11, There was a time when workers could depend on an employee pension plan and Social Security to cover their retirement expenses. Nowadays, pensions are scarce. And, the future of Social Security is murky at best.
Maybe this is why one in four Americans haven’t saved anything for retirement. And, those that did, aren’t saving enough.
But, it doesn’t have to be this way. We’ve got all the information you need about the best retirement plans and how to choose the right plan.
An Overview of Retirement Plans
When it comes to funding your golden years, you have three main choices.
- 401(k)s and similar retirement plans. Your employer might offer you free money if you contribute enough to qualify for a match. 401(k)s, 403(b)s, 457(b)s, defined benefit plans, and TSPs are some examples of employer-sponsored retirement plans.
- If you have maxed out your 401(k) at work or don’t have one at work. IRAs can be a viable option.
- You own a small business or are self-employed. Among the retirement accounts available to you are the SEP IRA, Solo 401(k), SIMPLE IRA, and profit-sharing accounts.
We will further breakdown and rank your retirement plan options. Depending on your financial situation, this may help you decide which option is right for you. However, you should always talk to a financial advisor about any retirement plan.
Employer-Sponsored Retirement Plans
401(k)s and other defined contribution (DC) plans have all but taken over the retirement market since their introduction in the early 1980s. In addition, the employer-sponsored retirement plan is probably your most valuable job benefit. The 2019 Employee Benefit Trends Study from MetLife found that 60% of respondents said retirement plans were a “must-have” when evaluating a prospective employer.
You should definitely opt-in if your employer offers a retirement savings plan. They can really help you make a big difference. Depending on where you work, though, your retirement options may differ.
401(k)s are the most common employers’ retirement plans. Every payday, your employer deducts money from your account and invests it for you. If you leave your job, your 401(k) funds remain in your account. Or, you can roll them over into a new account.
Under 401(k) plans, you may be able to make pre-tax contributions. Since they grow tax-deferred, invested funds and earnings aren’t taxed until you withdraw them in retirement.
To motivate employees to enroll in 401(k) plans, an employer may match a portion of their contributions.
For 2021 and 2022, the maximum 401(k) contribution is $19,500. If you’re 50 or older, you can contribute another $6,500. There is usually a penalty if you withdraw funds from a 401(k) before the age of 59 1/2.
It’s not uncommon for Roth options to be part of many 401(k) plans. These plans don’t require pre-tax contributions–they’re after-tax. When you withdraw in retirement, you don’t pay taxes on it.
Roth 401(k)s and traditional 401(k)s have the same contribution limits. If your employer matches Roth 401(k) contributions, you still get the match. According to federal regulations, it’ll go into your traditional 401(k).
Determining when you expect your taxes to be lower is the key to choosing between a Roth and traditional 401(k). If you make contributions to a 401(k) now, or if you withdraw money from it in retirement years from now.
Contributing to a traditional 401(k) account can lower your retirement taxes if your income taxes are higher today. For now, a Roth 401(k) account is a better choice if you think you are in a lower tax bracket than you will be in retirement.
One more thing. A 401(k) plan, wheter traditional or Roth, offered by your employer can’t require more than a year of service to participate. And the minimum age to participate cannot exceed 21.
403(b) plans work similarly to 401(k) plans. But it’s limited to ministers, public school employees, and nonprofit employees.
Other than who can use a 403(b), employees who have worked for their employer for at least 15 years will be able to contribute an extra $3,000 per year to a 403(b). In 2022, the contribution limit for 403(b) accounts is $20,500, or 100% of your compensation, whichever is lower. You can make catch-up contributions if you are over 50 and contribute an additional $6,500 per year.
Retirement withdrawals are generally treated as regular income. When you’re under 59 1/2, you’re subject to taxes and penalties for withdrawals.
Some nonprofit employees and employees of state and local governments can enroll in 457 plans. Their contribution limits resemble those of 401(k)s and 403(b)s. But in their final three years before retirement, they allow catch-up contributions of up to $39,000. These accounts are less likely to offer employer matching contributions — and taking an emergency withdrawal is tough.
