Understanding Retirement Accounts: Which One Is Best For You?

Looking down the road, planning for retirement is a major stressor for just about everyone. How much money will I need to retire? Will Social Security Benefits still be around? Will I have enough money to retire for good? How long will my retirement last? When it comes to saving for retirement and your golden years, there is no “one-size-fits-all” approach. Every individual situation will be different with varying strategies, careers paths and saving power. To make things harder… the old school pension plan is all but gone.

When the new “defined contribution plan” aka the IRA/401K came into play in the 1980’s, the pension plans all but vanished. Which can be a huge issue for those heading into retirement because, when it comes to defined contribution plans there is no set monthly payment once you retire. You only have what you put in yourself and if you are lucky, an employer matching a portion of your contributions. Ultimately the sole responsibility rests on you and you alone. You could find yourself in hot water if you do not have enough money built up and you could run out of cash in the middle of your retirement.

So, how can you save for retirement without a pension plan? You need to have a concrete game plan with SMART goals set in place to help keep you on track. You can set a monthly budget that will allow you to make monthly deposits into a 401(k), 403(b), an IRA and other retirement plans and investment accounts. The best thing to do is start planning early and let the power of time and compounding interest do the heavy lifting. That being said, it’s time to take a look at different retirement accounts that could benefit you!

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Individual Retirement Accounts (IRAs) are a defined contribution plan that is not sponsored by an employer, it is an Individual Retirement Account. An IRA provides the same tax benefits offered by 401(k) and other employer sponsored retirement accounts. Each year you earn taxable income, you can make traditional contributions that lower your income taxes right now.

Roth IRAs are a defined contribution plan that is not sponsored by an employer, it is an Individual Retirement Account. An IRA provides the same tax benefits offered by 401(k) and other employer sponsored retirement accounts. Each year you earn taxable income, you can make Roth contributions that will be tax free when you withdraw in retirement.

Spousal IRAs only apply those who file a joint tax return where only one spouse is earning taxable income. Each spouse has the opportunity to make contributions up to the current annual limit regardless of if they were earning taxable income themselves.

401(k) Is a common defined contribution plan offered by many private companies. Because it is a contribution-based plan, there is no fixed monthly benefit in retirement. You only have what you put in yourself and any employer contributions. Each company will have its own vesting period, typically that will be somewhere between 3 to 5 years.  Some companies will match your contributions up to a certain percentage, but not more than 6%. A 401k has both Roth and Traditional contribution options.  

403(b) Is a defined contribution plan offered by nonprofits and other tax-exempt employers and is very similar to a 401k. Because it is a contribution-based plan, there is no fixed monthly benefit in retirement. You only have what you put in yourself and any employer contributions. Each company will have its own vesting period, typically that will be somewhere between 3 to 5 years.  Some companies will match your contributions up to a certain percentage, but not more than 6%. A 403(b) has both Roth and Traditional contribution options.  

Standard Pension Plan – Pension plans fall under defined benefits plans. Meaning it has a fixed monthly benefit or a set formula that is promised as a benefit at retirement. It does not matter how long you live or how much money you put into the system. It will be a set monthly benefit for the remainder of your life. That is huge! Because what if you live longer than you expected? The benefit would continue regardless! A few industries still offer this like military, police/fire, some state and non-profit agencies, etc.

Federal Employees Retirement System (FERS) – Is a defined benefit plan specifically for federal employees. It is a fixed monthly benefit the remainder of your life. It has a 5-year vesting window and is paid for by the federal agency, not you as the employee. FERS is paid out based on the highest pay of three years and the total number of years completed with any federal agencies. Meaning, you can swap agencies and jobs around with out it impacting your retirement as long as the job still falls under federal employment.  

Thrift Savings Plan (TSP) – A Thrift Savings Plan is only available to federal government employees and military service members. It is a defined contribution plan meaning there is no fixed monthly benefit in retirement, you only have what you put in yourself for your retirement years. The retirement income will be based on how much money you saved and contributed while you were still working. Once you empty the tank so to speak, you won’t have any more money for retirement income.

Employee Stock Ownership Plans (ESOPS)

457(b) Is a defined contribution plan offered by government agencies, nonprofits, and tax-exempt employers. Because it is a contribution-based plan, there is no fixed monthly benefit in retirement. You only have what you put in yourself, employers do not contribute to 457 plans.

HSA

Solo 401(k)                                             

SEP IRAs are also known as a simplified employee pension. This plan allows small businesses or self-employed individuals to participate in making contributions to employee’s retirement accounts. SEP IRAs only allow traditional contribution and therefore, you cannot make Roth Contributions. SEP IRAs allow for higher contributions than Traditional IRAs, but each employee must receive proportional contributions across the board.

SIMPLE IRAs are also known as a savings incentive match plan for employees. SIMPLE IRAs are specifically for small businesses with less than 100 employees and don’t really have other retirement plans available. SIMPLE IRAs only allow traditional contributions and therefore, you cannot make Roth Contributions. They are generally easier to maintain but offer lower contribution limits than SEP IRAs or other employer sponsored plans.

Profit Sharing Plans

Association Retirement Plans

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It is important to remember that retirement accounts or other investment accounts will charge fees for their services. They are required to disclose what the fees are for and give accurate information. This is helpful for you when you are evaluating different accounts to work with. Make sure you carefully evaluate the fees associated with different accounts before diving in.

The income needed in retirement will not be the exact equivalent to your current expenses. FICA, your Social Security and Medicare tax deductions, will end and generally your health insurances costs will rise. It is also important to remember that retirement accounts or other investment accounts will charge fees for their services. They are required to disclose what the fees are for and give accurate information. This is helpful for you when you are evaluating different accounts to work with.

Because these accounts are specifically for retirement, withdrawing funds early (before the age of 59 ½) will lead to tax penalties. Generally, after you reach the age of 72 you must withdraw the required minimum distribution or risk incurring higher taxes on the amount you didn’t take out.

It is important to keep in mind that all investments have risk. But so does leaving your money hidden under your bed in a shoe box. Inflation is a silent killer of money. If you are not investing your money at a rate that matches the rise of annual inflation (2.5%ish) then you are actually losing money. Make smart money moves with companies that you trust and understand to set yourself up for success.

© EuduringFinances, 2021. All Rights Reserved.

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