5 Questions to Help You Choose the Best Retirement Plan

Written by Dayana Yochim
Edited by Carolyn Kimball
Fact-checked by Andrea Coombes

September 18, 2024

In the seemingly endless list of account choices — including Roth IRAs, traditional IRAs, SEP IRAs, 401(k)s, Roth 401(ks), 403(b)s, and so on — choosing the best type of retirement account comes down to your answers to five key questions.

1. What type of account is available to you?

Whether you work for a company, have your own business, earn income from odd jobs, or are a nonworking spouse, there’s a retirement savings account designed for your situation. The first step is identifying your options.

Workplace retirement accounts

If your employer provides access to a workplace retirement plan, such as a 401(k) or a 403(b), that’s a good place to start. Employer-sponsored plans provide an automated retirement savings system that allows you to invest your money for long-term growth. Many companies match a portion of the amount you save, providing an instant boost to your account balance.

The average company contribution is around 5% of pay, according to a study by the Plan Sponsor Council of America. (We’ll pause here for a quick job interview tip: Be sure to ask, “Is there a company match in the retirement plan?” when discussing employee benefits. While this perk might not pad your take-home pay right now, it can add thousands of dollars to your future retirement income.)

Self-employed/small business owner accounts

SEP IRAs (self-employed individual retirement accounts) and Solo 401(k)s, also called Solo-ks, give savers who do not work for The Man access to accounts with similarly high contribution limits. There’s a little more admin work required to set up these plans. But the higher contribution allowances make SEP IRAs and Solo-ks an attractive option for those whose employment status make them eligible for one.

Individual retirement accounts

No workplace plan? No worries! There’s one type of retirement account that’s available to everyone: IRAs, or individual retirement accounts.

IRAs can be opened at any financial services firm by any person who has earned income — that’s money from work. (Here’s a review of the best IRA accounts.) While there are different types of IRAs — like Roth, traditional, and spousal — that cater to different types of savers, what they all have in common is that the IRS does not tax your money (e.g., investment growth) while it remains in the account.

The most popular IRA types are traditional IRAs and Roth IRAs. In brief:

• A traditional IRA provides an upfront tax break. You fund the account with pre-tax dollars and don’t have to think about paying taxes until you start withdrawing money in retirement.
• A Roth IRA provides tax-free withdrawals in retirement. You fund the account with after-tax money (translation: No upfront break on income taxes allowed), and, because you already paid the IRS, distributions in retirement are not taxed.

Accounts for nonworking spouses

If you don’t have earned income — or make very little — but are married to someone who does, a spousal IRA (Roth or traditional) is your ticket into the world of tax-advantaged retirement savings accounts. Your eligibility to contribute to a Roth or traditional spousal IRA is based on whatever your spouse is allowed to contribute. (See What Is an IRA? for more.)

2. Do you meet the contribution requirements?

Now you know about your account options. The next question is: Are you eligible to contribute to those plans?

Workplace retirement plans are for the benefit of that company’s employees. Employer-sponsored plans may limit access to only full-time salaried staffers. However, access has been increasing in recent years. Provisions in the SECURE Act, passed in 2019, paved the way for plans to allow part-time salaried or hourly employees to contribute. Still, eligibility is determined by each company’s retirement plan rules.

IRAs require only that you earn income, or be the spouse of someone who does, to be able to contribute to an account. Going deeper into the IRA weeds, your income will determine a) if you’re allowed to contribute to a Roth IRA (more on those below), and b) how much of your contribution to a traditional IRA you’re allowed to subtract from the income you report to the IRS on your current year’s tax return.

The TL;DR of it is that no matter what, you can open and contribute to a traditional IRA. But will that contribution provide an upfront tax break? That’s the subject of roughly 1,087 pages of IRS tax code. (Joking: We stopped counting after we ran out of printer ink. But we do have a few handy IRA rules cheat sheets in our What Is an IRA?, What Is a 401(k)? and Comparing Roth IRA vs. Traditional IRA articles.)

3. How much money are you allowed to contribute?

The IRS limits the amount you can put in each type of retirement account each year. As a general rule, workplace plans allow you to save more money than IRAs — we’re talking tens of thousands of dollars more. Age also plays a factor. (One advantage of turning 50 is that the IRS lets you shovel even more money into a retirement account than the youngs are allowed to.)

Source: IRS.gov

4. Which account gives you the biggest break on taxes?

In addition to avoiding investment taxes while the money is in your account, the best thing about retirement plans is that they offer a tax break either upfront, by lowering your taxable income, or in the future, with tax-free withdrawals. The choice here comes down to picking the account that delivers the biggest tax break when it will be most beneficial to you.

The first consideration — the amount you’re allowed to shield from taxes — is a matter of simple math: Because of their higher contribution limits, workplace retirement plans allow you to shield more money ($16,000-$22,500 more) from the IRS than you can in an IRA, for example.

As for the timing of your tax break, the account choice comes down to whether to go with a Roth plan or a traditional plan. In a nutshell:

• If you think your income tax rate will be lower in retirement than it is right now, choosing a tax-deferred retirement account like a traditional IRA or 401(k) will save you more money in the long run. This is the most likely scenario if you’re currently in your prime earning years (which is your 40s and 50s, for most).
• If you expect your income tax rate in retirement to be higher than it is today — a more distinct likelihood if you’re in the early years of your career with decades of potential pay increases ahead of you — the Roth will give you the advantage in the game of keep-away with the IRS.

