Planning for retirement is very important for building wealth and to appease any unnecessary stress during our older years. Most people no longer receive company provided pensions to satisfy the needs of retirement or can safely rely on Social Security to provide for retirement. Starting to save for retirement, or further developing on the current strategy, can be overwhelming as there are several different account types to choose from and find the best retirement plans can be cumbersome.
The different account types line up to different strategies that serve as tools to make building wealth efficient for the account holder. Look at the following different types of retirement plans to see which accounts best lines up with your current situation and future goals.
IRA, Individual Retirement Account, or Traditional IRA
IRAs allow you to make tax-deferred investments to provide for your retirement. Tax-deferred means that you do not pay for taxes initially when contributing to the account, but you will pay taxes when making withdrawals. If in the future you expect your tax-rate to be lower than your current tax-rate, this may be a good account for you.
Important to note, this account is only available to those with earned income. For example, if you earn $4,000 in 2021, you’ll only be able to put up to $4,000 into the account in 2021. There are other restrictions as to how much you can contribute to this account annually.
In 2021, the annual contribution limit is $6,000 and $7,000 for people aged 50 and older. Your contributions may be tax deductible depending on your Adjusted Gross Income reported to the IRS in your contribution year. This account is a retirement account. Any withdrawal before the age of 59 ½ may be penalized by a 10% rate (there are exceptions to this rule). Or you can keep your money in your IRA until you are required to do so via required minimum distribution during the year you turn 72 years of age.
You may be able to set-up an IRA with a bank or other financial institution, a life insurance company, mutual fund manager, or stockbroker. IRAs usually have lower fees and more investment options than 401(k)s.
A Roth IRA is like a traditional IRA, including all its rules, except for a few key differences. It easily lands on the list of best retirement plans and is one of the more popular retirement plans as well.
The biggest difference is that qualified distributions are tax-free. Unlike a traditional IRA, your initial contributions are taxed; However, the money will grow tax-free in the account, and no income tax will be due on Roth IRA withdrawals in retirement provided the distribution is deemed qualified (yes, there are some rules to be followed, most notably that the initial contribution for distribution was done at least 5 years earlier).
So, a traditional IRA may save you money on taxes if your tax rate is smaller during your distribution, while a Roth IRA will not save you money right now (as you will be contributing with after-tax dollars) but will save you money in your retirement years as your money may be withdrawn tax free. A Roth IRA does not require that you take minimum distributions in retirement.
Like an IRA, you need to have earned income to be eligible to open an account. The amount contributed cannot be more than the amount you earn. For 2021, you can contribute up to $6,000, or $7,000 if you are age 50 or older. Important to note, that $6,000 (or $7,000) limits is combined contribution in IRA accounts. If you have both a traditional and Roth IRAs, the combined contribution cannot exceed the $6,000 (or $7,000) limits for 2021, or you will be penalized by the IRS for doing so. You may be able to set-up a ROTH IRA with a bank or other financial institution, a life insurance company, mutual fund manager, or stockbroker.
SIMPLE IRA, or Saving Incentive Match Plan for Employees Individual Retirement Account
A Simple IRA may be available to those who are self-employed or those who work for a small business with, generally, 100 or fewer employees. SIMPLE IRA plans do not have the start-up and operating costs of other conventional retirement plans, but they do require minimum distributions from the employer.
During the election period, the employer must tell employees which method will be used the following year either a 2% nonelective contribution (2% of compensation regardless of whether or how much the employee deferred) or 3% matching contribution (match of employee’s deferrals up to 3% of the employee’s compensation). This is a great reason to opt into this account if it is offered by your employer.
To be able to establish a SIMPLE IRA, the employee would need to have earned at least $5,000 from the company during the previous two years and be expected to receive at least $5,000 in the current year. For 2021, the contribution limits are $13,500. Those who are 50 years of age or older are allowed an additional “catch-up” contribution of $3,000. The amount contributed will be deducted from your taxable income, and then subject to taxes when withdrawn during retirement. The employee is always 100% fully vested or has ownership of all SIMPLE IRA money.
