Putting the pieces together for retirement

Debbie Heffernan Gallant, a financial planner in Rockville, Maryland, likens a retirement saving strategy to a jigsaw puzzle: You dump out all the pieces (your existing resources) and start figuring out how to connect them.

Problem is, the reach of your current resources might exceed the lifestyle you want to grasp. “Sometimes,” Gallant says, “the picture you end up with doesn't match the picture on the box.”

This means to approach this puzzle, you have to start thinking about how to supplement or build on what you already have. So, consider the options that may be available to you.

Workplace retirement plans

Have a traditional pension? Consider yourself lucky. The number of employer-paid “defined benefit” retirement plans has plummeted in recent decades. Their replacements: “defined contribution” plans like 401(k)s (typically for corporate and for-profit workers), 403(b)s (for education and health care professionals), 457(b)s (for government employees), and SIMPLE IRAs (for small business owners and employees).

While these plans have differences, their basics are the same: You contribute to your account automatically via payroll deduction; your money goes into investments you choose from a menu the employer or organization provides; and the account can grow tax-deferred until you withdraw from it, ideally in retirement.

Also, you may have the option to save through a “traditional” or Roth account, or both. With a traditional account, your contributions go in before taxes come out of your paycheck. This lowers your current taxable income (and tax bill) and means each dollar you contribute costs less than a dollar in take-home pay. But once you withdraw (presumably in retirement), you’ll owe income tax on the money.

On the flip side, you contribute after-tax dollars to a Roth. That will cost you more upfront, but the benefit can be significant: tax-free withdrawals as long as you hold the account at least five years and meet other criteria.

Many employers will also match part of your account contributions, which can help your savings grow even faster. If that’s available, make sure to contribute at least enough to earn every matching dollar.

Individual retirement accounts (IRAs)

An IRA is one of the best retirement vehicles because you can open it at any point, as long as you have earned income (self-employment included). Plus, even if you’re not working, you can still open and contribute to an IRA if your spouse is a wage earner.

Similar to many workplace plans, you can save through a traditional IRA, which lets you deduct contributions on your taxes, or a Roth IRA, which offers tax-free withdrawals if you qualify. Which to choose? The answer largely depends on whether you think your tax bracket will be higher or lower when you withdraw than when you contribute.

You can open both a traditional and a Roth IRA, but you can’t exceed the combined annual contribution limit Open in new window.

If you own a small business—even if you’re a sole proprietor—consider setting up a simplified employee pension (SEP). Essentially, this plan lets you contribute up to 25% of your business income—and the same percentage for each employee—into an SEP IRA. As for investments and withdrawal rules, it works just like an IRA: With a traditional account, you’ll get a tax break on contributions when you file your federal return or quarterly estimated taxes; with a Roth (now available thanks to 2022’s SECURE 2.0 Act), you’ll contribute pretax dollars to snag a tax-free payoff if you qualify down the road.                                                                                                     

Even so, if you’re a freelancer, you might consider a solo 401(k), aka a self-employed 401(k), instead. Not only can you contribute pretax (traditional) or after-tax (Roth) dollars; you can save more as both an employer and an employee, up to IRS limits. Both types of plans have plusses and minuses, so it pays to learn the difference Open in new window.

Cash

Savings outside your retirement accounts can include money you have in checking and savings accounts, and certificates of deposit (CDs). These are your most liquid, or easily accessed, retirement assets.

Annuities

To create a steady stream of income in retirement, many people turn to annuities. There are various types, generally differentiated by when they start paying out (deferred or immediate) and whether their payouts are predictable or not (fixed or variable).

“An annuity could help prevent you from running out of money,” says Gallant. Annuity payments are taxable as regular income. And while annuities have come a long way in consumer friendliness and cost transparency, make sure you understand the contract before you sign. A trusted financial advisor can help you make sense of it all.

Health savings accounts (HSAs)

An HSA can be a great way to save for … retirement, especially if you’re self-employed. HSAs are triple-tax-free: You contribute pretax or tax-deductible dollars, the account grows tax-deferred, and you won’t owe tax on withdrawals as long as they go toward medical expenses—now or in retirement. Once you turn 65, you can also withdraw for any purpose and only pay income tax, similar to a traditional IRA or 401(k).

HSAs are portable—the account belongs to you even if you leave your job. Plus, as with an IRA or 401(k), you can put HSA money in a range of investments that could help the account grow faster.

The drawback: You must be in a high-deductible health plan (HDHP) to open and contribute to an HSA. (HDHPs are best suited for people with fewer health concerns; as their name suggests, they have pricey deductibles and high out-of-pocket maximums. If you have high medical costs, you could deplete the account well before you retire.)

Taxable investments

Other ways to help create retirement income include mutual funds and exchange-traded funds (ETFs)—both invest in a long list of individual stocks, bonds, or other securities, offering a degree of diversification that can limit risk. You might also consider fixed-income investments like bonds, real estate, and dividend-paying stocks.