Retirement Vehicles

Saving for retirement is a top goal for many of us. There are many account options available for saving for retirement, which can make choosing one that matches your individual situation difficult. We are all in different places in life and have different needs and wants. This along with the differences in benefits and eligibility requirements that the many retirement account options available offer make it critically important to understand how they work so you can choose the best account for you.  

In this article, we’re breaking down the details of a few different types of retirement accounts available that can help you choose an account that matches your situation and your goals. 

Types of Retirement Accounts

Retirement accounts can be broken into two main categories – Defined Benefit Plans and Defined Contribution Plans.

Defined Benefit Plans are employer-sponsored and employer-managed retirement plans that provide an income during retirement. The benefit is most commonly a fixed dollar amount paid monthly and is based on many factors including salary and length of employment. Pensions are the most common type of defined benefit plan; however, social security is also considered one.   

Traditional pension plans are accounts that employers make contributions to for their employees. The funds are held and invested with the goal of providing an income during retirement. Employees do not have access to the funds and cannot make investment decisions on the account. They also do not offer any tax benefits to the employee while employed but can during retirement when receiving the payouts. Any withdrawals made from a pension plan before the age of 59 ½ will be subject to penalties. Pensions were very popular at one time but have seen a decline in recent years and have been replaced with options that are less expensive to maintain for employers.

Although social security is not technically a defined benefit plan because the employee makes the contribution and not the employer, it falls into this category because it works very similarly to one. Social Security started during the Great Depression as a way for retirees to have an income. Employees are typically automatically enrolled, and contributions are taken from their pay. Employees who have paid into the system for at least 10 years and are 62 or older are eligible to receive benefits.  

Defined Contribution Plans can be employer-sponsored or individually managed. These plans allow individuals to choose their investments and will provide an income in retirement based on the investments and their growth and returns. There are many different types of Defined Contribution Plans including 401(k)s, 403(b)s, and IRAs.

A 401(k) can be offered by employers and allows employees to make contributions that may be matched by the employer. These employer-matched contributions are typically subject to a “vesting” schedule, which means, that the amount the employee gets to keep is based on their time with the company or upon the fulfillment of certain contracts or programs. 401Ks typically offer both Traditional (pre-tax) and Roth (after-tax) options. There are yearly contribution limits and early withdrawal penalties. The 2023 employee contribution limit is $22,500. Those over 50 years old can contribute an additional $7500.00 per year as a “catch-up”.

Self-employed individuals or “solopreneurs” can contribute to a Solo 401K. These are also known as one-person plans or i401(k) and are for business owners with no employees other than their own spouses. Both the business owner and the business can make contributions to the account.  

A 403(b) plan is like a 401(k) but is for employees of tax-exempt organizations like public schools, churches, and non-profits. These plans allow for savings through pre-tax dollar contributions from both employers and employees. Most plans will also have a vesting schedule. These accounts are also subject to contribution limits of $22,500 per year. Those over 50 years old or with more than 15 years of service may qualify for “catch-up” contributions.

IRAs

IRAs are Individual Retirement Accounts that are managed by the individual and not an employer. Individuals can open and fund these accounts through banks, insurance companies, brokerage firms, and other financial institutions. There are several types of IRAS, including Traditional, Roth, SEP & and Simple. Each has its own rules regarding contribution limits, withdrawals, and taxes.

Traditional IRAs allow you to make contributions with pre-tax dollars. The amount of the contribution is not considered as income for tax purposes.

Roth IRAs allow you to make after-tax contributions. Withdrawals are tax-free as long as certain conditions are met. 

Both Traditional and Roth IRAs have yearly contribution limits. The 2023 limit for Traditional and Roth is $6500 or $7500 for those over age 50. Early withdrawals from either account before the age of 59 ½ may be subject to a 10% penalty.

SEP IRAs (Simplified Employment Pension) are retirement plans for small business owners and those who are self-employed. Contribution limits are much higher than other IRAs but are subject to the same early withdrawal penalties. Business owners that open a SEP for themselves must also open and fund one for their employees if they have any, however, employees cannot make contributions to the account but can fund their own Traditional or Roth IRA.

SIMPLE IRAs (Savings Incentive Match Plans for Employees) are established by employers and allow both the employer and employee to make contributions. Employee contributions are made with pre-tax dollars and grow tax-deferred. They are subject to contribution limits (2023 = $15,500/year) and early withdrawal penalties that can reach up to 25% based on how long the account has been opened.

As you can see, there are many account options available when saving for retirement. Are you ready to start your journey? Take the America Saves Pledge today and choose Retirement as your goal and we’ll be your partner! We’ll send you texts and emails full of tips and resources to help keep you motivated and on the right path.