With most Americans looking to retire by age 67, it seems that many are not yet on track to provide for a comfortable retirement. According to a TD Ameritrade study from earlier this year, most Americans still have a ways to go in securing their financial future. In many cases, Americans aren’t sure what type of retirement plan to invest in.
This article is intended to provide a high-level overview of retirement plans as you think through how to plan for retirement. Whether you are in your teens, 20s, 30s, 40s, or nearing retirement, we hope this article will provide helpful information. After all, planning for your retirement doesn’t need to be scary or overwhelming.
Understanding various retirement plan options is easier than you think. Check out this list of six retirement plans that you might want to know more about.
For Americans, a 401(k) retirement plan refers to an employer-sponsored program where employees have the opportunity to have money taken out of their paychecks through an automatic payroll withholding and put into an account designed specifically for retirement purposes. In some cases, the employer opts to contribute to the account as well. In a traditional 401(k) plan, the investment earnings are not taxed until the employee later withdraws money from the account.
One of the nice benefits of 401(k) plans is that in most cases, you can deduct your money early in the event of an emergency. However, early withdrawals do come with a 10% early withdrawal penalty. Taking the money out early in the event of an emergency will leave you with less funds for your retirement. In some cases, employers may offer employees the ability to take out a loan against their vested funds for a small fee, ensuring that employees can get the money they need for short-term use without the need for a withdrawal and penalty.
Often referred to by their acronym, IRAs, can be used to invest in stocks, bonds, mutual funds, and exchange-traded funds (ETFs). IRAs come in several varieties including traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. Many people choose to invest in IRAs when their employers do not offer a 401(k) or another type of company-benefit retirement plan.
As indicated above, a Roth IRA is one of the varieties of individual retirement accounts available to those looking to invest in their retirement. The key thing to know about a Roth IRA is that it is an after-tax plan. This means that you put money into your Roth IRA after you have already been taxed on those dollars.
You can take the extra dollars that you have each month and invest those funds into a Roth IRA. Since you have already been taxed on those dollars, you won’t be taxed again at the time of withdrawal. However, it is important to note that depending on your age, per the Internal Revenue Service (IRS), you can only contribute a total of $6,000 per year to your individual retirement accounts.
This retirement option combines the aspects of the Roth IRA and the traditional 401(k). This is a relatively new option offered by some employers. A cool feature of the Roth 401(k) is that there are no contribution limits like there are with the Roth IRA. You can make your annual contribution just as you would with a traditional 401(k), just with after-tax dollars instead of pre-tax dollars.
Though the name would imply that this is an easy or simple fund to manage (which it is), SIMPLE refers to Savings Incentive Match for Employees. These SIMPLE retirement plans are geared towards small businesses with up to 100 employees.
These plans work much like a 401(k) plan as contributions are made using pre-tax withdrawals from the employee’s paycheck. The money will then grow on a tax-deferred basis until retirement. Another important note is that with SIMPLE IRAs, you can’t borrow money in advance of retirement as you can with a 401(k) plan.
SEP IRAs are Simplified Employee Pensions (known as self-employed retirement plans), which for people who are self-employed with no employees. These plans allow you to contribute a portion of your income to your retirement account.
As of 2020, the maximum amount that you can contribute to these accounts is higher than with other retirement accounts. Per the IRS, you can contribute 25% of your income or $57,000 annually, whichever is less. Further, contributions to an SEP IRA are made on a pre-tax basis. As such, these contributions will lower your taxable earnings for the contribution year.
Making the decision to invest in a retirement plan, and how much to invest, is a personal decision based on your circumstances and retirement needs. There is no one-size-fits-all approach to retirement planning. If you are not yet investing in a retirement plan and are looking to adjust your budget so that you can do so, you may consider working with a financial advisor or retirement plan consultant that can assess your individual circumstances and retirement needs.
Disclaimer: The content of this article is for informational purposes only. Nothing contained in this article should be construed as investment advice. Any reference to a particular retirement plan is not, and should not be construed as, a recommendation or as a guarantee regarding that specific retirement plan.