December 6, 2022
What we’ll cover:
If you have a retirement plan (or multiple plans), you might just know it as a place you put money for your future. But did you understand your retirement account type options before signing up for one?
Learning about different retirement account type options – including the contribution limits and tax treatments of each – may teach you ways to boost your savings. For instance, did you know it’s possible to have multiple retirement plans, rather than just letting your 401(k) do all the work?
We’ll cover some of the basic rules of different retirement plans, along with pros and cons for each. While this should help provide you with an overview of the retirement landscape, it’s a good idea to consult a financial advisor or tax professional to help you choose the best plan for you.
If you work for an employer, you may likely have access to some sort of employee-sponsored plan. Here’s an overview of some of the options that may be available to you.
These are the most popular employer-sponsored retirement plans in the US, with participation in these plans growing among all age groups.
Companies set up these plans to allow their workers to save for retirement. Employees define the amount they want to contribute from their paycheck… hence the name "defined contribution."
There are three main types, which are structured and operate in similar ways:
Contribution details: Employees contribute; sometimes employers may also contribute. Contribution limits are $20,500 for each of these plans in 2022 ($22,500 for 2023). For 2022, catch-up contributions of an additional $6,500 may be allowed for those 50 and older. For 2023, the catch-up contribution limit is $7,500.
RMDs: Each of these plans are subject to required minimum distributions ("RMDs") rules. Visit the IRS website for details.
Withdrawal rules: While 401(k)s and 403(b)s may hit you with a 10% penalty for withdrawing your money early (before age 59 ½), there generally is no penalty for early withdrawals from a 457(b).
What we like: Employer match. Some employers may offer matching contributions, which means for every dollar you contribute up to a certain point, your employer will also contribute some amount.
What we don’t like: Limited options in plan choice since plans are offered by your employer. Employer contributions may be subject to a vesting period (that is, you have to work for the company for a certain amount of time before you can receive this matching benefit).
Good for: Individuals who want a low-maintenance way to grow their retirement savings. Bonus points if you work at a company that offers an employer match.
These plans are pretty much what they sound like: a combination of a 401(k) and a Roth IRA.
These plans are pretty much what they sound like: a combination of a 401(k) and a Roth IRA. Like a 401(k), money is taken directly out of your paycheck. Like a Roth IRA, you pay taxes on your contributions, but withdrawals in retirement are tax-free, provided you have held the account for at least five years and don’t withdraw until you reach 59 ½.
Contribution details: Same as the Traditional 401(k): Employees contribute, and sometimes employers may also contribute. Total contribution limits are $20,500 for 2022 and $22,500 for 2023. For 2022, catch-up contributions of an additional $6,500 (or $7,500 for 2023) may be allowed for those 50 and older. Note: If you have both a Traditional and Roth 401(k), your total contribution limit between the two is $20,500 for 2022 and $22,500 for 2023.
RMDs: Roth 401(k)s are subject to RMD rules. This will change starting in 2024, in that RMD rules will not apply to Roth 401(k) participants while they are alive (but their beneficiaries may have to take RMDs after the account owner's passing). Visit the IRS website for details.
Withdrawal rules: To qualify for tax-free withdrawals, you must have held the account for a minimum of five years and be at least 59 ½ years old.
What we like: You can contribute at any income level. While Roth IRAs have income limits, Roth 401(k)s do not.
What we don’t like: Withdrawals are less flexible than a 401(k), which doesn’t have the five-year rule.
Good for: Individuals who prefer to pay taxes now and get them out of the way, or think they may be in a higher tax bracket in retirement.
These plans, commonly referred to as pension plans, provide a fixed, pre-determined benefit for employees when they retire.
With these plans, the amount of money you’ll receive in retirement (considered a benefit) might be a fixed amount or based on a formula defined by the employer … hence the name “defined benefit.” Typically, the formula includes factors like an employee’s tenure and salary history. In short, you know with more certainty how much you can expect to receive in retirement.
Contribution details: Generally the employer makes most of the contributions, though employees may be required or allowed to contribute. Typically, employers will define the investments in the plan.
Withdrawal rules: These are set by your employer.
What we like: Since benefits are either fixed or based on a formula, you know what sort of income to expect in retirement.
What we don’t like: Pensions are a dying breed. Generally, you also have to be willing to stick with the same company for a while if you want to make the most out of this benefit.
Good for: Individuals who work at a company that offers this benefit, and plan on staying with that company until they retire.
As you can probably guess by the name, these plans are set up by individuals.
Like other retirement plans, IRAs can be made up of an array of financial products, including stocks, bonds and mutual funds that are reserved for retirement.
A big draw for IRAs? Even if you already have a retirement plan set up through your workplace, you may still be able to open an IRA.
When you contribute to a Traditional IRA, your money grows tax-deferred until withdrawn in retirement. Depending on your circumstances, your contributions may be tax deductible, which effectively lowers your taxable income. As always, it's a good idea to consult a tax professional if you have questions.
Contribution details: Individuals contribute. Contribution limits are $6,000 for 2022 and $6,500 for 2023. Catch-up contributions of an additional $1,000 may be allowed for those 50 and older.
RMDs: Traditional IRAs are subject to RMD rules. Visit the IRS website for more information.
Withdrawal rules: If you withdraw your money before age 59 ½, you may be subject to tax and a 10% penalty.
