Note on Account Types

Contributing to a 401k or any pre-tax account can be tax inefficient, especially if you are in a low income tax bracket. While you get a tax deduction or income deferral upfront, it may not be the best long-term strategy, especially considering the historically low tax rates in recent years.

Account Types

401k: Employer-sponsored retirement account for private-sector employees. Contributions are made pre-tax, reducing current taxable income. Earnings grow tax-deferred until withdrawal during retirement.

403b: Similar to 401(k) but designed for employees of non-profit organizations, public schools, and certain tax-exempt entities.

457 and Other Government Plans: Retirement accounts for state and local government employees or certain tax-exempt organizations. Contributions and earnings are tax-deferred until withdrawal.

Defined Benefit and Defined Contribution Plans: Defined Benefit guarantees a specific retirement benefit based on salary and years of service. Defined Contribution (e.g., 401(k)) allows employees and/or employers to contribute funds, and the final benefit depends on the contributions’ performance.

SEP IRA: Simplified Employee Pension Individual Retirement Account for self-employed individuals and small business owners. Contributions are tax-deductible, and earnings grow tax-deferred until withdrawal.

SIMPLE IRA: Savings Incentive Match Plan for Employees Individual Retirement Account designed for small businesses. Both employees and employers contribute, and it offers simpler administration and lower contribution limits than 401(k)s.

ROTH IRA: Individual Retirement Account where contributions are made with after-tax dollars, but qualified withdrawals (after age 59½) are tax-free. Earnings grow tax-free as well.

Traditional IRA: Individual Retirement Account where contributions may be tax-deductible, and earnings grow tax-deferred until withdrawal. Taxes are paid upon withdrawal during retirement.

Taxable Brokerage: A regular brokerage account with no special tax advantages. Capital gains, dividends, and interest are taxable in the year they are received.

UGMA & UTMA: Uniform Gifts/Transfers to Minors Act accounts used to hold and manage assets for a minor until they reach the age of majority, at which point the assets become theirs.

529 Plan: Education savings plan that offers tax advantages when saving for qualified education expenses. Earnings grow tax-free, and withdrawals for educational purposes are also tax-free.

Coverdell Education Savings Plan: Another education savings plan for primary, secondary, and higher education expenses. Similar to a Roth IRA, contributions are made with after-tax dollars, and qualified withdrawals are tax-free.

HSA: An HSA (Health Savings Account) is a tax-advantaged savings account designed to help individuals with high-deductible health insurance plans save money for qualified medical expenses. Contributions to the HSA are tax-deductible, grow tax-free, and withdrawals for eligible medical expenses are tax-free. The account owner can use the funds to pay for medical expenses, such as doctor visits, prescriptions, and hospital costs.

Bonus for HSAs: The shoebox rule allows you to keep and accumulate medical receipts and documentation in a designated container (like a shoebox) over time, typically throughout the year. Then, you can use these receipts to reimburse yourself from your Health Savings Account (HSA) for eligible medical expenses incurred in previous years. As long as you maintain the receipts to substantiate the expense, you can use this rule.

Resources

https://www.irs.gov/retirement-plans