4 Kinds of Retirement Plans

Retirement planning is a critical component of securing your financial future. It is important to build a significant retirement corpus for yourself that will last you your retirement years. There is no right time to begin planning for retirement, however, the earlier you start, the more likelihood of you attaining your retirement goals. Retirement goals include creating and identifying additional sources of income, creating a budget, growing your savings, and managing your assets and risk.

To make informed decisions, it's important to understand the different types of retirement plans available. By learning about the features, benefits, and considerations of each plan, you can better navigate the world of retirement planning and choose the option that suits your long-term goals. Additionally, it is advisable to consult a financial advisor who can provide personalized guidance and help you gain a deeper understanding of these retirement plans.

This article explores four common retirement plans that everyone should know about.

4 Kinds of Retirement Plans You Need to Know

1. 401(k)

A 401k is an employer-sponsored, tax-advantaged retirement plan that a company may offer its employees. Contributions to a 401k are made directly from the employee’s salary. The company can also match the employee’s contribution up to a certain limit. This is basically free money. The Internal Revenue Service (IRS) sets the contribution limits and may change every year. For 2023, the contribution limits for a 401k are as follows:

• Investors can contribute up to a maximum of $22,500 per year. However, if you are 50 or older, you can make an additional catch-up contribution of $7,500 annually.
• The employee and the employer can make a maximum combined contribution of $66,000 ($73,500 with catch-up).

There are primarily two kinds of 401ks. These are:

1. Traditional 401k

In a traditional 401k, you contribute pre-tax dollars which means your withdrawals will be taxed in retirement as per the tax bracket you fall into for the year you make withdrawals. Moreover, since you owe tax on your withdrawals, the IRS mandates that you must take out Required Mandatory Distributions (RMDs) from the age of 72, failing which you will be charged a penalty.

2. Roth 401k

 In a Roth 401k, you make contributions from your after-tax dollars, meaning you can make tax-free withdrawals in retirement. Since you pay tax upfront when making a contribution, you are exempt from the same in retirement. Additionally, you do not have to make any mandatory withdrawals in retirement, unlike a traditional 401k. However, in order to make a tax and penalty-free withdrawal, you must be 59.5 years of age at the time of your first distribution and must have held your account for at least five years.

2. Individual Retirement Account (IRA)

An IRA is a tax-advantaged retirement savings account that can be opened by a bank, a mutual fund house, a broker, an investment company, or an online brokerage firm. You have a wide range of investment options available to choose from such as stocks, bonds, exchange-traded funds (ETFs), and mutual funds. There are several kinds of IRAs where the taxes on each type of account is handled differently. These are:

a. Traditional IRA: In a traditional IRA, you can make tax-deductible contributions to earn tax-deferred growth and earnings. For 2023, you can make a contribution of $6,500 along with an additional catch-up contribution of $1,000, if you are 50 or up. Do note that if you make an early withdrawal from your traditional IRA account i.e. before reaching 59.5 years of age, a 10% penalty will be levied on the withdrawal. Also, similar to a 401k, you must take out RMDs after you turn 72.

b. Roth IRA: Though contributions to a Roth IRA are not tax-deductible (contributions are made from after-tax dollars), you can make tax-free withdrawals in retirement provided you are 59.5 years of age and have held your Roth account for at least a period of five years. The contribution limits are the same as a traditional IRA. Compared to a traditional IRA, you can access a broader range of investment options like money market funds, equities, ETFs, mutual funds, bonds, certificates of deposit (CDs), and more.

c. Spousal IRA: A spousal IRA is a regular IRA with the critical difference being that working spouses can make a contribution to a traditional or Roth IRA on behalf of their non-working spouses. Specially designed for married couples, a spousal IRA acts as a way to save money for retirement if one spouse is presently not working. This can be a great source of boosting retirement income for married couples.

d. SEP-IRA: Also known as a Simplified Employee Pension (SEP), a SEP-IRA can be set up by self-employed workers like independent contractors, freelancers, as well as small-business owners. For 2023, you can contribute up to 25% of your total compensation or $66,000, whichever is less.

e. SIMPLE IRA: SIMPLE or Savings Incentive Match Plan for Employees IRA is designed for small businesses having 100 or fewer employees. It is primarily used by small businesses and self-employed individuals. SIMPLE IRA follows the same withdrawal rules as a traditional IRA. For 2023, employees can contribute a maximum of $15,500 with an additional catch-up contribution of $3,500 if they are 50 and up.

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3. Thrift savings plan (TSP)

A TSP is a kind of retirement investment plan designed for federal employees and uniformed services personnel. It is similar to a 401k and offers the same benefits to government employees that are available to private sector employees. For 2023, you can make an annual contribution of $22,500 and an additional catch-up contribution of $7,500 if you are 50 and up.

The major features of a TSP are:

• It offers automatic payroll transfers which means your contributions are directly deducted from your paycheck.
• It allows matching contributions wherein the agency will match your contributions thereby boosting your savings.
• It provides a Roth version of TSP wherein you can contribute after-tax dollars to make tax-free withdrawals in retirement.
• It allows the transfer of a 401(k) and IRA to a TSP and vice versa when employees switch their jobs.

4. Cash-balance pension plan

A cash balance pension plan refers to a defined-benefit pension plan wherein the employer credits the employee’s account with a set percentage of their yearly compensation as well as any interest charges that may have accumulated over the year. The main benefit of this plan is that contribution limits increase with age. For example, individuals aged 60 and above can save more than $300,000 per annum.

To conclude

Based on your employment, risk tolerance, and financial needs, you may invest in a number of retirement plans as per your choice. While some retirement accounts such as a 401k are offered by employers, others like IRAs can be opened by individuals themselves. Though each retirement account may have different benefits and drawbacks, all of these plans do help you accumulate significant savings for retirement. Due to rising inflation and the shrinking value of Social Security benefits, it is vital that you begin planning for retirement as early as possible.

You may also consult with a professional financial advisor who will be able to explain the various retirement plans, their benefits, taxability, contribution limits, etc., and guide you effectively in building a substantial retirement corpus. Use the free advisor match service to connect with 1-3 financial advisors based on your financial requirements. All you need to do is answer a few simple questions about yourself and the match tool will find advisors that match your financial needs.