The future can feel overwhelming – planning for it even more so. With so many acronyms and options thrown around for savings and investment accounts, figuring out the right retirement path can feel like navigating a financial maze.
Fear not, weary traveler. This guide demystifies the different retirement savings accounts available in the US. From 401(k)s to IRAs, we’ll break down the benefits and considerations of six popular plan options, empowering you to make informed decisions for a secure and comfortable retirement.
6 Different Retirement Savings Accounts You Should Know
1. The 401(k)
A popular choice, the 401(k) acts like a company-sponsored piggy bank, as a portion of your paycheck is directly contributed to the fund. There are two main types – traditional and Roth – each with different tax implications:
- Traditional 401(k): Contributions are made directly from your paycheck before taxes are removed (reducing your taxable income).
- Roth 401(k): Contributions are made after income is taxed.
Note that not all companies offer a 401(k), and there are contribution limits to these accounts ($23,000 if you’re under 50 years of age and $30,500 if you’re older). However, the 401(k) can be a potent way to save for your future – especially if your company offers a matching program.
In fact, Fidelity Investments research shows that starting a 401(k) at age 22 and contributing just 6% of your salary could result in a retirement nest egg of over $1 million by age 67, assuming an average annual return of 7%.
Other quick facts to know:
- Many employers offer matching contributions, which can help boost your savings.
- Money grows tax-deferred within the account, allowing potential compound interest to work like magic.
- Automatic contributions directly from your paycheck make it a real “set it and forget it” option for those who prefer a more hands-off approach.
2. The Traditional IRA
If your employer doesn’t offer a 401(k) or you want more control over your investment options, the Traditional IRA can make a great choice. Unlike employer-sponsored 401(k)s, anyone with earned income (including spouses of working individuals) can contribute to a Traditional IRA.
Other quick facts to know:
- Banks or brokers usually hold the account and invest funds based on your choices.
- You contribute pre-tax dollars for tax-deferred growth until retirement withdrawals, and contributions are tax-deductible.
- In 2024, you can contribute up to $7,000 annually, or $8,000 if you’re aged 50 and up.
3. The SIMPLE IRA
SIMPLE IRAs (Savings Incentive Match Plan for Employees IRA) are mainly used for small businesses (100 or fewer employees) that want to offer a retirement plan but don’t have the resources for a more complex one. With a SIMPLE IRA, your employer may match a portion of your contributions or give a fixed amount each year, although it’s not required.
Employees have autonomy over the money they contribute to their retirement accounts (similar to a Traditional IRA). However, note that SIMPLE IRAs can only be rolled over to another IRA after they have been established for two years or will face a 10% penalty.
Other quick facts to know:
- SIMPLE IRAs are designed to be simple to understand and participate in. It’s a straightforward way to start saving for retirement without much hassle.
- Like a Traditional IRA, your contributions go into the account pre-tax, lowering your taxable income immediately.
- Any contributions your employer makes belong to you right away. This differs from other plans, where you might have to wait a certain period to invest.
- Contributions are likely made through payroll deduction, so saving becomes automatic.
- There’s a limit on how much you can contribute each year ($16,000 in 2024, with a catch-up provision for those over 50).
4. The Roth IRA
The key difference between a Roth IRA and other retirement plans is how taxes are handled on contributions and withdrawals.
For example, A Roth IRA offers tax-free growth and tax-free qualified withdrawals but no upfront tax break on contributions. Traditional IRAs and most employer plans offer tax-deductible contributions and tax-deferred growth, but withdrawals are taxed as income in retirement.
Other quick facts to know:
- Qualified withdrawals from a Roth IRA (including contributions) are tax-free and penalty-free, potentially leaving you with more flexibility.
- No minimum distributions are required until after your death, so you can leave your money growing tax-free for longer.
- Contributions are limited to $7,000 in 2024. If you’re over 50, you can contribute an extra $1,000 in catch-up funds
5. The SEP IRA
SEP plans (Simplified Employee Pension IRA) allow simple and flexible contributions. SEP contributions are tax-deductible for employers, making them a desirable option for businesses of all sizes. Plus, employers can contribute up to 25% of employees’ compensation to their SEP IRA.
Similar to a traditional IRA, contributions are pre-tax, lowering current taxable income. Furthermore, the money grows tax-deferred until you withdraw it in retirement. This translates to keeping more of your hard-earned money upfront.
Other quick facts to know:
- While your employer makes the contributions, you have full control over how to invest the money using the options offered by the managing financial institution.
- Employers aren’t locked into contributing yearly, unlike other retirement plans. Instead, they decide the contribution percentage each year. Note that this doesn’t affect the employee’s ability to make contributions to the SEP IRA.
- Your SEP IRA goes with you: You can easily roll it over into another IRA without tax penalties!
6. The 403(b)
A 403(b) is a retirement savings plan for employees of certain non-profit organizations, like schools, charities, and libraries. It’s similar to a 401(k) plan offered by many businesses but with some key differences.
For example, while 401(k)s generally offer broader investment options (including mutual funds, stocks, bonds, and index funds), a 403(b) is typically focused on mutual funds and annuities. 403(b)s tend to have less strict regulations than a 401(k), but it is not common for employers to offer a contribution match.
Other quick facts to know:
- The money you contribute and any investment earnings grow tax-deferred within a 403(b) account.
- You can easily roll a 403(b) over into another IRA or 403(b) plan.
- Contributions to a 403(b) plan are made with pre-tax dollars, which means paying less upfront.
Planning for retirement doesn’t have to be daunting. Remember, the best retirement savings plan for you will depend on your individual circumstances. By considering your income, age, risk tolerance, and retirement goals, you can make an informed decision that sets you up for a secure and comfortable future.
Ready to take the next step?
When you’re ready to discuss and develop a personalized retirement plan, we invite you to schedule a free consultation with the Clarity Wealth team – just click here to grab a spot on our calendar.
