It’s never too early to start planning for your retirement, but there are several different types of retirement accounts. If you’re new to investment and retirement plans, you’re in the right place. There are more than a dozen major types of retirement accounts and many subcategories. We take a candid look at the various retirement plan available and provide an overview of each. The information in this guide to help you choose the best options for your retirement portfolio. Even if you already participate in a retirement plan, you can have more than one in most circumstances.
How many different types of retirement plans are there?
According to the IRS website, there are 14 major types of retirement plans. Although there are more types, the lines become blurry as some are subtypes. These include Individual Retirement Arrangements, also known as IRAs, the distinctly different Roth IRAs, 401k and 403b Plans, Simple IRAs, SEP and SARSEP plans, Payroll Deduction IRAs, Profit-Sharing Plans, Defined Benefit Plans, Money Purchase Plans, Employee Stock Ownership Plans, Governmental Plans, and 457 Plans. There are subtypes within these major headings.
Individual Retirement Plans, also known as Traditional IRAs are funds that you open on your own and are not joined through an employer, according to SoFi Learn. These plans have a contribution limit of $6,000 annually for people under age 50 and $7,000 for those 50 and older. Some contributions may be eligible for tax deductions to lower your tax bill for such contributions. Your money in a Traditional IRA can grow at a tax-deferred rate. This type of IRA is suitable for those who wish to lower their tax bill through contributions that are eligible for the credit. It is worth noting that withdrawing funds before age 59 and a half results in a 10 percent penalty. Most Traditional IRAs require you to start making withdrawals at the age of 72.
Roth IRAs are similar to Traditional with the same contribution limits. They’re funds that you open on your own. This type of retirement plan is ideal for anyone who wants the ability to withdraw from the account during retirement without the requirement to pay taxes. It’s recommended for those who are in a low-income bracket but are likely to advance to a higher tax bracket through time. Unlike Traditional IRAs, the Roth is made with after-tax funds and you receive no deductions for contributions made. However, the fund does grow at a tax-free rate. Only those with an earned income are eligible to contribute to a Roth IR, up to a modified AGI of $122,000. Some types of early withdrawals do come with a penalty.
Simple IRA Plans
Simple IRAs are joined through your employer. The company employing workers makes contributions as a part of the benefits package and workers are not mandated to make contributions unless they want to do so. They may, however, make contributions that match the contributions made by their employers. The funding is on a pre-tax basis and grows tax-deferred. This means that taxes are paid during retirement on withdrawals made. There is a contribution limit for persons under the age of 50, of $13,500 per year. This amount increases to $16,500 annually at age 50 and beyond. The greatest benefit is that contributions of two percent of the worker’s salary are made by the sponsoring employers which amount to free money. Some companies will match up to three percent for workers who make voluntary contributions. It is feasible for employees to set themselves up for a more comfortable retirement after they are past their working years, by maximizing the allowed limit of contributions through a Simple IRA plan. It’s wise to let the fund ride at least until reaching the age of 50 and a half. There is a stiff penalty of 25 percent for early withdrawals before age 59 and a half.
You don’t have to work for someone else to have a good retirement account. Simplified Employee Plans are retirement accounts that small business owners, as well as self-employed workers, start on their own. Contributions made to reduce taxable income. This is perhaps one of the biggest benefits of this type of retirement account. Up to $57,000 or 25 percent of a worker’s earned income is the annual contribution limit. This type of retirement plan offers Self-employed persons a suitable alternative to employer-sponsored plans.
US News describes several more variety plans beginning the 401 k Plans. This type of retirement plan is available through select employers. Not all workplaces offer them, but it’s one of the more common employee-sponsored retirement plans. If you are age 50 or younger, you may contribute up to $19,500 per year to its plan, and up to $26,000 if you’re age 50 and older. The deductions are made from taxable income earned. Some employers match part of the contributions. Withdrawals are required at age 72, but there are penalties for early withdrawal under age 59 and a half in most cases.
403b retirement plans are available for some employees of tax exempt organizations. There are some similarities between 403b and 401 k plans. The maximum allowed contribution for workers under 50 is $19,500 and for those that are 50 and above, it is $26,000. The earnings that are grown in these accounts are tax-free while they are accruing. When you reach retirement, the IRS views withdrawals as taxable income. These types of accounts may also include some IRAs and Roth IRAs. One of the most outstanding benefits of this type of retirement plan is the tax-free growth, but it’s important to remember that when you can actually begin withdrawing the funds, you will be required to pay taxes on the proceeds, so plan accordingly if you want to have a comfortable retirement income.