Like other plans, penalties may be assessed if you withdraw funds prior to being 59 ½ years of age. To open a SIMPLE IRA account, consult your employer. For self-employed people, you may be able to set-up a SIMPLE IRA with a bank or other financial institution, a life insurance company, mutual fund manager, or stockbroker.
SEP IRA, or Simplified Employee Pension Individual Retirement Account,
A SEP IRA may be available for small business owners with several employees and self-employed individuals. A SEP IRA does not have the initiation and operating costs of a conventional retirement plan. The contribution limits for SEP IRA for 2021 are either 25% of your compensation or $58,000, whichever is less. These contributions are made by the employer, not the employee. The employer decides how much to contribute to each employee. They must be consistent to all eligible employees.
Contributions are made with pre-tax money, and then taxes will be due during distributions. The employee does not determine how much to contribute, only which investment funds to allocate funds to. Money withdrawn before the age of 59 ½ may be subject to penalties. This account also has minimum distributions requirements by the age of 72. To open a SEP IRA account, consult your employer. For self-employed people, you may be able to set-up a SEP IRA with a bank or other financial institution, a life insurance company, mutual fund manager, or stockbroker.
A 401(k) account is a profit-sharing offered by some for-profit employers. Many people consider the 401(k) the best retirement plan, but also it is the most commonplace as many employers will set this up for you and even contribute on your behalf in some cases.
In 2021, the IRS allows a contribution up to $19,500, or up to $26,000 if you are over 50 years of age. The contribution amount is determined by employees using pre-tax funds. Some employers may offer a match up to a certain percentage. This is a great reason to open a 401(k) account as any match done by an employer could be considered a bonus.
It is important to check the rules of the match as some employees require a certain time in the workplace to be fully vested. The amount contributed to a 401(k) is deducted from your taxable income and taxed when funds are withdrawn. So again, this could save you on your tax burden in the future if your tax rate is lower during your retirement years.
Part of the money withdrawn can be designated in a Roth account, meaning, the contribution amounts come from post-taxed funds and then the money will grow tax-free in the account, and no income tax will be due on Roth withdrawals in retirement provided the distribution is deemed qualified.
Like an IRA, there may be penalties if you withdraw funds by the age of 59 ½ and require minimum distributions at age 72. 401(k) accounts usually have higher fees and less investment options than IRAs. You may be able to set-up 401(k) through your employer should they offer the benefit.
Solo 401(k), One Participant
A Solo 401(k) is an option for those self-employed individuals, for themselves and their spouse. This option may be convenient for people like realtors, contractors, or other self-employed professionals who do not work for a large corporation that has retirement account plans available.
These plans have the same rules and requirements as any other 401(k) plan. Contribution limits for 2021 are $19,500, or $26,000 for those who are over 50 years of age plus employer nonelective contributions up to 25% of compensation. Total pre-tax contributions cannot exceed $58,000, or, if you are 50 years of age or older, you can make an additional catch-up contribution of $6,500. The money will be deposited into account pre-tax, and then taxed during distribution as income. You may be able to set-up a Solo 401(k) with a bank or other financial institution, a life insurance company, mutual fund manager, or stockbroker.
A 403(b) may be available for you if you work in the nonprofit or tax-exempt sector. Like a 401(k) you are eligible to contribute up to $19,500 in 2021. If you are the age of 50 or older once again you have an opportunity to contribute a higher amount, up to $26,000 to give you the ability to catch up should you need to. Contributions are taken from tax-free funds and will grow as such, until you make withdrawals. At that time, you will pay taxes with your tax rate during that period as the distributions are considered taxable income. To set-up a 403(b) consult your non-profit, or nontaxable organization, to see if program is available.
If you work for a state, or local government organization, you may be eligible to open a 457(b) retirement account. Contribution limitations are once again $19,500, or $26,000 for those who are 50 years of age older for 2021. A different feature about this account is that it does give you more freedom should you wish to withdraw funds before the age of 59 ½. You will still pay taxes on any funds withdrawn, but you may not pay the 10% penalty typically assessed in a retirement account. To set-up a 457(b) consult your government employer, to see if program is available
There you have it! This has been a summary of retirement plans listed in IRS.gov. If you are initially setting up your account, be sure to further investigate the specifications of each account to further learn how you can abide by all its restrictions and further learn to take advantage of its benefits.