An Overview of the Most Common Retirement Plans
Looking to sock away more money for retirement? You’ll need to know your investment options, their pros and cons, and which one is the best for you. That’s precisely what we’ll cover in this post.
IRA plans
An IRA (individual retirement arrangement) is an account featuring various tax benefits and designed specifically to help fund your retirement. You can invest in many different assets within the account—including stocks, bonds, ETFs, and mutual funds—and while many different types of IRAs are available, traditional and Roth IRAs are the two most common options.
Traditional IRA
A traditional IRA is a “tax-deferred” account, meaning you’ll pay taxes on a future date and any contributions you make are typically funded with pre-tax dollars; earnings grow tax-deferred until you withdraw them in retirement.
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The biggest benefits associated with a traditional IRA, mentioned above, are those related to taxes. These tax advantages are very appealing to investors, especially those (most of us) who find it difficult (if not impossible) to predict what our tax bracket will look like during retirement. More specifically, these breaks help diversify your retirement income by complementing any tax-free accounts you may have.
Though you can withdraw money from your traditional IRA at any time, keep in mind that you’re required to pay corresponding taxes and your withdrawal may trigger penalties (depending on timing). For example, an early withdrawal penalty of 10% is generally assessed on those who withdraw money from their traditional IRA prior to the age of 59½ (click here to read about some exceptions).
Traditional IRA contribution limits ($7,000 for those under the age of 50 and $8,000 for those age 50+ in 2024) likely won’t help you save for a fully funded retirement. Since a traditional IRA is a tax-deferred account, Uncle Sam requires you to pay taxes on your asset. Required minimum distributions (RMDs)—the minimum amount of money one must withdraw from an IRA by April 1 the year after turning 73—come into play here, with annual withdrawals then due by December 31 thereafter.
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Traditional IRAs make the most sense if you’re just starting out and/or looking for simplicity, as they’re the easiest option to establish and don’t have any special filing requirements.
Roth IRA
Unlike the immediate tax breaks accompanying a traditional IRA, these come later with a Roth IRA—as the latter is funded with after-tax dollars, and you can enjoy tax-free withdrawals on qualified distributions in retirement.
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In addition to the aforementioned tax benefits, you can withdraw Roth IRA contributions at any time tax and penalty-free: which is sometimes beneficial if you’re struggling to make ends meet or need the funds for a temporary expense. Just note this is true for contributions only; if you withdraw any earnings before you’re eligible to make a qualified withdrawal, you’ll likely be required to pay taxes and face a 10% early withdrawal penalty on the same.
A Roth IRA is also sometimes an excellent wealth-transfer vehicle, allowing you to pass any amount to your heirs—tax-free!
As for one con, much stricter income limits prevent some people from contributing to a Roth IRA (whereas one can contribute to a traditional IRA regardless of how much money he/she earns).
For example, single filers with a modified adjusted gross income (MAGI) of over $161,000 in 2024 are not eligible to contribute to a Roth IRA (those with a MAGI between $146,000 and $161,000 can only contribute a reduced amount).
For those filing jointly, the maximum MAGI limit is $240,000 based on contribution qualifications. If your joint MAGI is more than $230,000 but less than $240,000, your maximum allowed annual contribution is reduced.
Contribution limits for a Roth IRA ($7,000 for those under the age of 50 and $8,000 for those age 50+ in 2024) likely won’t help you save for a fully funded retirement.
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Generally speaking, a Roth IRA makes the most sense for those seeking the flexibility to withdraw funds (contributions) without penalty, no need to worry about RMDs, and/or the ability to diversify retirement savings with both tax-free and taxable accounts.
Spousal IRA
A spousal IRA isn’t a special type of account; it’s just your typical Roth or traditional IRA that’s subject to identical contribution limits, income limits, catch-up contributions, and other rules. So, what exactly is the difference, then? As the name implies, a spousal IRA is opened by your spouse, in his or her name, and has a few associated eligibility requirements. For example, while one typically needs to have earned income to contribute to an IRA, a spousal IRA is one exception to this IRS provision as it allows a working spouse to make contributions on behalf of a marriage partner who brings in no (or very little) income.
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Spousal IRAs are sometimes key for couples looking to sock away savings for retirement, especially if one spouse has left the workforce to raise children or care for a family member. The biggest benefits are associated tax breaks, as these types of investments are subject to the same rules as Roth and traditional IRAs.
There are really no cons associated with spousal IRAs, but keep in mind that while the working spouse is funding the account, the non-working spouse controls the IRA (co-ownership is not allowed) and is therefore completely responsible for making all investment decisions—whether with respect to stocks, bonds, mutual funds, or ETFs for asset allocation. What’s more, he or she is not obligated to name his/her spouse as an account beneficiary or seek consent to name someone else as the same. Account distributions (withdrawals) are shared in retirement, however.
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Spousal IRAs are often an excellent option for couples to save for retirement, especially since this time of life certainly won’t come cheap.
