Saving for retirement is critical, but it's just as important to think about where to stash your cash. There are seemingly countless options, from 401(k)s to IRAs to 403(b)s and more.
However, not all accounts are created equal, and sometimes there are advantages to saving in one type of account over another. And if you plan to continue working late in life, there's one particular retirement account that could cost you.
Finding the right place to park your savings
As you're shopping around for the right retirement account, you may be focused primarily on factors such as fees, tax advantages, or employer matching contributions. One element you may not be considering, though, is when you'll need to start making withdrawals.
With tax-deferred accounts like 401(k)s and traditional IRAs, you'll owe income taxes on your withdrawals in retirement. Because Uncle Sam wants his money sooner rather than later, you'll have to start taking required minimum distributions (RMDs) from these types of accounts at age 72.
If you're still working at age 72, you may be able to avoid making withdrawals from a 401(k) plan offered by your current employer. However, traditional IRAs are still subject to RMDs, regardless of whether you're still working or retired.
One possible fix would be to roll over your traditional IRA into your 401(k) plan account. However, not all employers allow workers to roll over funds from a traditional IRA to a 401(k), so you may be stuck taking RMDs from a traditional IRA whether you're ready or not.
Saving primarily in a traditional IRA could be expensive if you plan to work past age 72, because once you start taking RMDs, those withdrawals plus your wages from your job could push you into a higher tax bracket. This is particularly true if you have a lot of savings stashed in a traditional IRA, because the higher your account balance, the larger your RMDs will be. And if you simply don't take your RMD, you'll be hit with a hefty penalty of 50% of the amount you were supposed to withdraw.
A better option for older workers
Rather than keeping your savings in a traditional IRA, you may opt instead to save in a Roth IRA if you expect to work into your 70s or beyond. With a Roth IRA, you're not required to take RMDs for the rest of your life. Because you've already paid taxes on your initial contributions with this type of account, the IRS isn't in a hurry for you to start making withdrawals.
Roth IRAs are similar to traditional IRAs in most regards, save for how your contributions are taxed and when you need to start making withdrawals. With both types of accounts, you can save up to $6,000 per year, plus an additional $1,000 per year for those age 50 or older.
Another bonus of investing in a Roth IRA is that if you continue to work past age 72, that can give your savings more time to grow. Ideally, you shouldn't touch your retirement savings until you need them. If you're forced to start taking RMDs before you're ready to spend that money, that can limit your investments' growth potential. But by saving in a Roth IRA, you can leave your money alone for as long as you'd like.
Thinking about your retirement account withdrawals before you're even retired may not be at the top of your priority list, but it's important to consider this factor as you're preparing for your senior years. By saving in the right type of account, you can save yourself loads of cash in the future.