Deciding how you want to plan for retirement doesn’t have to be difficult if you know the best types of retirement plans to go with. Understanding these different types of retirement plans is pretty easier than you think, although each type has its own unique benefits and limitations. Some of these limitations can be a limit on the amount of money you can contribute yearly or your gross yearly income.
The withdrawals tax treatment and the withdrawal age – that doesn’t involve penalty – may be different from one plan to the other. Studying the difference between the types of retirement plans can make you understand which plan is right for you.
11 Types of retirement plans
The 401k plan is a retirement account in a workplace that is offered as part of the employee benefits. The account enables you to contribute part of your pre-tax paycheck to investments with tax-deferred features. This allows for a reduction in the total amount of income to pay tax on, in that particular year.
For instance, if your income is $100,000 but decided to contribute $10,000 to your 401k, it means you would only be taxed on $90,000.
Until the money in the retirement account is withdrawn, the investment profits grow tax-deferred. If the fund is withdrawn from the account before you get to the age of 59 /2, a 10% penalty fee could be levied on you. The withdrawal could also be subjected to State and Federal income taxes. However, 401k loans are allowed by some plans if you find yourself in an emergency cash situation.
Up to 6% of contributions of employees are matched to a 401k by some employers. But for a number of years in your plan, you might not be fully vested. This simply means you won’t be able to take the contribution of your employer with you if you leave the company before the stipulated time elapsed, but you are the owner of your own contribution to the plan.
An important employee benefit could have been ignored if you are not contributing up to the company match, which is free money effectively. Savings can be made easier by contributions through automatic payroll deductions by employers who offered these plans.
These types of plans often have limited investment choices, and high administrative and management fees. A limit contribution is imposed per year by the IRS, although 401k plans are more generous than other plans. The limit was $19,500 in 2020 and still remain in that same price in 2021, If you are 50 years old or above, and take the allowed $6,500 catch-up contribution advantage, the limit can be increased to $26,000.
Varied types of retirement plans for this account include the 403b, the same retirement account that is offered to clergy, educators (for instance in public school), workers at 501C(3) tax-exempt organizations, and the 457 plans that are offered to both local and state government workers.
Solo 401k plans
This type of plan is also called a one-participant 401k plan and is designed for the individual business owner that has no workers. A self-employed individual with no employees can also be eligible for a solo 401k. Up to $58,000 contributions are allowed by the IRS in 2021. A catch-up of around $6,500 contributions can also be made if you are 50 years or above.
You may be eligible for a 403b plan if work for a tax-exempt or a non-profit organization. 401k and this account are similar in that they both allow you to contribute as much as $19,500 in 2021. Up to $26,000 can be set aside if you are 50 years and above. Until your earnings are withdrawn, they gro tax-free. Distributions from 403b plans are also considered taxable income.
The local and state government offer the 457b plans. If you are less than 50 years of age and eligible, you’ll be able to contribute up to $19,500, but if you are 50 years and above, you can contribute up to $26,000 in 2021. A withdrawal can also be made from the account before the age of 59½ without any incurring penalties.
An investment account that is tax-favored is called an IRA. The account can be used to invest in bonds, stocks, mutual funds, ETFs, and other investment types after money is placed into it, and investment decisions are made by yourself or you hired someone else to do it for you. If your employer does not offer a retirement plan or if your 401k contributions for the year have been maxed out, then you may consider investing in a traditional IRA.
Up to $6,000 can be contributed in 2021 if you are less than 50 years of age, but if you are 50 years or above, this can be increased to $7,000, this limit is as that of 2020. No tax will be paid annually on investments profits, and this helps them to grow very fast.
If there’s no 401k retirement account, Ira contributions can be deducted by many taxpayers on their income tax returns, and this will greatly reduce their taxable income in that year. Some restrictions may exist depending on the income.
When withdrawal is done in retirement, income taxes are paid on the money contributed and gained.
Investments can be bought and sold within the IRA plans, if money is withdrawn before you reach the age of 59½, a 10% penalty fee may be imposed on you as that is known as “premature distribution”, just like 401k. The withdrawal will also be subjected to income, state and federal taxes.
The Roth Ira is different from the traditional IRA in that after-tax money is used to contribute to Roth IRA, however, any generated money within the Roth IRA won’t be taxed again.
Roth IRA contributions can be withdrawn without any penalty fee before the retirement age, provided your first contribution has passed 5 years. You are not required to start withdrawing at the age of 72 years as you are with 401k, traditional IRAs, and other retirement savings plans.
If you think you want to grow your income and you are just starting out, putting your money in Roth IRA is the best place to begin investing your extra cash. As a matter of fact, your contributions can be made to both IRA and Roth IRA, but the total contribution to both plans can not exceed the $6,000 limit for the year, but if you are 50 years or above, it can be increased to $7,000.
Self-directed IRA (SDIRA)
Both a traditional IRA and a self-directed IRA have eligibility requirements and limits on contribution, but they differ in the amount of investment you can make. Funds in self-directed Ira can be placed in alternative assets such as precious metals, cryptocurrencies, and real estate, unlike traditional accounts.
The features of 401k plans and the Roth IRA are combined in Roth 401k. Roth 401k was introduced in 2006 and is among the types of retirement plans that are offered through employers. Just like Roth IRA, After-tax is used to make contributions, rather than using your pre-tax salary. If you remain in the plan for 5 years, at least, earnings and contributions are not taxed again.
The simple IRA (Savings Incentive Match for Employees) is among the types of retirement plans that can be offered by small businesses with up to 100 employees. It resembles the 401k in features.
Pre-tax paycheck withdrawals are used to make contributions, and until retirement, the money grows tax-deferred, but high penalty fees may be imposed on you in early withdrawal.
An additional 10% tax will have to be paid on the withdrawn amount from your simple IRA unless you qualify for an exception, just like 401k and the traditional IRAs. The additional tax can be increased from 10% to 25% if the withdrawal was made within the first two years of you starting to participate in SIMPLE IRA. Although Simple Ira resembles 401k with some features, you can not borrow from it as you can from 401k.
If you have no employees and you’re self-employed, Simplified Employee Pension (SEP) IRA is one of the types of retirement plans that allows you to use a portion of your income as a contribution to your own retirement account. These contributions can be fully deducted from your taxable income.
The limits on maximum annual contribution as of 2021 are higher than most of the tax-favored types of retirement plans, which is $58,000 or 25% of your total income – whichever that is less.
Taxes won’t be paid on any amount contributed, however, taxes will be paid on any withdrawn funds. Funds can be withdrawn from the age of 72 years. However, penalties may be imposed on you if you made any withdrawal before the age of 59½ years.
Health Savings Accounts (HSA)
If you are planning to build an account to help you in covering health bills in retirement, health savings accounts are the best types of retirement plans to go with. A high deductible health insurance plan needs to be available before you can be eligible for an HSA. As of 2021, up to $3,600 can be contributed as an individual to an HSA, but if there is family coverage, then up to $7,200 can be contributed.
If you are 55 years or above, an additional $1,000 is allowed, and the amount contributed in an HSA is tax-free. It can also be withdrawn tax-free if they are used in paying for qualifying medical expenses.