457b retirement plans are offered for employees of state and local governments. This type of retirement plan allows workers who are under 50 years of age to contribute up to $19,500 towards retirement. Those who are age 50 or more have a larger limit of up to $26,000. One of the greatest benefits of 457b plans is that there is no penalty for withdrawing funds before reaching the age of 59 and a half. This is a feature that is not available with most other types of retirement plans and it’s one of the perks of being an employee of a city, state, or county.
A SARSEP Retirement plan is a type of SEP that was established before the year 1997. It is a salary reduction arrangement that features a choice of employer contributions for part of their pay to an IRA, or an arrangement that is an Annuity. This is an arrangement that was made for employees eligible on or before 1996. This is a type of retirement plan that can no longer be set up. It is obsolete but some are still in existence today. The IRS must in some cases amend the current laws to ensure that the tax advantages of this type of old plan are maintained.
Profit-Sharing Retirement Plan (PSP)
A PSP is a type of retirement plan that is arranged to provide employees with a portion of the profits of the company that they work for. Another name for this type of retirement plan is a deferred profit-sharing plan. The amount of funds that employees under this plan receive are based upon either the annual or quarterly earnings of a company and a percentage of that figure is issued. Most PSPs feature a unique set of restrictions on withdrawals as to when and how without incurring penalties.
Thrift Savings Retirement Plan
The TSP retirement plan is designed for federal employees and military members. This plan allows for investment into accounts that offer tax advantages for retirement. They work similar to a 401k plan and may be traditional or Roth IRAs as well. Contributions may be automatically directed from the employee’s paycheck. There are five different fund options as subcategories of Thrift Savings Retirement plans. Investors have a choice of Government Securities Investment G funds, Fixed Income Index Investment F Fund, Common Stock Index Investment C Fund, Small Capitalization Stock Index S Fund, or the International Stock Index Investment I Fund. Allocations may also be mixed among the five options.
Taxable Investment Retirement Accounts
This is a type of retirement plan that works like an IRA or 401k, with the exception that they are more flexible. There are no income limits imposed and anyone at any income level can invest. Withdrawals can be made at any time with no penalties for early withdrawal and you don’t need to offer an explanation for why you’re withdrawing funds. This is a popular option for workers interested in early retirement. The downside to this type of retirement account is that taxes must be paid on all earnings of the fund. It doesn’t offer investors any kind of tax advantage.
Defined Benefit Plans
This type of retirement account is also referred to as a Pension Plan. Pension Plans are set up to guarantee that you will receive a retirement payout that is based on your length of employment and the salary history of your work at the company. The only requirement to receive such a pension plan is to remain on the job in a participating company. This type of retirement plan is not as commonly offered as it was in the past. It’s something that is seen more often in governmental positions.
Taxable Investment Accounts
A Taxable Investment Retirement Account is similar to an IRA or a 401k, except for its flexibility. This type of account has advantages that neither of the latter offer. There are no income limits for eligibility. Accounts are opened by the individual through a brokerage firm. There are no penalties for early withdrawal. You may invest in a taxable investment retirement account after you’ve made the maximum allowable contributions to any other existing retirement accounts. Just be aware of the fact that you will be required to pay taxes on the fund as it earns money. You must account for it on your annual IRS Federal Tax forms.
Practically everyone should begin thinking about their retirement, even if it is many years in the future. Those who start retirement accounts early in life will have the most comfortable life after their working years have come to a close. It’s wise to become familiar with the various type of retirement accounts are out there and how they can be beneficial in your golden years. Be advised that the information provided here is an overview of the basics of each type of retirement account with a few of the pros and cons are thrown in to help you understand the gist of the plan type. Most retirement plans come with a long list of restrictions, rules, eligibility requirements, and terms and conditions to comply with the IRS mandates. There are often both benefits and disadvantages. As for which is the best option, this depends upon your unique situation. There are no one-size-fits all type of retirement plan. It’s always a good idea to delve into the particulars of each type of retirement strategy before making a decision about where to invest. You may also wish to speak with a professional financial advisor to point out the benefits of certain plans that fit in with your current financial situation and your plans for the future.