Most of us know it’s important to contribute to a retirement plan, but many people struggle starting out because choosing a plan can be overwhelming. I’m here to make the decision a little easier, starting with a quick review of the major benefits and drawbacks of the most common retirement plans.
You may be ineligible for some simply because of the industry you work in. To help you make an informed, confident decision, the following overview explains eight of the most common retirement plans.
1. Traditional IRA
The key benefit of a traditional IRA is the ability to deduct contributions from your tax return up to the $6,000 government-mandated limit; $7,000 if you are over 50.
If you are covered by a retirement plan by your employer, you will need to check with the IRS as there are income rules that apply to the deduction capability. You can find those rules by clicking here.
Anyone is allowed to contribute to an IRA, and the money is invested in asset classes chosen by the account holder. With traditional IRA’s, required minimum distributions start when the holder reaches the age of 72 or 70½ if you reached 70½ before January 1, 2020.
2. Roth IRA
The Roth IRA’s most distinguishable feature is that taxes are paid as you contribute, while growth and withdrawals in retirement are tax-free. This can either be a huge benefit, or huge drawback depending on your tax bracket now and what is your expected tax bracket in retirement.
Roth IRAs also have a high degree of freedom. You can always make penalty-free principal withdrawals from your account as well as penalty-free withdrawals for education, disability, and death. Moreover, there are no mandatory minimum distributions like there are with most other plans, and owners can pass the account onto their children as part of an estate.
Nearly half of all employers offer 401(k) plans to their employees, and because of that prevalence, the 401(k) is one of the easiest and best ways to start investing for retirement.
Typically, employers match employee contributions up to a certain amount. Contributions are pre-tax, which generally means that you don’t pay taxes on the money you put in. However, taxes are applicable to withdrawals in retirement. The yearly contribution limit for 2021 is $19,500 if you’re under 50 years old. If you’re over 50, the limit climbs to $26,000.
4. Roth 401(k)
The Roth 401(k) was introduced in 2006 to combine the benefits of the Roth IRA and 401(k). Like a Roth IRA, taxes are levied when you contribute. Once you reach retirement age, you can make withdrawals tax-free. Like a 401(k), employers can also make contributions. However, employer contributions aren’t deposited into the Roth 401(k) account; rather, they’re placed in a standard, separate 401(k).
The 403(b) and the 401(k) are nearly identical, including their yearly contribution limits for 2021. The main difference is that the 403(b) is only available to people working for non-profits, government organizations, school districts, and religious groups. These plans are advantageous because they’re exempt from some administrative costs that do apply to the 401(k).
6. Solo 401(k)
Solo/individual 401(k)s are typically reserved for small business owners, and come with lots of control. You can choose where to invest, whether that’s in traditional stock options, precious metals, or anywhere else. Contribution is lenient, too. You can invest up to $58,000 per year(as of 2021), or nothing at all. However, these plans are reserved for the smallest of small business owners. If you have employees who aren’t your spouse, you probably aren’t eligible.
7. SIMPLE IRA
“Simple” is derived from“Savings Incentive Match Plan for Employees;” it’s a match plan set up by small business owners for their employees. In order for an employee to be eligible, he or she must have earned $5,000 from the employer. Like most other plans, tax is deferred until it’s distributed upon retirement. The big drawback with these plans is that there are huge transfer and early withdrawal penalties—up to 25%.
8. SEP IRA
SEP stands for Simplified Employee Pension. These are plans geared toward business owners who want to provide retirement benefits to their employees. SEP IRAs follow most of the same rules as Traditional IRAs, with one big exception: you can contribute $58,000 per year(as of 2021) or 25% of the employee’s compensation into a SEP IRA. Funding a SEP IRA is flexible, meaning you can adjust how much you contribute, as needed.
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Choosing Your Strategy
Each plan has additional benefits and drawbacks. There is really no one-size-fits-all,“perfect” plan. If you have questions about which plan would be the best for you, give us a call.
Disclaimer: To the best of our knowledge, the information contained herein is accurate and reliable as of the date of publication; however, we do not assume any obligation to update the numbers on an ongoing basis.