What we like: More choice and control in investment types. While your options for 401(k) plans are typically limited to what your employer offers, you can shop for many options when choosing an IRA.
What we don’t like: Lower contribution limits than 401(k)s.
Good for: Individuals who don’t have a 401(k) offered through work and/or would prefer more flexibility in choosing a retirement plan.
With a Roth IRA, you pay taxes on your contributions, but your withdrawals in retirement are tax-free. This may be attractive if you expect your tax rate to be higher in retirement than it is today.
Contribution details: Individuals contribute. Contribution limits are $6,000 for 2022 and $6,500 for 2023. Catch up contributions of an additional $1,000 may be allowed for those 50 and older.
Withdrawal rules: You can withdraw your contributions at any time, without incurring taxes or penalties. However, earnings on your contributions may be subject to tax and a 10% penalty if you withdraw your money before 59 ½. (Learn more: What Are the Penalites for Withdrawing Early From an IRA?).
What we like: Not having to pay taxes on withdrawals in retirement.
What we don’t like: There are income limits. If you make a certain amount – either as an individual or married couple – you will not be eligible to contribute to a Roth IRA, or your contribution amount may be reduced. Read up on the IRS rules if you’re considering opening one.
Good for: Individuals who think they might be subject to a higher tax rate in retirement and/or want to supplement an existing taxable retirement account, such as a 401(k).
We should start off by clarifying that there’s no such thing as a “Spousal IRA” account. A Spousal IRA is simply a strategy that allows single-income, married couples who file taxes jointly to set up an IRA (Traditional or Roth) for the non-working spouse.
There are IRS rules about how these are structured (along with income restrictions), but here’s a high-level illustration of how it works.
Let’s look at a married couple: Jesse and Logan. Jesse works, Logan does not.
Typically, the IRS only allows income-earners like Jesse to set up an IRA. However, since Jesse and Logan are married and file taxes jointly, Logan can set up an IRA and Jesse, as the income-earner, can contribute. The key is that the account is in Logan’s name (it’s not a joint account) and Jesse contributes.
Contribution details: The working spouse contributes. Since this is set up as a Traditional or Roth IRA, the same contribution limits apply.
Withdrawal rules: Depending on whether you have this set up as a Traditional or Roth IRA, the same withdrawal rules apply.
What we like: Allows married households with a single taxable income to boost their retirement savings.
What we don’t like: Spousal IRAs only work for married couples who file jointly.
Good for: Married couples where one spouse is not working or earning little income.
If you’re self-employed or own your business, chances are you make a lot of important decisions. And setting up a retirement plan – either for yourself and/or for your employees – is no exception.
This can often be really challenging, but a lot comes down to making sure you have the right plan for your business.
A Simplified Employee Pension IRA is a retirement account that offers tax advantages for business owners and the self-employed.
And it actually is simple. As the business owner, you can shop for a SEP IRA from various financial institutions and pick the details of your plan. Contributions are tax-deductible and the money grows tax-deferred until retirement.
Contribution details: Contribution limit in 2022 is $61,000 ($66,000 for 2023) or 25% of compensation, whichever is less. If you contribute to a SEP IRA for yourself and your employees, you must contribute to everyone’s account equally (based on a percentage of salary). You can’t pay yourself a greater percentage, and you can’t play favorites.
RMDs: SEP IRAs are subject to required minimum distribution rules (for more details, see IRS Retirement Topics: RMDs).
Withdrawal rules: If you withdraw your money before age 59 ½, you may be subject to income tax and a 10% penalty.
What we like: Employees may combine these with a Traditional or Roth IRA. Read up on the IRS rules for more details here.
What we don’t like: Catch-up contributions aren’t allowed for those 50 and older. There’s also no Roth version of a SEP IRA, which means there’s no option to pay taxes now and withdraw your money tax-free in retirement.
Good for: Individuals who are self-employed or own a small business with few or no employees.
The alphabet soup of all retirement plans, SIMPLE stands for Savings Incentive Match Plan for Employees. SIMPLE IRAs allow employees in companies with 100 or fewer employees to contribute to a Traditional IRA, and employers must contribute. In this way, it’s similar to companies that offer matching 401(k)s.
The difference is in the details of employer matching. With SIMPLE IRAs, employers are required to either: match every contribution an employee makes to their plan, up to 3% of the salary, or contribute a flat 2% of the employee’s salary, regardless of whether the employee chooses to contribute.
Contribution details: Employers must contribute, employees can contribute. Contribution limits for employees are $14,000 in 2022 ($15,500 in 2023). For 2022, catch-up contributions of an additional $3,000 ($3,500 for 2023) may be allowed for those 50 and older.
RMDs: SIMPLE IRAs are subject to required minimum distribution rules (for more details, see IRS Retirement Topics: RMDs).
Withdrawal rules: Generally, you pay tax on any withdrawals from your SIMPLE IRA, but you may be subject to an additional 10% tax if you withdraw before age 59 ½. Additionally, that amount can jump to 25% if you haven’t held the account for at least two years. Visit the IRS's website here for more details on SIMPLE IRAs.
What we like: Employers are required to contribute.
What we don’t like: Lower contribution limits than 401(k)s.
Good for: Smaller companies generally with fewer than 100 employees.
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