“When is the best time to plan for my retirement?” That is a question that should be on your mind. Data reveals that 64% of Americans are not financially ready for retirement.
What is even more alarming is that 48% of American workers don’t care about their retirement.
If you are someone planning for retirement in your early years, then congratulations! You already have the right mindset. All you need is the proper direction.
Retiring comfortably begins with understanding the different types of retirement accounts that will work for you best.
Thus, I invite you to explore the different kinds of retirement accounts, which we’ll delve into below. I promise to keep it clear and simple, because this topic is all too often made complex.
Are you working for a company? If so, one of the most common types of retirement accounts you’ll encounter is the 401(k). It is an employer-sponsored retirement fund that aims to help employees save up some money through mutual funds, target date funds, or other plan offerings.
Also, there are two types of 401(k) plans, namely, the Roth and the traditional type.
1. Traditional 401(k)
A traditional 401(k) lets you make contributions using pre-tax dollars (your gross income). This way, you lower your taxable income, saving you cash come tax time.
However, this income and any profits you make will be taxed when you withdraw it at retirement. The downside of this is that tax rates are historically low right now and they could rise between now and when you retire.
If you’re lucky, your employer may offer you a full or partial match for your contributions.
2. Roth 401(k)
A Roth 401(k) is the exact opposite. The contributions you make to a Roth 401(k) are made with after-tax dollars. This means that there’s no upfront tax deduction to help you at this stage of your life.
There’s a flip side to this, though. Withdrawals of both your contributions and your earnings are tax-free when you pull them out in your later years.
To get this perk, you need to be over age 59 and a half and have held your account for at least five years.
In case you are working for a tax-exempt, non-profit organization, you will encounter the 403(b) plan. A 403(b) works almost the same as a 401(k) plan.
They both offer the same tax treatments and early withdrawal penalties. They also have the same limits as far as contributions go.
However, they differ in one key aspect, which is the investment options. If a 401(k) plan usually comes with mutual fund options, a 403(b) comes with various insurance products. These include annuities and other options that yield low returns.
Another employer-sponsored retirement plan is the pension plan. The amount of pension you will receive upon retirement depends on two factors. These factors are the length of your employment and your salary history.
Thus, as an employee, your only duty is to do your job well and remain with the company until you retire. With this setup, the risk falls on your employer’s shoulders. They will have to save and invest your contributions to ensure your retirement payout.
Interestingly, only 21% of all workers in the country participate in a pension plan. This includes workers from the private sector and state and local governments.
This low percentage reflects that pension plans have gradually been phased out by most employers. Today, most workers and business owners utilize either a 401(k) or a 403(b) plan.
There is also the thrift savings plan or TSP. This retirement plan is for members of the military, as well as federal workers. The TSP gives these workers a chance to invest in something tax-advantaged.
The government entity you are working for can take out your contributions directly from your salary. As for the investment options, there are five that TSP offers:
- Government Securities Investment or (G) Fund
- Common Stock Index Investment or (C) Fund
- Small Capitalization Stock Index or (S) Fund
Completing the options are the Fixed Income Index Investment or (F) Fund and the International Stock Index Investment or (I) Fund.
The Individual Retirement Arrangement (IRA)
With the uncertainty of the times, you can go beyond the traditional method of relying on your employer for your retirement plan. You can create a do-it-yourself (DIY) plan by leveraging an Individual Retirement Arrangement (IRA).
An IRA is an account that lets you save for your retirement outside of what your company offers.
The good thing about IRAs is the flexibility they offer. You can use an IRA to invest in the usual options of stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Depending on how you structure it, you can also invest in more advanced investments like annuities and real estate.
Like the 401(k), IRAs also come in two forms: the traditional and the Roth.
1. Traditional IRA
Like the traditional 401(k), it’s a matter of when you make your tax payments. Traditional IRA allows you to make contributions with pre-tax dollars. The importance of this is that it lowers your overall taxable income.
This will benefit you the most if you’re in a high tax bracket.
2. Roth IRA
Roth IRA plans are the opposite. You make contributions using after-tax dollars. This means you won’t get any immediate tax benefits.
However, both your contributions and your gains will be entirely tax-free when you withdraw them in retirement. This means you won’t need to worry about what happens to state or federal tax brackets in the coming years.
3. SIMPLE IRA
This stands for Savings Incentive Match Plan for Employees. This is often an option for you if you work in a small business. It’s another traditional IRA plan that serves to help small businesses give benefits to long-term employees.
How this works is that each employee makes an annual contribution. In 2021, it’s expected to be capped at $13,500.
If you’re over the age of 50, making a catch-up contribution becomes an option. This allows you to increase your annual maximum to $16,500.
4. SEP Plan
Are you a self-employed individual? Consider setting up a SEP plan. This is a tailor-made plan to help individuals add to their savings accounts little by little.
What makes the SEP IRA powerful is that it has a substantially higher annual contribution limit. It’s higher than either standard IRA and 401(k) plans. This means that you can save up much more toward retirement than you would with standardized plans.
A key restriction of SEP IRAs is that only an employer can contribute to a SEP IRA, and they are required to make contributions to full-time employees that equal their own contributions.
For this reason, SEP IRAs are usually leverage by self-employed folks or small-business owners with few or no employees.
Taxable Investment Accounts for Retirement
If you want more flexibility and unlimited contributions, then this approach would be your best bet.
A taxable account is simply a normal savings or investment account that you “earmark” for retirement.
With a taxable investment account, you don’t need to worry about any income limits. Regardless of how big your salary is, you can put in as much money as you want. You can also invest in any type of asset that you want, from stocks to bonds to real estate.
Also, taxable investment accounts let you pull out your money anytime you want. And you can do so without paying any early withdrawal fees and penalties.
Types of Retirement Accounts For Your Future
Now that you understand the different types of retirement accounts, planning for retirement becomes more manageable. But why wait for your retirement payout when you can make more money today?