Taxes are deferred on the account. Again, you won’t owe taxes on contributions or earnings until you begin taking withdrawals in retirement. Several 457(b) plans permit Roth accounts, which are similar to Roth 401(k)s.
In the U.S., an individual retirement account (IRA) is a valuable way to save for retirement. Contributions to an account in 2022 can be up to $6,000 for individuals, and up to $7,000 for workers over the age of 50.
IRAs come in many varieties, such as the traditional IRA, Roth IRA, spousal IRA, rollover IRA, SEP IRA, and SIMPLE IRA. Here are the characteristics and differences of each.
You are probably most familiar with the traditional IRA. It’s comparable to a traditional 401(k). The differences? It has lower contribution limits, phase-out deductions as your income rises, and provides free choice in retirement funds.
Contributions are pre-tax, just like in a traditional 401(k). Until the payouts begin between the ages of 59.5 and 72, the funds grow and gain interest without triggering tax liabilities. The amount of taxes you have to pay at that age is likely to be lower as well because your income is likely to be lower.
IRA contributions will be capped at $6,000 per year in 2021 and 2022. You can contribute up to $7,000 per year if you are 50 or older.
Generally, a traditional IRA is one of the best retirement plans arvailable. A match-matching 401(k) plan is somewhat better, however. Alternatively, if your employer does not offer a defined contribution plan, you may contribute to a traditional IRA. Be aware, though, that the tax deduction for contributions is not available to you if you earn more than $100,000.
IRAs also have Roth versions, just as 401(k) plans do. There are, however, some special provisions for IRAs.
Savings are made after-tax in Roth 401(k)s. The individual pays taxes on his or her income, then puts the money into a Roth IRA. Distributions are tax-free after the money accumulates in the Roth IRA.
People who expect to have a higher income after retirement than they do now are likely to benefit from Roth plans. Roth IRAs also retain the contribution limit of a traditional IRA.
Additional conditions apply, however. The first disadvantage of Roth IRAs is that they aren’t available to high-earners. Those who make over $140,000 a year, or $208,000 for a couple, are not eligible to contribute to a Roth IRA.
However, once you’ve opened a Roth IRA, you can keep the money in it. Contrary to traditional 401(k)s and IRAs, Roth IRAs don’t have to be tapped by the age of 72. As such, the government can get a piece.
Additionally, Roth IRAs can only be funded with earned income. It cannot hold rental income, dividends, capital gains, or interest from loans.
It has to be money that you’ve made through work.
401(k)s are complex and expensive, which is one of their big drawbacks. It’s not a requirement that businesses offer 401(k) plans, but some small firms may be unable to afford them if they don’t.
A big disadvantage of an IRA is the low contribution limit. If you have a retirement fund, you may wish to contribute more than the maximum of $6,000 or $7,000 .
These two problems can be solved by a SEP IRA, or Simplified Employee Pension IRA.
It combines some of the features of an IRA and a 401(k). Employees have some control over investments, and contributions are relatively high with the result of an employer-sponsored retirement fund. In 2022, the contribution limit is 25 percent of compensation or $61,000, whichever is less. In the case of self-employed individuals, calculating contribution limits is more challenging.
Employers play a key role in SEP IRAs, which are different from other IRAs. You can set up a SEP IRA as a sole proprietor, partnership, or corporation. Employees can contribute to their retirement fund from their pre-tax earnings, which allows them to give them a retirement fund. Traditional IRAs and SEP IRAs offer the same tax deferrals.
Additional IRA plans.
While the three plans listed above are the most common types of IRAs there are even more IRA options.
Small businesses with fewer than 100 employees can take advantage of the Savings Incentive Match Plan for Employees (SIMPLE) IRA. In 2021, you may contribute up to $13,500 ($14,500 in 2022). In addition to the 3% matching contribution, employers can choose to make a 2% nonelective contribution to their employees’ SIMPLE IRAs.
