Retirement planning is an essential part of your overall financial strategy. One crucial aspect of this planning is choosing the right retirement account for you. There are various types of retirement accounts available, and each comes with its unique features, advantages, and disadvantages.
In this article, we’ll explore and compare different types of retirement accounts to help you make informed decisions about your retirement savings plan.
A traditional Individual Retirement Account (IRA) is one of the most common types of retirement accounts. Contributing to a traditional IRA allows you to receive tax deductions on your contributions, and the earnings on your investments in the account grow tax-deferred until withdrawal.
However, when you withdraw funds from a traditional IRA after age 59½, you must pay ordinary income taxes on both the original contributions and any earnings that have accumulated over time. Additionally, starting at age 72, you must take Required Minimum Distributions (RMDs) from your traditional IRA each year.
A Roth IRA is another popular type of individual retirement account. Unlike a traditional IRA, contributions to a Roth IRA are made with after-tax dollars – which means that you won’t receive a tax-deduction upfront like with traditional IRAs.
Earnings on investments in a Roth IRA grow tax-free throughout the life of the account – and when you withdraw funds from a Roth IRA (after meeting certain conditions), you won’t owe any taxes on those withdrawals. Also, unlike traditional IRAs, there are no RMD’s required at any age during the lifetime of the original owner
It’s also worth noting that when you contribute to a Roth IRA earlier in life before making too much money because there are income restrictions for contributing once earning thresholds exceed limits set by IRS rules.
SEP-IRA stands for Simplified Employee Pension Individual Retirement Account. This type of account is designed for self-employed people and small business owners. SEP-IRAs provide a simplified way for them to contribute to their own retirement as well as the retirement of their employees.
SEP-IRA contributions are tax-deductible, and any earnings on investments within the plan grow tax-deferred until withdrawal. The maximum contribution allowed per year is tied to income and limits set by the IRS each year.
A SIMPLE IRA (Savings Incentive Match Plan for Employees) is another type of employee retirement account that’s designed specifically for small businesses with 100 or fewer employees.
Contributions to a SIMPLE IRA are made with pre-tax funds, which can lower your taxable income and save you money in taxes. The employer must contribute either a matching contribution up to 3% of an employee’s salary or making a non-elective contribution equaling 2% of employees’ salary regardless if participating in plan
Withdrawals from a SIMPLE IRA are taxed as ordinary income, and like other types of retirement accounts, early withdrawals before age 59½ may result in penalties.
A traditional 401(k) plan is a workplace savings plan that allows you to save pre-tax dollars from your paycheck, reducing your taxable income. Employers can also choose to match contributions up to certain levels defined by the plan document.
The contributions made into traditional 401(k) plans grow tax-deferred while invested. This means you do not pay taxes on investment gains until withdrawn when reach aged 59½ or older. Beginning at age 72, as with traditional IRAs, RMD’s are required annually based upon Internal Revenue Service guidelines
Upon distribution, withdrawals from a Traditional 401(k) will be subject to ordinary income taxes based on applicable tax bracket at time receive
Some employers now offer Roths within their company’s qualified plans – known as Roth 401(k)s. The contributions to a Roth 401(k) plan are made after-tax, meaning you do not receive an upfront tax break on your contributions.
The investment earnings grow tax-free within the account. You won’t owe any taxes on qualified distributions made from a Roth 401(k) after age 59½ and the account has been open for at least five years. RMDs apply to Roth 401(k)’s that are rolled over to a Roth IRA upon death of the plan participant or when transferring between employers
Comparing Retirement Accounts
Now that we’ve explored different types of retirement accounts let’s compare them.