Rollover IRA
A rollover IRA allows you to move funds from an employer-sponsored retirement account (e.g., a 401(k), 403(b), or profit-sharing plan) to an IRA. While you can roll over an IRA at any time, this most often occurs when someone changes jobs or retires.
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Rolling over your old 401(k) or 403(b) into an IRA offers many advantages including more control over your investments (given more options), tax advantages (especially if you go the Roth IRA route) and simplified finances; if you plan on changing jobs at least a few times throughout the remainder of your career, you’ll appreciate your IRA as a single destination for the entire breadth of your older retirement savings plans.
Rollover IRA downsides, meanwhile, include a lack of loan options (meaning you can’t borrow from your IRA as you often can from a 401(k) plan), and while rolling over your 401(k) to an IRA typically doesn’t summon a fee, new IRA account fees are sometimes higher than those for 401(k)s.
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While rolling over your 401(k) or 403(b) into an IRA is often a preferred choice due to the simplicity and flexibility of these accounts, this is sometimes not suitable for all employees in the midst of a job change. For example, if you plan on taking early distributions and you’re 55 or older, it may behoove you to keep the money in your existing 401(k).
SEP IRA
Though similar to traditional IRAs, SEP (Simplified Employee Pension Plan) IRAs are specifically designed for those who operate as a sole proprietor or business owner, are in a partnership, or earn self-employment income.
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Alongside tax advantages, SEP IRAs also have much higher contribution limits than both traditional and Roth IRAs (allowing for contributions of up to 25% of total compensation or a maximum of $69,000 in 2024), are easy to set up and maintain, and are flexible overall—employers can decide how much they want to contribute on an annual basis, providing flexibility during periods when business income might fluctuate.
Some SEP IRA drawbacks include that they don’t allow for catch-up contributions nor borrowing from the account. They also have mandatory employee contributions, meaning business owners who contribute to their own SEP IRAs are obligated to do the same—reflecting equal compensation—for any employees.
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SEP IRAs are often most beneficial for small businesses with no or few employees or self-employed individuals seeking the flexibility to choose when and how much to contribute (especially with respect to a seasonal business or fluctuating income).
SIMPLE IRA
A SIMPLE IRA is a retirement savings plan designed specifically for small businesses and self-employed individuals. As with a 401(k), a SIMPLE IRA is a tax-deferred vehicle: meaning you fund the account with pre-tax dollars and pay taxes on any future withdrawals. SIMPLE IRAs also allow employers to make contributions on behalf of employees.
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If you’re an employee, SIMPLE IRAs feature tax-deferred savings, employer matching, investment choices that often outnumber those of a 401(k), and immediate vesting from Day 1. They also allow for catch-up contributions.
On the flip side, while contribution limits for SIMPLE IRAs are higher than IRAs ($16,000 for anyone under age 50 and $19,500 for anyone age 50+ in 2024), they are lower than their 401(k) counterparts, loans aren’t allowed, and steep early withdrawal penalties (as well as strict rollover rules) exist.
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If you’re seeking a reliable way to save for the future, a SIMPLE IRA can help achieve your goals. However, as with any investment, you’ll need to determine how much to contribute and how exactly to invest your money when pursuing this option.
Defined contribution plans
A defined contribution plan (DC) is a retirement plan whereby employees and/or employers contribute to the employee’s individual plan account.
401(k)
A traditional 401(k) is an employer-sponsored retirement account that comprises various investments—typically stocks, bonds, and mutual funds—employees can choose from themselves or with the help of a financial advisor. Those who wish to participate can invest a percentage of their pretax income to fund their account, with the money automatically withdrawn from their paychecks. As an added benefit, most employers match employee contributions (up to a predefined percentage): essentially “free money” for the participating employee!
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First and foremost, contributions are tax-deferred as the account is funded with pretax dollars: meaning you won’t pay taxes on money in your account until you make a withdrawal.
Because contributions (up to $23,000 in 2024) are made with pretax dollars, meanwhile, they also lower your taxable income. For example, if you earn $100,000 a year and contribute $15,000 annually to your 401(k), only $85,000 of your earnings are subject to tax; your 401(k) contributions can therefore ultimately drop you into a lower tax bracket.
Another 401(k) benefit is tax-free growth; any 401(k) balance gains grow tax-free, provided you don’t withdraw money from the account prior to hitting the minimum age requirement.
As with any retirement account, however, some drawbacks do exist including account fees, limited investment options (especially compared to an IRA), and early withdrawal fees if you pull money out before the age of 59½.
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A 401(k) provides an easy way to kickstart the retirement savings process, especially since owning an account comes with several tax advantages. As many employers also match a portion of your savings, there’s simply no reason not to open a 401(k) account if you’re eligible.
403(b) and 457(b)
These operate just like 401(k) plans, but 403(b) plans are offered by public schools, charities, and some religious institutions while 457(b) plans are available only to employees of state and local governments and some tax-exempt organizations.