Here’s more info to help you decide:

If you want a tax break right now, invest in a traditional IRA or 401(k)

These accounts give you an upfront tax break by letting you put money in the account before it’s taxed. The amount you contribute lowers your taxable income for the year on a dollar-for-dollar basis.

You can’t avoid the IRS forever, though. Down the road when you start withdrawing money from the account in retirement, you’ll pay income taxes on distributions at your then tax rate.

It’s important to note that in a traditional IRA, the ability to subtract the amount of your contributions from your current year’s reported income may be curtailed if you or your spouse has access to a workplace retirement plan and your income exceeds IRS limits. (These rules don’t apply to traditional 401(k) plans.) There is a consolation prize: You can still contribute to a traditional IRA and let your investments grow tax-deferred; you just won’t get that upfront tax break.

If you want a tax break in retirement, you’ll get it with a Roth

Both Roth IRAs and Roth 401(k)s provide tax-free withdrawals in retirement. Since you fund Roth IRAs and Roth 401(k)s with post-tax dollars, you forgo the upfront tax break in exchange for owing the IRS nothing when you take distributions.

Before you fall in love with the idea of a Roth, know this: The option to invest in a Roth IRA or Roth 401(k) may not even be on the table. Your salary determines how much — if anything — you’re allowed to contribute to a Roth IRA each year. Roth 401(k)s have no such income restrictions; however, not all employer-sponsored retirement plans offer a Roth option. It’s more likely you’ll be offered a choice if you work for a large employer.

We parse out the differences in taxes, eligibility, income limits and other key IRS rules in our Roth IRA vs. Traditional IRA article.

5. How will contributions affect your take-home pay?

Putting aside money for the future will, naturally, lower the amount you’re left with to spend in the present. But how much it impacts your take-home pay depends on the type of retirement account you use. It all comes down to how much of your income the IRS is able to tax.

• Traditional 401(k) and IRA contributions leave you with more paycheck now. The magic of pre-tax contributions is that the money you stash in your retirement account lowers your taxable income on a dollar-for-dollar basis. That leaves less of your earnings (your salary minus your contributions) for the payroll tax wolves to dine on … until retirement, when you’re required to pay income taxes on distributions from the account.
• Roth 401(k) and IRA contributions take a bigger bite out of your take-home pay. Roths are funded with post-tax dollars. That means the IRS gets to include the amount you save in the “we can tax it” pile when it adds up your taxable gross income for the year. The result is reduced take-home pay. However, when it’s time to start withdrawing funds in retirement, you won’t owe taxes on distributions since you paid your tab upfront.

How much of a difference in take-home pay are we talking about? Let’s say your annual salary is $75,000, your tax rate is 22%, and you contribute $15,000 a year to your company 401(k). In this scenario, contributing to a traditional 401(k) provides an additional $3,300 in take-home pay per year, or $275 per month, than if you saved the same amount in a Roth 401(k).

While it’s tempting to choose the option that pads your current take-home pay, also consider your future take-home pay. Remember, unlike traditional retirement plan income, qualified Roth distributions are tax-free. We’ll use the same scenario as above and assume a conservative 4% estimated average annual return in your portfolio. For someone who plans to retire in 30 years, contributing to the Roth 401(k) will provide roughly $88,000 a year in tax-free income during retirement versus $68,000 you’ll get from a traditional 401(k) after paying required taxes on withdrawals.

The best retirement account is …

We just threw a lot of numbers and tax rules at you, but the bottom line is this: There are no bad account choices when it comes to saving for retirement.

Thanks to their tax-favored status, IRAs, 401(k)s, Roths, SEPs, and all the rest are all worthy parking spots for your long-term savings. Even better, if you’re eligible to contribute to multiple types of retirement accounts, the IRS allows you to mix and match in the same year, with one caveat: Your total contributions cannot exceed the annual limits for each type of account. (Example: For 2024 you can split your savings between a Roth IRA and a traditional IRA as long as the combined total is less than $7,000 if you’re under 50.)

Why choose a variety pack? Investing in a mix of accounts with different tax treatments gives you more maneuverability in retirement when you’re taking distributions. In low-income years (meaning lower income-tax rate years), you can withdraw money from a traditional plan when the income tax hit won’t be as harsh. Vice-versa with the Roth, where tax-free withdrawals let you avoid the issue altogether if you’re in a higher income bracket.

The most important thing is to save for retirement in an account that shields as much of your money as possible from taxes either now or in the future. Your answers to the questions above will help further hone your savings strategy by identifying the best retirement accounts available to you.

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About the Editorial Team

Dayana Yochim is a former Senior Writer/Editor at Reink Media Group who has written about personal finance and investing for more than 20 years. Her work has appeared in outlets including HerMoney.com, NerdWallet and the Motley Fool, and has been syndicated nationally. Dayana has also been a guest expert on "Today" and Good Morning America.

Carolyn Kimball is a former managing editor for StockBrokers.com and investor.com. Carolyn has more than 20 years of writing and editing experience at major media outlets including NerdWallet, the Los Angeles Times and the San Jose Mercury News. She specializes in coverage of personal financial products and services, wielding her editing skills to clarify complex (some might say befuddling) topics to help consumers make informed decisions about their money.

Andrea Coombes has 20+ years of experience helping people reach their financial goals. Her personal finance articles have appeared in the Wall Street Journal, USA Today, MarketWatch, Forbes, and other publications, and she's shared her expertise on CBS, NPR, "Marketplace," and more. She's been a financial coach and certified consumer credit counselor, and is working on becoming a Certified Financial Planner. She knows that owning pets isn't necessarily the best financial decision; her dog and two cats would argue this point.