Employees with earned income are typically eligible for IRAs. Spousal IRAs allow spouses of workers with earned income to contribute to IRAs as well. The spouse who is working must have a taxable income that exceeds that contributed to any IRAs, and the spousal IRA can be either a traditional or Roth IRA.
Rollover IRAs happen when you move a retirement account from one IRA to another. Money is transferred from one account to the rollover IRA tax-free. Traditional or Roth IRAs can be rolled over at any institution that allows them. And, there’s no limit to how much you can transfer.
Payroll deduction IRA.
It’s easy to set up payroll deduction IRAs for business owners. Employees can open IRAs at financial institutions of their choosing, and payroll deductions fund those IRAs. If you’re a small business owner, you can only contribute to employees’ IRAs.
Solo 401(k) Plan
“As you might have surmised, a solo 401(k) is a retirement plan designed, well, for individuals,” explains Due founder John Rampton. “Specifically, business owners who only employee me, myself, and I.”
“Sole proprietors, independent contractors, and freelancers all quality — just as long as they don’t employ anyone else,” he adds. “And, don’t try to pull a quick one on the IRS as they are very strict about this requirement.”
The following caveats apply, however.
First, if you’re married. In this case, you’re both covered.
A second example is if you have a day job and a side hustle. “You may be able to contribute to both,” John says. “However, to play it safe, double-check with a tax professional.”
“And, in case you’re curious, there are no age or income restrictions when it comes to a solo 401(k).” You can contribute up to $61,000 in 2022 or $67,500 if you’re 50 or older because you can contribute as both an employee and employer.
In short, anyone can open a solo 401(k). And it can be a traditional or Roth account.
In a similar manner to a pension plan, a fixed annuity can provide guaranteed and lifetime payments. In fact, 9 in 10 investors, according to the Protected Retirement Income and Planning Study conducted by ALI and CANNEX, would prefer a retirement income plan that guarantees an income or protects the principal.
Compared to some other annuity contracts, like indexed or variable annuities, fixed annuities are easier to understand and compare. For instance, with a Fixed Annuity, you can get 3% a month on your money.
A fixed annuity typically has predictable benefits and is tax-deferred. It can also provide a death benefit to your beneficiaries. And, as an annuity is not subject to IRS contribution limits. As such, you can invest whatever amount you want for your retirement.
Moreover, fixed annuities are among the safest and most secure investments. Moreover, state insurance departments heavily regulate them. Because of that, they’re not affected by market changes. It’s usually possible to access 10% of your annuity’s cash value each year without any penalties if you’re over 59 1/2.
But, there are some disadvantages to be be aware:
- A fixed annuity provides retirement savings. Therefore, the IRS imposes a 10% penalty on gains withdrawn from fixed annuities for those under 59 ½.
- The ordinary income tax applies to withdrawals and payouts.
- Fixed annuities may not keep up with inflation.
- A fixed annuity is not always the best retirement income option. They’re usually used to build wealth. You should get a variable annuity if you want to turn your assets into income.
- The FDIC doesn’t insure fixed annuities. However, they’re backed by state-regulated insurers.
Old School Pensions
Some large companies, the military, and the government may offer pension plans, states the SoFi team. As more employees take responsibility for their retirement, these are becoming less common. In fact, as of 2019, only 14% of Fortune 500 companies offered defined-benefit plans to new hires, according to a study released by Willis Towers Watson. This is down from 59% in 1998.
Despite their rarity, they still do exist. So, they are worth noting.
Pension plans generally fall into two broad categories:
Defined benefit pension.
When you retire, these plans, also referred to as cash balance plans, provide you with a lifetime income. The amount you get depends on your income and how long you’ve worked. An example would be taking the average of your last five years of salary and adding 3% for each year of service to 80%. You’d get $60,000 if you worked for 20 years, earning $100,000 on average in your last five years.
Before you retire, make sure you understand your various payout options.
Defined contribution pension.
