The sooner you prepare for retirement, the better. In fact, the recommendation is to begin saving as soon as you earn an income.
Does that mean if you haven’t gotten a jump start on saving that you won’t be able to have a comfortable retirement? Absolutely not.
There are so many retirement plans, all with different drawbacks and benefits depending on your age and financial situation. In fact, The Internal Revenue Service (IRS) lists 14 types of retirement plans.
Here we will look at six of the most popular types of retirement plans and how they work.
A 401(k) is one of the most common retirement plans. Your employer offers this type of plan and sometimes will match your contribution. A 401(k) is elective but is appealing because many employers match the employee’s contribution.
The IRS limits the yearly contribution amounts. Employees under the age of 50 can contribute up to $19,500 annually, with those over the age of 50 capped at $26,000. 401(k) plans can be held as mutual funds, annuities, stocks and bonds.
A 403(b) retirement plan is an annuity plan with a tax shelter. These plans are offered by schools and certain 501(c) eligible organizations. They are cheaper for employers to offer than 401(k) plans. Employers sometimes match employee contributions.
Because the contributions are tax-free until the funds are withdrawn, there are usually financial benefits to participating in a 403 (b) plan. The contributions are held in the form of mutual funds or annuities.
Traditional Independent Retirement Account (IRA)
A Traditional IRA is a way to contribute tax-deferred money to a retirement account. Like other types of plans, the taxes will be paid at the time of withdrawal. The funds can be invested into pretty much any stock, bond, or mutual fund.
Unlike a 401(k), a Traditional IRA is a plan held by an individual and not sponsored by an employer. Anyone with a taxable income is eligible for this type of IRA. The current limits for IRA contributions are $6,000 per year, or $7,000 for individuals over the age of 50.
Unlike a Traditional IRA, with a Roth IRA you pay taxes on contributions upfront. However, you do not pay taxes when funds are withdrawn. Roth IRAs can only be established by individuals with an Adjusted Gross Income (AGI) below a certain level set by the IRS. The amounts that can be contributed are reduced as AGI increases.
Savings Incentive Match Plans for Employees (SIMPLE IRA)
This type of program is used by smaller employers or new businesses that do not offer a 401(k) retirement plan. The money contributed is tax-free and held and grown in a retirement account. Taxes are owed when the retirement plan is cashed out. A SIMPLE plan has higher contribution limits than a Traditional IRA with a cap of $13,500 per year, or $16,500 for employees over 50.
Employee Stock Ownership Plans (ESOPs)
An ESOP is a retirement plan where company stock is put in a retirement account for an employee. Essentially, the employee holds an ownership interest in the company. This is a common type of retirement plan offered by start-up companies. The plans often vest over time, urging employees to stay at the company for a certain amount of time.
There are several retirement plans we didn’t discuss here. The best way to decide on a suitable plan for your situation is to consult with a wealth management professional.