling

00:55them.

00:56So you're getting taxable gains as you go along.

00:59The other type of account that many people are familiar with would be an IRA or a 401K.

01:04Typically that's money that's going in on a pre-tax basis and then coming out on an

01:09after-tax basis.

01:10So you're getting a tax deduction in many respects for putting money into a 401K.

01:15It grows tax-free.

01:16And then when you withdraw the money, it gets taxed as ordinary income.

01:20And then the last type of account that people need to think about would be a Roth IRA, where

01:24the money is going in on an after-tax basis.

01:27It grows tax-free.

01:29And then when you withdraw the money years from now, it is a non-tax or tax-free event.

01:35And then the last account I should mention, because many employers are now offering this

01:38to their employees, would be health savings accounts.

01:41And these are really unique because the money is going in on a pre-tax basis.

01:44It's growing tax-free.

01:46And then if it's used for qualified medical expenses, it's tax-free as well on the withdrawal.

01:52So four different types of accounts.

01:54And I would recommend that people sort of have money in each of these buckets.

01:58Because when you get to retirement, one of the things that you want to make sure that

02:01happens is that you have the ability to create what's called tax-efficient income.

02:06What's the income that will result in the least amount of taxes based on where the money

02:10is coming out of, whether it's your Roth or your taxable account or your IRA or your HSA

02:15for that matter.

02:16And what typically happens to many people is they save almost exclusively in their 401K.

02:22And then when they get to retirement, they think they might have a million dollars set

02:25aside for retirement.

02:27But what in fact happens is you actually may only have $700,000 set aside because $300,000

02:32of that money will get taxed as ordinary income as it comes out of the account.

02:37And if you had saved perhaps, say, in a traditional 401K along with a Roth 401K, then you might

02:42at least have the option of being able to withdraw some money tax-free in retirement

02:47as well as money from your traditional 401K and maybe reduce your overall tax burden over

02:52the course of your retirement, which is ultimately the goal.

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