Retirement Accounts in the United States

Welcome Johnie!

Money makes the world go round.

Money does not buy happiness.

Cash is king.

Money is a terrible master but an excellent servant.

Money has no smell.

The best things in life are free.

Money is the root of all evil.

Money talks.

I could go on and on. We have all heard all the popular idioms and sayings about money. Some say that money is the best thing ever, and others say the world would be better off without money. Whatever side of the fence you fall on, we all agree that money is important. Hence this blog post is about the most common retirement accounts for new immigrants in the United States.

When I moved, I had access to retirement accounts, specifically a 401K plan. I had no idea what that meant. I just understood that it was an account where I could save money for retirement. My employer would contribute some money as well. This money comes out of my paycheck before getting my final salary. I was asked if I wanted to contribute, and I shrugged and said sure. It seemed reasonable, with no potential downsides. And then I promptly forgot about it.

In hindsight, I should have paid more attention because I missed an incredible opportunity to supercharge my retirement accounts. This is what I consider one of my biggest financial mistakes since moving to the United States. You know that mistake that haunts you for years after… this is it for me.

Retirement planning is crucial, and you must understand all the options available to you and what each one means as a new immigrant to the US. For many immigrants, your work history in the US will likely be shorter than native-born Americans, affecting your social security benefits. Like me, you may also be unfamiliar with the different types of retirement accounts available in the United States. You may have different financial goals than native-born Americans, so you must understand all your options.

Benefits of Planning for Retirement

Embracing the American Dream: As immigrants, we come to the United States seeking a better life for ourselves and our families. Retirement planning is an integral part of realizing the American Dream. It empowers us to secure a comfortable and financially independent future, ensuring that all our hard work and sacrifices pay off both now and in the long term.

The Power of Time and Compound Interest: This has been called the world’s eighth wonder! I also love this description- money makes money, and the money that money makes, makes money. Retirement planning is not just about saving money; it’s about harnessing the power of time and the magic of compound interest. Starting early allows your savings to grow exponentially over time. By taking advantage of retirement accounts, you can make your money work for you and build a solid foundation for your future.

Maximizing Social Security Benefits: Understanding the United States Social Security system is vital for new immigrants. You can maximize your retirement benefits by planning and starting early.

Mitigating Uncertainties: Life is full of uncertainties, and preparation for them is crucial. Retirement planning provides a safety net during unforeseen circumstances, such as health issues or unexpected expenses. It offers peace of mind, knowing you have a financial cushion to fall back on when needed.

Leveraging Employer-Sponsored Retirement Plans: Many employers in the United States offer retirement plans, such as 401(k)s or 403(b)s. Many employers will also provide a ‘match,’ which is free money and part of your benefits. Never leave this on the table! They can be a boost to your retirement savings.

Tax Advantages: Many retirement accounts have tax benefits immediately or down the road. Retirement accounts offer valuable tax advantages, saving us money in the long run. Traditional IRAs and 401(k)s provide tax-deferred growth, meaning we won’t pay taxes on the contributions until withdrawal, potentially reducing your current tax burden. On the other hand, Roth IRAs offer tax-free growth, providing tax advantages during retirement. Understanding how both of the options work helps you strategize for your goals.

Building Wealth for Future Generations: Moving to the US was likely a decision you made for yourself, your family, and future generations. Retirement planning helps you secure not just your future but also enables you to leave a legacy for your loved ones. Building wealth and making smart financial decisions can create a foundation beyond your retirement and lifetime, benefiting future generations.

Basics of Retirement Planning in The United States

At its most basic, the United States retirement system is a three-legged stool: Social Security, employer-sponsored retirement plans, and individual retirement accounts (IRAs).

Retirement Accounts For New Immigrants in The United States

Social Security: At the heart of the US retirement system lies Social Security. This program provides a safety net for retirees, disabled individuals, and survivors. To access Social Security, you will need a Social Security Number. If you do not have one yet, you should read my blog post on how to apply for a Social Security Number. Social Security benefits can play a significant role in your retirement income. You qualify for Social Security benefits based on your work history and earnings. This amount is deducted pretax from your paycheck.