Typically, employers contribute a fixed percentage of your salary each year to this pension plan. You will generally see the value of your money grow over time. However, leaving in the first 3-5 years might mean losing all of it. If you stay longer, you own more of it and you can take it home.
There are some plans that invest your money for you. But most let you decide how you want to invest it.
In both cases, participation is automatic. If you have a retirement plan, understand its value, even if you don’t contribute. These are important compensation benefits if you work in the military, for the government, or for a firm that has one.
Whenever you change jobs, make sure you understand the vesting schedule of your pension or profit sharing plan. After all, leaving too soon could mean forfeiting your pension.
The Federal Thrift Savings Plan
Thrift Savings Plans (TSP) are only available to federal employees and uniformed service members. They function much like corporate 401(k) plans. A TSP lets you put pre-tax money in, and if you withdraw it after retirement, it grows tax-deferred. Some TSPs even offer Roth 401(k)s.
There are usually five low-cost investment options available to participants. Among these are bond funds, S&P 500 index funds, small-cap funds, international stock funds, plus Treasury securities funds.
Moreover, federal workers can invest in those core funds through several lifecycle funds with different retirement dates. This should simplify the process of selecting investments.
The main drawback of this plan is that your account balance is always uncertain at retirement. But, that’s the same with all defined contribution plans.
There’s a $20,500 cap on TSP contributions in 2022. If you’re 50 or older, you can contribute $6,500 more.
Cash-Value Life Insurance Plan
Companies sometimes offer insurance vehicles. Among the options available are whole life, variable life, universal life , and variable universal life. They build cash value while providing a death benefit and a retirement income.
When you withdraw the cash value, your cost basis comes out first. However, if you don’t do it right and the policy lapses, you could get a big tax bill.
People who have maxed out all other retirement-saving options should consider these products. Once you’ve reached the maximum contributions for your 401(k) and IRA, you might consider this retirement plan.
Nonqualified Deferred Compensation Plans (NQDC)
If you’re not a CEO or CFO, you’re not eligible to get an NQDC. You can choose from two main types of NQDCs if you’re in the C-Suite. The first is a 401(k) plan with company matching and salary deferrals. The second is an employer-sponsored plan.
Usually, the latter one doesn’t get funded. A “mere promise to pay” can be used to claim money from a debtor. It’s riskier since the company has to be financially stable.
Additionally, it’s tax-deferred, so you’ll save money. Until distributions are taxed, employers can’t deduct contributions.
Frequently Asked Questions
1. Among retirement plans, which are the best?
IRAs are one of the best individual retirement plans. These include traditional IRAs, Roth IRAs, and spouse IRAs. They are open to anyone with an income.
The best employer retirement plans are 401(k), 403(b), or 457(b).
2. What is the maximum contribution I can make to my 401(k) and/or IRA?
For 2022, the annual contribution limit is $20,500. However, if you’re 50 and over, you can contribute an additional $6,500 per year.
As for IRAs, the annual contribution limit fo 2022 is $6,000. Or $7,000 if you’re age 50 or older.
3. What are my options for the money in my 401(k) or pension plans?
Generally, there are four broad options.
- Keep it invested in the company’s plan.
- Receive a lifetime income by annuitizing.
- Withdraw the account balance, pay taxes, and then invest it.
- Rollover to an IRA or other pension fund. If you do, you won’t have to pay taxes. And, you’ll continue to defer the income tax.
4. What can I do to prepare for retirement while I’m still young?
As early as possible, you should begin saving for your retirement. By living within your means, you can save more money and live on a lower amount in retirement. Don’t forget to take advantage of the retirement plans offered by your employer to help supplement your retirement income. If not available, you can fund your retirement though an IRA or Solo 401(k).
Taking advantage of all these options will allow you to save the money you need to live comfortably in retirement.
5. How much money is a good amount for retirement?
A variety of factors determine retirement income. Among them are your current lifestyle, retirement lifestyle, obligations, and health. Experts say that you should have 80% of your salary in retirement.