9 Most Popular Retirement Accounts You Should Understand

retirement accountsWith the wide variety and differing complexities of retirement accounts, choosing the right one can be extremely confusing and intimidating.

Ultimately, choosing the best account to begin saving for your retirement will mainly depend on what options your employer offers, if you are self-employed, and what your income level is.

Regardless of which option works best for you, it is important to begin planning for your retirement today.

According to a study by Charles Schwab, the average American will need $1.7 million to retire comfortably. Unfortunately, the majority of Americans are nowhere near this level of retirement savings when they reach retirement age.

Fortunately for you, we have put together a detailed guide of the most common types of retirement plans. Take a look through the different types of accounts below and get started investing for your future.

Most Popular Retirement Accounts You Need To Know

1. Traditional 401(k) Plan

A Traditional 401(k) plan is a plan offered by your employer. It is typically the easiest way for individuals to get started on their retirement savings.

You set aside a portion of your salary as a contribution to the plan. If your employer offers a match, they will also contribute to your 401k plan.

In most cases, this employer match is a set percentage of your salary and is considered free money since your employer is giving you money for your retirement.

Taxes

If you choose to contribute money to a Traditional 401(k) plan, your taxable income will be reduced in that year and your money will grow tax-deferred.

For example, if you earn $50,000 and contribute $10,000 to your 401k plan, your taxable income will only be $40,000.

Assuming you are in a 22% tax bracket, this means you pay $2,200 less in income taxes.

When you withdraw the money in retirement, you will be required to pay income taxes on your withdrawals.

Also, once you hit 70 1/2 years old, you will be forced to take a distribution every year from your 401k plan.

Contribution Limits

In 2020, the contribution limit for a Traditional 401(k) plan is $19,500. However, if you are over the age of 50, you can contribute an additional $6,500 into your 401(k) plan for a total of up to $26,000 per year.

Pros:

  • Employers may match a percentage of your contributions
  • Contributions reduce your taxable income so you will pay less taxes
  • Contributions are easy to automate through payroll deductions
  • Retirement assets can be carried from one employer to another
  • 401(k) plans have a high contribution limit
  • Investment growth is not taxable until you withdraw the money

Cons:

  • 401(k) plans have limited investment options
  • Required to pay income taxes on withdrawals of funds in retirement
  • Will pay early withdrawal fees if you withdraw funds before age 59 ½ 

Best Suited For

This plan is best suited for individuals that work for a company that offers a Traditional 401(k) plan. It is also great for people who prefer to automate their retirement savings because the contributions are deducted from your paycheck and automatically invested.

2. Solo 401(k) Plan

A Solo 401(k) is also known as a One-Participant 401(k). It was created for individual business owners that do not have any employees.

A Solo 401(k) allows you to make contributions as both the employer and an employee.

Taxes

In a Solo 401(k), employer contributions will be taxed upon withdrawal in retirement. However, you can choose if your contributions that you make as an employee are made before-tax or after-tax.

If you choose to have your contributions taxed upon withdrawal, you will reduce your current taxable income like in a Traditional 401(k).

Contribution Limits

In a Solo 401(k), you will be allowed to make contributions as both an employee and an employer. The maximum contribution for 2020 is $57,000, however, if you are over 50 years old, you will be able to contribute an additional $6,500 for a total contribution of $63,500.

Pros:

  • Solo 401(k) plans have a high contribution limit
  • Allowed to make contributions as an employer and as an employee
  • Ability to choose tax treatment of employee contributions

Cons:

  • Solo 401(k) plans have limited investment options
  • Certain limitations on contributions based on income of business
  • Required to pay income taxes on withdrawals in retirement
  • Will pay early withdrawal fees if you withdraw funds before age 59 ½ 

Best Suited For

This type of retirement account is best suited for sole proprietors with no employees.

3. 403(b)

A 403(b) plan is very similar to a Traditional 401(k) plan, however, it is designed for employees of a non-profit or tax exempt organizations like teachers.