Employer-sponsored retirement plans: Many employers offer retirement plans to their employees. These plans can include 401(k) plans, 403(b) plans, 457(b) plans, and pension plans. You contribute to these plans on a pretax basis, which can help you save more money immediately as it reduces your taxable income, which means a larger refund come tax season. If you have no idea what I just said, I covered tax filing in this blog post, be sure to check it out.

Individual retirement accounts (IRAs): IRAs are retirement accounts that you can set up on your own. There are two main types of IRAs: traditional IRAs and Roth IRAs. Traditional IRAs allow you to deduct contributions from your taxable income, while Roth IRAs do not. However, withdrawals from Roth IRAs are tax-free. Understanding the benefits and eligibility criteria for each type of IRA can help you choose the best option for your specific circumstance.

Social Security

As I mentioned, Social Security offers retirement benefits based on your work history and contributions to the program. As an immigrant, you may be eligible for Social Security retirement benefits if you have earned enough credits through work in the United States. Social Security credits are units of measurement used to determine eligibility for Social Security benefits. They represent your work and the earnings you have received over time. The Social Security Administration (SSA) assigns credits to your record based on your income and the number of years you work. The more credits you accumulate, the higher your potential benefit will be.

You can earn up to four credits yearly, depending on your income. The amount of earnings required to earn a credit changes annually because it is based on the average wage level in the national economy. In 2023, the amount needed to earn one credit is $1,640, or $6,560 for all four credits. These credits are not based on the taxes paid into the Social Security System but on the total income earned. To qualify for Social Security retirement benefits, you generally need 40 credits. Exceptions are made for immigrants who do not have a long enough work history in the US and immigrated from a country with a social security agreement with the US.

The amount of your Social Security retirement benefit will depend on your earnings history and the age at which you start receiving benefits. If you start receiving benefits at age 62, your benefits will reduce. If you wait until your full retirement age (FRA), which is between 66 and 67, you will receive a larger payout.

Employer-Sponsored Retirement Plans

401(k) Plans

A 401(k) plan is a retirement savings plan that allows you to contribute a portion of your salary to an account on a tax-deferred, aka ‘pretax’ basis. This means that you won’t have to pay taxes on your contributions until you withdraw the money from the plan in retirement, and they are tax-deductible.

To be eligible to participate in a 401(k) plan, you must generally be an employee of the company that sponsors the plan. When you become eligible is determined by your employer. Some employers may offer immediate eligibility, while others have you wait up to three to six months. The enrollment process for a 401(k) plan is usually simple. You must complete an enrollment form and designate how much you want to contribute. This information is generally in your benefits packet and covered during your orientation. You can usually change your contribution amount at any time during the year. For the 2023 year, you can contribute up to $22,500. If you’re 50 or older, you can make an additional catch-up contribution of $6,500.

One of the significant advantages of a 401(k) plan is the opportunity for employer matching contributions. Your employer may match a portion of your contributions to a certain percentage of your salary. This is free money, so at the minimum, contribute enough to maximize your employer match. You are leaving money on the table otherwise. The annual contribution limits set by the IRS are on your contribution only and exclude employer matching and contributions.

401(k) plans provide different investment options, including mutual funds, target-date funds, individual stocks, and bonds. Take the time to understand your investment options and assess your risk tolerance and retirement goals. Asset allocation, or spreading your investments across different asset classes, is crucial to manage risk and optimize returns. Many plans offer tools and resources to help you make informed investment decisions.

There are restrictions on when you can withdraw money from your 401(k) plan without paying a penalty. You can generally withdraw money from your 401(k) plan without penalty after age 59½. If you withdraw money from your 401(k) plan before age 59½, you may have to pay a 10% early withdrawal penalty. There are a few exceptions to this rule, such as if you withdraw money to pay for qualified education expenses or to pay medical costs not covered by insurance.

