In a recent exclusive interview from the New York Stock Exchange, TheStreet host Conway Gittens discussed retirement savings options with Retirement Daily expert Robert Powell.
Gittens got straight to the point, clarifying some questions many Americans have on the subject.
"Walk me through some of the options for retirement savings, because a lot of people start scratching their heads," Gittens said. "It's like alphabet soup — 401(k), Roth IRA, all these numbers, all these letters."
"But there are tax implications not just for the money that you're putting in, but when you're ready to retire, the money that you're going to take out," he continued. "So can you talk a little bit about how those different plans work, especially when it comes to taxes?"
Powell suggested four types of retirement accounts to think about.
"There would be the taxable account where you might be investing in stocks and bonds, and mutual funds. And the money that's going in is after tax," he said. "And then when it comes out, it will be taxed in some form or fashion or it will be taxed along the way."
"So if you're investing, say, in a CD that could be taxed as current interest — income as ordinary income — it could," he added.
A certificate of deposit (CD), is a savings account banks and credit unions offer that allow people to deposit money at a fixed interest rate for a period of time.
"It could be, maybe, if you have stocks in your taxable account and you're buying and selling them, it could be taxed as capital gains as you go along," Powell added.
Then Powell discussed other retirement savings options many Americans face.
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More retirement savings options, including IRAs and 401(k)s
Powell explained tax considerations on other ways people can reach their retirement savings goals.
"The other type of account that many people are familiar with would be an IRA or a 401(k)," he said. "Typically, that's money that's going in on a pre-tax basis and and then coming out on an after-tax basis."
"So you're getting a tax deduction in many respects for putting money into a 401(k). It grows tax free," he explained. "And then when you withdraw the money, it gets taxed as ordinary income."
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How Roth IRAs and HSAs play a role in retirement savings efforts
Powell focused on Roth IRAs as an important option.
"People need to think about a Roth IRA, where the money is going in on an after-tax basis," Powell explained. "It grows tax free. And then when you withdraw the money years from now, it is a non-tax or a tax-free event. "
Powell added another savings account to the mix of considerations.
"The last account I should mention, because many employers are now offering this to their employees, would be health savings accounts," he said.
"And these are really unique because the money's going in on a pre-tax basis," he added. "It's growing tax free. And then if it's used for qualified medical expenses, it's tax free as well on the withdrawals."
Powell summarized the conversation with a few more relevant insights.
"So four different types of accounts. And I would recommend that people have money in each of these buckets, because when you get to retirement, one of the things that you want to make sure that happens is that you have the ability to create what's called tax-efficient income," he said.
"What's the income that will result in the least amount of taxes based on where the money is coming out of, whether it's your Roth or your taxable account or your IRA or your HSA for that matter?" he asked.
"And what typically happens to many people is they save almost exclusively in their 401(k). And then when they get to retirement, they think they might have a million set aside for retirement," Powell explained.
"But what in fact happens is you actually may only have $700,000 set aside because $300,000 of that money will get taxed as ordinary income as it comes out of the account," he said.
Powell then suggested that the advantage of having separate accounts is a key approach.
"If you had saved perhaps in a traditional 401(k), along with a Roth, then you might at least have the option of being able to withdraw some money tax-free in retirement, as well as money from your traditional 401(k) and maybe reduce your overall tax burden over the course of your retirement," Powell said.
"Which is ultimately the goal."
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