|Retirement Account Type
|Pre-Tax Deductions; Earnings Grow Tax-Deferred until withdrawn; Ordinary Income Taxes due upon withdrawals
|$6,000 ($7,000 if aged 50+) annually
|Required Minimum Distributions (RMDs) Required at age 72
|After-Tax Deductions; Earnings Grow Tax-Free until withdrawn (after meeting certain conditions); No taxes owed upon qualified distributions
|$6,000 ($7,000 if aged 50+) annually
|No RMD’s required for original owner
|Pre-Tax Deductions; Earnings Grow Tax-Deferred until withdrawn; Limit varies by income and IRS guidelines
|Pre-Tax Deductions; Employer Match required (3% matching or equal non-elective contribution of up to 2%)
|Penalties apply with early withdrawals before age 59½
|Pre-Tax Deductions via Employer Payroll Reductions; Contributions capped at $19,500 ($26,000 if aged over +50), Employer Match required as defined by plan document; Earnings Grow Tax-Deferred until withdrawn when reach aged 59½ or older
|$19,500 ($26,000 if aged over +50) annually
|RMD’s required at age 72 based on IRS guidelines
|After-Tax Deductions via Employer Payroll Reductions; Contributions capped at $19,500 ($26,000 if aged over +50), Employer Match required as defined by plan document; Earnings Grow Tax-Free until Qualifying Distributions are Made after meeting certain conditions including a holding period of five years
|$19,500 ($26,000 if aged over +50) annually
|RMDs apply to account when transferred to a Roth IRA upon death or between employers
When comparing different types of retirement accounts, it’s important to consider the tax treatment of contributions and withdrawals as well as contribution limits and any required minimum distributions.
If you’re looking for an account where you contribute pre-tax dollars and delay paying taxes on investment gains until withdrawing funds in retirement – a traditional IRA or 401(k) is likely best for your goals.
If you’d prefer to pay taxes upfront on contributions but then never again on earnings growth then investing in a Roth may be preferable. You could also look into a similar feature with your employer while participating in their companies’ qualified plan.
Ultimately, the right type of retirement account for you will depend on your unique financial situation and goals. Consider seeking advice from a financial advisor before making any decisions about saving for retirement.
What are the different types of retirement accounts?
There are four main types of retirement accounts: Traditional IRA, Roth IRA, 401(k), and SEP IRA.
What is the difference between a Traditional IRA and a Roth IRA?
The main difference is when you pay taxes. With a Traditional IRA, you take pre-tax dollars and pay taxes upon withdrawal. With a Roth IRA, you contribute after-tax dollars and withdraw tax-free in retirement.
Can anyone contribute to a 401(k)?
No. Generally, only employees who are offered the plan by their employer can contribute to a 401(k).
What is an advantage of contributing to a SEP IRA for self-employed individuals?
Self-employed individuals can contribute more than they could with other retirement plans like Traditional or Roth IRAs. They can also make contributions as both the employee and employer.
How does an employer match work with a 401(k)?
An employer will typically match contributions up to a certain percentage of an employee’s salary. For example, if an employee contributes 5% of their salary, the employer may match that contribution up to another 5%.
Can you withdraw money from your Traditional IRA before age 59 and a half without penalty?
In most cases, no. If you do need to withdraw money before that age for certain reasons like disability or buying your first home, there are exceptions that may allow it without penalty. However, it’s best to speak with a financial advisor before doing so.
Are there income limits for contributing to a Roth IRA?
Yes, there are income limits that determine how much you can contribute annually based on filing status. For single filers in 2021, the limit begins at $125,000 of modified adjusted gross income and phases out at $140,000. For married filers, the range is $198,000 to $208,000.
Can you have multiple retirement accounts?
Yes, you can have multiple retirement accounts. It’s important to make sure you’re not exceeding contribution limits set by the IRS for each account type. It’s also good practice to consolidate accounts whenever possible to simplify management and take advantage of economies of scale with diverse investments.
What happens to your 401(k) if you change jobs?
If you leave a job where you had a 401(k), it’s generally a good idea to rollover that money into your new employer’s plan or an IRA. Alternatively, some former employees choose to cash out their 401(k), but this typically comes with penalties and tax implications.
How can I determine which retirement account is best for me?
The best account for someone depends on many factors like age, income level, risk tolerance, goals and more. Speaking with a financial advisor who can help analyze your needs and long-term plans can be incredibly valuable in making the right decision.