Understanding the Differences Among Popular Retirement Account Options

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Understanding the Differences Among Popular Retirement Account Options_mature woman raising hand to ask a question

Planning for retirement is an important process that everyone should begin early in their careers. One essential step in preparing for retirement is to select the plan that may be best for you. You’ve likely heard of various retirement accounts over the years. If you’re evaluating your current plan or looking to get enrolled, here’s a list of the most popular retirement account options to help get you started:

Employer-sponsored retirement plans

If your company offers a retirement plan, particularly one with a match, this option may be the most advantageous for you. These are simple to use since all you need to do is determine how much you want pulled from each paycheck, and the deposit will happen automatically.

Here are some of the most common retirement plans typically offered by employers:

401(k)

Employee contributions are taken out of paychecks pre-tax and directed to a dedicated account. The money is taxed when it’s withdrawn. The IRS sets contribution limits each year, and for 2020 and 2021, workers can’t put more than $19,500 into their 401(k).

There’s one exception to this rule: catch-up contributions. These are intended for people age 50 or older to ramp up their retirement savings. For employees who meet the age requirements, the maximum contribution is $26,000 ($6,500 more than the base limit).

The money in a 401(k) is meant to be untouched until retirement, though people may be able to make withdrawals or even a loan from their plan for specific reasons outlined by the plan sponsor. However, there are some instances when someone can access their 401(k) savings early without incurring a tax penalty, such as if the plan participant sustains a total and permanent disability.

403(b)

The major difference between a 401(k) and a 403(b) is the type of employer that offers the retirement plan. These are commonly found in public schools, churches and 501(c)(3) non-profit organizations. They’re also referred to as tax-sheltered annuities (TSA plans).

Some employees also have access to Roth 403(b) plans, in which contributions are taxed when directed to the account instead of when they are withdrawn.

457

State and local governmental and other tax-exempt entities can set up 457(b) plans for their employees. The contribution limit is the same for the 401(k) and 403(b) plans, but the catch-up rules are slightly different. Instead of being able to contribute an additional $6,500, workers with a 457 plan who are three years or less from retirement can contribute double the normal limit: $39,000 in 2020 and 2021.

SIMPLE IRA

Smaller employers that want to sponsor a retirement plan for their employees may consider going with a SIMPLE (Savings Incentive Match Plan for Employees) IRA. With this arrangement, employers and employees can still contribute to traditional IRA accounts.

The contribution limit for SIMPLE IRAs is lower than that for 401(k)s and other employer-sponsored retirement accounts; in 2020 and 2021, it’s $13,500. While an employee can participate in multiple plans, the total amount that individuals can contribute to all retirement plans, including the SIMPLE IRA, is $19,500.

Employers that offer SIMPLE IRAs can’t offer any other retirement plan option, and must contribute to employees’ accounts.

Health Savings Account

Though not typically thought of as a retirement account, an HSA can be a valuable long-term savings vehicle. The money you put in your HSA can go toward medical expenses, but there’s no deadline for you to use the money, and it’ll continue rolling over indefinitely. As such, you could feasibly continue stockpiling savings in your HSA for decades to come, assuming your contributions outpaced your need up until your retirement years.

One important thing to note about HSA funds: if you spend them on non-medical expenses before age 65, you’ll be charged a 20 percent tax penalty. However, chances are you’ll incur some type of medical expense at some point. The average 65-year-old couple retiring today will expect to have $280,000 in medical and health care costs throughout their retirement.

Understanding the Differences Among Popular Retirement Account Options_two mature women discussing retirement options

Retirement plans not offered through employers

Employer-sponsored plans have many perks, but they’re not the only way to prepare for retirement. A few reasons a person may want to look into other choices include:

  • Your employer doesn’t offer a retirement plan
  • You’re self-employed or a business owner
  • You’re working as a freelancer or contractor
  • You want to supplement an employer-sponsored retirement plan

Here are some of the most common options for retirement plans not offered through employers:

Solo 401(k)

Solo 401(k)s, also called one-participant 401(k)s, have all the same rules as a traditional 401(k), with one key difference: it’s for business owners who don’t have employees. These cover one person and their spouse, if applicable.

IRA and Roth IRAs

Anyone can set up a traditional or a Roth IRA with their financial institution of choice. These accounts allow you (or your spouse, if you file taxes jointly) to contribute to the IRA until you’re 70 ½ years old as long as you have earned income. Additionally, you must choose to contribute to an IRA or a 401k as you cannot contribute to both in the same year.

The contribution limit is notably lower than 401(k)s and similar retirement savings vehicles: $6,000 for 2020 and 2021, $7,000 if you’re 50 or older. While you can open multiple IRAs, this limit applies to your contributions to all of them combined.

Once you turn 70 ½, a few things happen if you have a traditional IRA:

Neither rule applies to Roth IRAs. You can withdraw funds at any time for both traditional and Roth IRAs, with a 10 percent tax applied if you’re younger than 59 ½ when you make your withdrawals—unless the reason for your withdrawal is a qualified exception.

Contributions of traditional IRAs may be tax-deductible, but not for Roth IRAs. Conversely, traditional IRA distributions and withdrawals are taxable, but not for Roth IRAs.

Understanding your retirement options

What are your retirement goals? Are you on track to reach those goals? Retirement planning starts with understanding your retirement needs. Once you have a retirement goal you can begin to work toward achieving your goal. To determine your retirement need start with our Save for Retirement calculator.

Planning for retirement is important, but it can be confusing if you’re going at it alone. To get a better idea of your options and which may benefit you the most, request a complimentary consultation with a Financial Advisor. We can discuss your options and explain the pros and cons of various savings vehicles, including IRAs.

Disclosures

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