403(b) Plans

These are pretty similar to 401 (k) plans, with mostly the same rules and regulations, except that 403(b) plans are primarily offered to employees of nonprofit organizations. The annual limits are the same, the investment options are similar, and the rules regarding withdrawal are the same. 403(b)s typically follow a universal availability rule which means that if an employer offers a 403(b) plan to one employee, it must be provided to all employees, regardless of their employment status or the number of hours worked, except for if you work fewer than 20 hours a week.

Vesting

A quick note on vesting which applies to both 401(k) and 403(b) plans. For the employer match, many employers require some years of service for their contributions to vest. Vesting refers to ownership of employer contributions. When you are fully vested, you own the employer contributions to your retirement account, and you can take it with you when you leave. You may lose all or some employer contributions if you leave before vesting. Employers are different, and the vesting schedule will be in your benefits package.

457(b) Plans

In addition to the popular 401(k) and 403(b) plans, certain government, and non-governmental employees have access to a unique retirement savings vehicle called a 457(b) plan. A 457(b) plan is another tax-deferred compensation retirement plan available to employees of state and local governments, as well as certain non-governmental organizations such as nonprofits.

Like 401(k) plans, contributions to 457(b) plans are pretax monies, which means you won’t have to pay taxes on your contributions until you withdraw the money, and it reduces your taxable income. The contribution limits are typically the same as those for a 401(k)/403(b). If you have access to either a 401(k)/403(b) and a 457(b), you can make maximal contributions to both accounts. For example, in 2023, the total contribution limit is $22,500 X 2 $45,000. Typically, employers do not provide a match for 457 plans.

A unique advantage of 457(b) plans is the absence of the early withdrawal penalty. Unlike other retirement plans that impose withdrawal penalties before age 59½, 457(b) plans allow you to withdraw funds penalty-free upon separation from service. However, like 401(k) and 403(b) plans, withdrawals are subject to income tax at withdrawal time.

A key difference between governmental and non-governmental 457(b)

A governmental 457(b) has funds held in a trust not subject to the employer’s creditors. i.e., if the employer goes bankrupt (which is highly unlikely because this is governmental), the money in the 457 is protected. Your money is safe. Secondly, if you leave your employer, you can roll over your money to a 401(K), an IRA, or another 457 (b) that accepts rollovers if you choose to. Non-governmental 457(b)s are not protected and subject to your employers’ creditors, i.e., if your employer goes bankrupt, you could lose your money because employees are typically lower in priority than creditors in bankruptcy cases. Secondly, you can only roll over a non-governmental 457(b) to another 457(b) that accepts rollovers. The most common option if you separate from your employer is to choose a distribution taxed as normal income tax.

If you have access to a non-governmental 457(b), you should still consider it depending on your employer’s financial stability and your unique situation. Especially if you are considering early retirement since there are no early withdrawal penalties.

Individual Retirement Accounts

There are two main types of individual retirement accounts (IRA), a traditional IRA and a Roth IRA. You can open either of these accounts if you have earned income.

Traditional IRA

A traditional IRA is a tax-deferred retirement savings account. This means you can deduct your contributions to a traditional IRA from your taxable income in the year you make them. Your contributions grow tax-deferred, meaning you won’t have to pay taxes on the investment earnings until you withdraw the money in retirement.

Tax Advantages and Contribution Limits

Tax-Deductible Contributions: Contributions made to a Traditional IRA are typically tax-deductible, meaning you can reduce your annual taxable income. However, it’s important to note that if an employer-sponsored retirement plan covers you or your spouse, the tax deduction for Traditional IRA contributions may be limited based on your income.

Tax-Deferred Growth: The earnings on your investments within the Traditional IRA grow on a tax-deferred basis. This allows your investments to compound over time without immediate tax implications, potentially accelerating the growth of your retirement savings.

Potential Lower Tax Bracket in Retirement: Traditional IRAs are designed to provide retirement income. When you withdraw funds during retirement, your income will likely be lower than during your working years. This may place you in a lower tax bracket, potentially resulting in lower taxes paid on your IRA withdrawals.