Taxes

Contributions will be taxed as income upon withdrawal in retirement. Similar to other 401(k) retirement accounts, contributions will reduce your taxable income in the current year.

Contribution Limits

The contribution limit in 2020 for a 403(b) plan is $19,500. If you are over 50 years old, you will be able to contribute an additional $6,500 for an aggregate total contribution of $26,000.

Pros:

  • Greater flexibility on early withdrawals
  • Contributions are easy to automate through payroll deductions
  • Employers may match a percentage of your contributions
  • Contributions reduce your taxable income so you will pay less taxes
  • 403(b) plans have a high contribution limit

Cons:

  • Will pay early withdrawal fees if you withdraw funds before age 59 ½ 
  • 403(b) plans have limited investment options
  • Required to pay income taxes on withdrawals in retirement

Best Suited For

This is a retirement account that works best for employees of a non-profit or tax exempt organization such as a school district.

4. 457(b)

A 457(b) plan is a deferred compensation for employees of state and local governments. It is very similar to a 401(k) or a 403(b) except for the fact that employees who participate in these plans can make withdrawals any time after retirement.

They do not need to wait until they are age 59 ½ or older. They just need to be retired.

Taxes

For the most part, contributions are treated like a Traditional 401(k). However, some employers may sponsor plans that allow you to make after-tax contributions.

If your plan allows you to make after-tax contributions, your taxable income will not be reduced in the current year, but you will not be required to pay income taxes on withdrawals in retirement.

Contribution Limits

The maximum contribution for a 457(b) plan in 2020 is $19,500. If you are 50 years or older you may make contributions up to a maximum of $26,000.

Pros:

  • May have option to choose if contributions are made either before-tax or after-tax
  • Can withdraw funds at any age once you retire
  • Employer may match a percentage of your contributions

Cons:

  • 457(b) plans have limited investment options
  • Could lose early withdrawal advantage if you need to roll your plan into another retirement plan option

Best Suited For

This plan is best suited for employees of state and local governments.

5. Traditional IRA

A Traditional Individual Retirement Account is a retirement account that is not sponsored by an employer. It is an account that you open and fund entirely on your own.

You will need to have earned income to be able to contribute to a Traditional IRA.

Taxes

If you choose to contribute to a Traditional IRA, contributions will lower your taxable income in the current year and your contributions will grow tax-deferred.

Contribution Limits

The maximum contribution for 2020 is $6,000. If you are over 50 years old, you may make an additional contribution of $1,000 for an aggregate total of $7,000.

Pros:

  • Contributions will grow tax-deferred
  • Can deduct (or partially deduct depending on income level) contributions from your taxable income
  • Better choice of investment options

Cons:

  • Lower contribution limits than 401(k) plans
  • May not be eligible to participate if your income exceeds certain levels

Best Suited For

A Traditional IRA is typically best suited for individuals looking to lower their tax bills due to the deductibility of their contributions.

It is also suitable for individuals who have too high of an income to be eligible for a Roth IRA.

6. Roth IRA

Similar to a Traditional IRA, a Roth IRA is not an employer-sponsored retirement plan. You will need to open and fund the account on your own and will need to have earned income.

Taxes

Unlike a Traditional IRA, you contributions will be made after-tax. This means your money will grow tax-free and you will not be required to pay income taxes on withdrawals in retirement.

Contribution Limits

The maximum contribution limit in 2020 for a Roth IRA is identical to a Traditional IRA. $6,000 unless you are 50 years or older in which case the maximum contribution is $7,000.

Pros:

  • Contributions will grow tax-deferred
  • Can deduct (or partially deduct depending on income level) contributions from your taxable income
  • Can withdraw your contributions (cannot withdraw capital gains) at any time without penalty and without income taxes
  • Better choice of investment options

Cons:

  • Lower contribution limits than 401(k) plans
  • May not be eligible to participate if your income exceeds certain levels

Best Suited For

A Roth IRA is best suited for individuals who are in a lower income tax bracket and expect to be in a higher income tax bracket in the future.

