The Many Options of Retirement Plans
When thinking about their financial future, most people typically consider the benefits of establishing a retirement plan. There are many factors that influence which type of plan is best for each person, including goals, financial and employment situation, and the possibility of current deductions against income. As there are many options, it is always advised that one speak with their financial professional to discuss the various retirement plan options and which one may be best suited for them.
Most people have the option of participating in a retirement plan through their employer. The type of plan an employee may participate in is dependent on their type of employer – 401(k) plans are sponsored by private employers, 401(b) plans are sponsored by public schools, churches, and certain charities, and 457 plans are sponsored by certain state and local governments and non-governmental agencies. Other retirement plan options include Savings Incentive Match Plan for Employees (SIMPLE) Individual Retirement Accounts (IRA) and Simplified Employee Pension (SEP) IRA.
The Internal Revenue Code (IRC) places limits on how much money may be contributed to each type of retirement plan each year. For example, in 2023 an employee may contribute up to $22,500 to a 401(k) and an additional “catch-up” contribution of $7,500 if they are 50 years old or older. The IRS adjusts retirement plan contribution limits annually for inflation.
Aside from retirement plans via one’s employer, people can establish retirement plans on an individual basis. The traditional IRA and Roth IRA are among the most common. There are two main differences between the two – First, contributions to traditional IRAs are made with pre-tax money and earnings grow tax-deferred, with taxes paid when the money is withdrawn in retirement. Conversely, Roth IRA contributions are made with after-tax money and earnings grow tax-free, with all withdrawals tax-free in retirement. Although anyone with earned income may make contributions to traditional IRAs, there are income phaseout limits that affect the ability to contribute to Roth IRAs. Once above the limit, you may no longer contribute to a Roth IRA. Additionally, only traditional IRA contributions can be deductible, up to certain income limits. Another major difference between the two is that traditional IRAs have Required Minimum Distributions (RMD), which is the minimum amount you must withdraw from your account each year, while Roth IRAs do not. All RMDs are included in your taxable income in the year received, except for any part that was taxed before (your basis, or what you put into the account).
These are only a few of the many types of retirement plans. There are other options available, either through an employer or on an individual basis. As mentioned, your financial professional will be able to recommend the most appropriate plan based on many factors, including your goals, employment situation, financial position, and preferred tax planning technique. It is best to begin saving for retirement as early as possible, however it is never too late. There are ways to speed up the process of saving, depending on your employment situation, which can also be discussed with your financial professional.