While Traditional IRAs offer tax advantages during the accumulation phase, there are specific rules regarding withdrawals during retirement:

Required Minimum Distributions (RMDs): Starting at age 72 (or 70½ if you reached that age before 2020), you must begin taking minimum distributions from your Traditional IRA annually. These withdrawals are subject to income tax based on your tax bracket at withdrawal time.

Early Withdrawal Penalties: If you withdraw from your Traditional IRA before age 59½, you may face an early withdrawal penalty of 10% in addition to regular income taxes. There are some exceptions to this penalty, e.g., for certain qualified expenses or hardships, but avoid early withdrawals to maximize your retirement savings’ tax benefits and potential growth.

Taxation of Withdrawals: When you withdraw funds from your Traditional IRA during retirement, the withdrawals are subject to income tax. The withdrawals are income, and the tax rate will depend on your tax bracket at that time.

Roth IRA

Roth IRAs are tax-advantaged retirement accounts that allow you to contribute after-tax income toward your retirement savings. Unlike Traditional IRAs, contributions to Roth IRAs are not tax-deductible. However, the earnings on your investments within the account grow tax-free, and qualified withdrawals in retirement are also tax-free. There are income limits for contributing to a Roth IRA. Contribution limits phase out depending on your modified adjusted gross income and tax filing status. In 2023 for single earners, the income range is $138,000 – $153,000; for married filing jointly, the income range is $218,000- $228-000; and for those who are married and filing separately, the income range is $0-$10,000.

Tax Advantages and Contribution Limits

Tax-Free Growth: The earnings on your investments within a Roth IRA grow tax-free. This means you won’t owe taxes on the gains when you withdraw the funds during retirement, provided the withdrawals are qualified.

Tax-Free Withdrawals: Qualified withdrawals from Roth IRAs are completely tax-free. This is a significant advantage as it allows you to access your retirement savings without incurring additional tax burdens, potentially increasing your spending power during retirement.

Flexibility: Roth IRAs offer flexibility when it comes to contributions. You can contribute at any age if you have earned income and meet the eligibility requirements. Additionally, you are not required to take minimum distributions during your lifetime, allowing your savings to grow further.

Withdrawal Rules and Tax Implications

Qualified Withdrawals: To enjoy tax-free withdrawals from a Roth IRA, you must meet two conditions: (1) the account must be open for at least five years, and (2) you must be at least 59½ years old. Qualified withdrawals also include distributions due to disability or for a first-time home purchase (up to certain limits).

Non-Qualified Withdrawals: If you make withdrawals that do not meet the qualified criteria, the earnings portion is subject to income tax and potentially a 10% early withdrawal penalty. However, contributions can be withdrawn anytime without tax or penalty, as they have already been taxed.

For 2023, the IRS contribution limit is $6500 across all IRAs combined (or $7,000 if you’re 50 or older), or your taxable compensation for the year if it’s less than the limit. Staying within these limits is imperative to avoid potential penalties and maximize the tax advantages.

My big mistake was not contributing to my Roth IRA for the first four years after I moved. I kept my money in a savings account instead. It was a missed opportunity to grow my money tax-free. Not a major blunder but one that still haunts me. It would be best if you looked into opening a Roth IRA. Depending on your situation, this can be a significant boost for your retirement.

How to Designate Your Savings

A good order to contribute to your retirement accounts is to contribute to your 401(k) or 403(b) until you get your employer match at the minimum, then consider opening a traditional or Roth IRA and contributing to the full limit and then going back to contribute to the maximum for either your 401(k) or 403(b), and then your 457(b) if you have access to one. If you earn enough to max out all these accounts and still have some money left over, you should consider opening a taxable account and putting your extra money there.

Disclaimer: I am not a financial planner; I only provide advice based on the experience and knowledge I have gleaned over the years!

Some resources for more information on retirement planning

We have covered a lot of information in this post, and I hope this blog post has been helpful. Remember, retirement planning is important for everyone. So don’t wait. Start planning for your retirement today!

If you have any questions, please feel free to comment below.