Saving for retirement is one of the most important decisions one makes during their lifetime. Over 60% of American’s have $5,000 or less saved for retirement. While pension plans are becoming less and less common, social security is becoming less guaranteed than anytime in the last half-century, yet there are many different retirement options.
The key to retirement planning is to know which option is most suitable for you.
Let us look at the different types of plans and the suitability of each.
Individual Retirement Plans
IRA (Individual Retirement Plan)- These plans come in two forms: Traditional IRA and Roth IRA.
The type of individual retirement account you choose can significantly affect you and your family’s long-term savings. So it’s worth understanding the differences between traditional IRAs and Roth IRAs in order to select the best one for you.
The comparison looks like this:
Traditional and Roth IRAs provide generous tax breaks. It is a matter of timing when you get to claim them. Traditional IRA contributions are tax deductible on both state and federal tax returns for the year you make the contribution, while withdrawals in retirement are taxed at ordinary income tax rates. Roth IRAs provide no tax break for contributions, but earnings and withdrawals are generally tax-free. So with traditional IRAs, you avoid taxes when you put the money in. With Roth IRAs, you avoid taxes when you take it out in retirement.
Employer sponsored plans
These are very common and come in different shapes and sizes depending on the business.
401(k) Plan- Usually offered by for-profit employers and often companies will offer a “matching” program where they offer to match what the employee contributes to the plan. During tough business cycles, the matching program could get reduced or cut as companies address budget concerns.
SIMPLE IRA- A SIMPLE IRA is an employer sponsored retirement plan offered within small businesses that have 100 or less employees.
SEP (Simplified Employee Pension Plan)- These plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. Under a SEP, an employer contributes directly to traditional individual retirement accounts (SEP-IRAs) for all employees (including themselves). A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.
403(b)- Is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only Internal Revenue Code 501(c)(3) organizations), cooperative hospital service organizations, and self-employed ministers in the United States.
457 Plans- A 457 plan is a kind of defined contribution retirement plan available to state and local public employees, but can also be offered by certain nonprofit organizations. They work much the same way as 401(k) plans: you can opt to divert part of your salary into the plan, and the money is automatically deducted from your paycheck before taxes are taken out.
529 Plans- This plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 Plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. These plans offer an individual to save for college expenses without incurring any taxes while the plan grows. Although contributions are not deductible, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college and may be used to pay out of state tuition as well.
Coverdell ESA (Education Savings Account)- These accounts work very much like a 529 Plan, offering tax-free investment growth and tax-free withdrawals when the funds are spent on qualified education expenses. However, in addition to college expenses, certain K-12 purchases are also considered qualified when using a Coverdell ESA. This type of education plan has much lower maximum contribution limits per child, and they are only available to families below a specified income level.