Utilizing this option will result in paying less taxes now than they would later on.

7. Self-Directed IRA

A Self-Directed IRA is very similar to a Traditional IRA. The major difference is the broader investment choices available in a Self-Directed IRA and the control over those investments.

Taxes

A Self-Directed IRA has the same tax treatment as a Traditional IRA. Contributions will reduce your taxable income in the current year but withdrawals in retirement will be treated as income and taxed.

Contribution Limits

The maximum contribution for a Self-Directed IRA in 2020 is $6,000, however, if you are 50 years or older you may make an additional $1,000 contribution.

Pros:

  • Self-Directed IRAs have a broad range of investment options
  • Contributions will grow tax-deferred
  • You have more control over your investments
  • Potential for higher rates of return with riskier investments

Cons:

  • Depending on investment choice, you may have a low level of liquidity
  • Riskier investment choices may not work out and could damage retirement savings

Best Suited For

A Self-Directed IRA is best suited for seasoned investors who wish to invest in alternative assets.

This is not recommended for individuals with minimal investment knowledge.

8. SIMPLE IRA

Another retirement account option is a Savings Incentive Match Plan for Employees.

This is a retirement plan offered by companies with 100 employees or less.

In a SIMPLE IRA, employers must match contributions up to 3% of an employees salary or they can contribute 2% of an employees salary if they do not make any contributions.

Employees must have made at least $5,000 in the previous two years and are expected to make $5,000 in the current year in order to participate. 

Taxes

Contributions will reduce your current taxable income. You will pay income taxes on withdrawals in retirement.

Contribution Limits

The maximum contribution limit for 2020 is $13,500 unless you are 50 years or older, in which case you can contribute up to $16,500.

Pros:

  • Employers are required to match up to a minimum amount of your salary regardless of your participation
  • Contributions will grow tax-deferred

Cons:

  • No after-tax contribution options 
  • Will pay early withdrawal fees if you withdraw funds before age 59 ½ 

Best Suited For

A SIMPLE IRA is best suited for employees of a small business that does not offer or is not able to offer another 401(k) option.

9. SEP IRA

A Simplified Employee Pension IRA is a type of Traditional IRA for self-employed individuals.

SEP IRAs can be set up for self-employed individuals and/or their employees.

Taxes

Contributions will reduce your taxable income in the current year. You will pay income taxes on withdrawals in retirement.

Contribution Limits

The maximum contribution is the lesser of 25% of your total compensation or $57,000. There is no additional catch up contribution for those 50 years and older.

Pros:

  • SEP IRA plans have a high contribution limit
  • Can be combined with a Traditional IRA or a Roth IRA

Cons:

  • No catch up contributions for individuals 50 and older
  • No after-tax contribution options
  • Will pay early withdrawal fees if you withdraw funds before age 59 ½

Best Suited For

A SEP IRA is best suited for self-employed individuals with few or no employees.

Final Thoughts

When it comes to planning for retirement, the most important thing is not which retirement account you choose. The most important thing is to start investing early, and investing as much as you can afford to. 

The different tax treatment and contribution limits of each retirement account may have an impact on your total savings, but it will be minimal in the grand scheme of things.

The greatest impact on your retirement savings is simply time. Maximize the amount of time your investments can grow before you need to start drawing from your retirement savings.

So, choose the retirement account that best suits you right now and start investing money into your future. Retirement is the greatest expense anyone will have in their lifetime.

Make sure you are preparing for it with the right retirement account for you.

Author Bio: Austin is the founder of The Logic of Money, a personal finance website that writes about saving money, budgeting, retirement, debt, and credit. He studied Finance, Investments, and Banking as well as Real Estate and Urban Land Economics in college. He has a passion for finance and hopes to help others by simplifying complex financial topics.

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