Solo 401(k)
Also known as an “individual 401(k),” a solo 401(k) is another retirement plan option that features many of the same rules and requirements as an employer-sponsored 401(k) but is specifically designed for self-employed workers.
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Solo 401(k) plans offer a wider breadth of investment options than an employer-sponsored plan and can fund alternative investments such as real estate and cryptocurrencies.
Business owners can contribute both as an employer and employee, but total contributions cannot exceed $69,000—with an additional $7,500 in catch-up contributions (for those age 50 or older). Employees, meanwhile, can contribute up to $23,000 with an additional $7,500 in catch-up contributions (with contributions simply deducted from one’s paycheck) or set up a traditional solo 401(k) or Roth solo 401(k) that mimics Roth IRA tax treatment.
That said, solo 401(k) plans are a little more complicated to set up (compared to a SEP IRA) and come preloaded with additional filing requirements for assets exceeding $250,000. Furthermore, participants cannot have any full-time employees and are only permitted to add a spouse to the plan.
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A solo 401(k) can best help business owners and their spouses aiming to maximize retirement savings and/or seeking the flexibility to save even more during years when their business is most profitable.
Annuities
An annuity is a type of insurance product that provides investors with a guaranteed stream of income. You pay money up front (via a lump sum or series of payments), which is then invested and later paid out per an agreed-upon time, amount, and timeframe.
All annuities have two components: the principal you pay into it and returns on the same. Depending on the type of annuity you establish, you can fund the account with either pre-tax (“qualified”) or post-tax (“non-qualified”) dollars. Annuity account investments can grow tax-free no matter which option you choose.
There are two basic annuity categories: immediate and deferred. While an immediate annuity provides a guaranteed income stream (often within a year) in exchange for a lump sum paid today, deferred annuities are more common and task participants with making a series of payments over a period of time to begin collecting upon retirement.
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The biggest benefit of a deferred annuity is that it creates a stream of income for life, especially important if you’re worried about running out of money during retirement.
However, annuities are sometimes complex (some needlessly) and come with a wealth of perplexing features. They’re also expensive and often include a variety of fees that make them even less attractive.
Another reason to steer clear of an annuity is that the investment may not provide the level of returns you can potentially achieve elsewhere. This is a critical consideration, especially if you haven’t yet maxed out other retirement vehicles such as your 401(k) and IRA.
Finally, if the insurance company that sold your annuity goes bankrupt, this can adversely impact your payouts given limited coverage with state guaranty associations. It’s therefore crucial to select a reputable insurance company with a long track record of financial strength.
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If you’re a conservative investor seeking guaranteed income for the rest of your life, are worried about running out of money during retirement, and/or already maxed out other retirement vehicles, an annuity may be appropriate for you.
Traditional pensions
Fully funded by employers, traditional pensions provide a fixed monthly benefit to workers when they retire. Because these are less common today than they were years ago (per the U.S. Bureau of Labor Statistics, fewer than 15% percent of private industry workers had access to one in 2022), we’ll keep this section brief.
If a pension applies to you, primary considerations include when to leave your company (as your benefit is generally tied to years of service and compensation), whether or not to take a lump sum pension offer, and which pension payout options to select.
Cash value life insurance plans
A permanent life insurance policy is one way to supplement your retirement savings, with these policies typically allowing you to build or “accrue” cash value (funded by a portion of your premiums) in addition to your death benefit. Think of a cash value insurance policy as an investment-like savings account that includes a death benefit.
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One distinct advantage of this option is the ability to withdraw from the cash value/savings you’ve built on an as-needed basis and spend the money as you wish.
Drawbacks are associated with withdrawals, however, so never take these transactions lightly. For example, any amount withdrawn is deducted from your death benefit: thus leaving less for your loved ones. Tax implications are also sometimes in play, especially if you dip into any gains (the value exceeding your basis or what you had paid in premiums).
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Generally speaking, if you’ve maxed out all other retirement savings vehicles and want to continue investing, you might want to consider this specific type of life insurance.
In sum: the most common retirement plan choices
It’s important to know your options when looking to save for your future. This post hopefully did just that, arming you with a high-level understanding of the most common retirement plan types investors rely on to accumulate wealth.
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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.
Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.
Fixed and variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59½ are subject to a 10% IRS penalty tax, and surrender charges may apply. Variable annuities are subject to market risk and may lose value. Riders are additional guarantee options that are available to an annuity or life insurance contract holder. While some riders are part of an existing contract, many others may carry additional fees, charges, and restrictions, and the policyholder should review his or her contract carefully before purchasing. All guarantees are based on the claims-paying ability of the issuing insurance company.
This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contact your insurance agent. This article is intended to assist in educating you about insurance generally and not to provide personal service. It may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation, or activities that may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. If you need more information or would like personal advice, you should consult an insurance professional. You may also visit your state’s insurance department for more information.
