As I mentioned two weeks ago, the rest of our Money Monday segments together will be dedicated to retirement. And today, I want to run through the different types of retirement accounts out there.
THAT SOUNDS GOOD. LET’S START WITH THOSE AVAILABLE THROUGH EMPLOYERS
The retirement account most familiar to Americans is the 401(k). These accounts allow you to contribute a portion of your pre-tax income, with taxes being deferred until you make withdrawals.
One of the biggest perks of 401(k) accounts and other retirement plans is the employer match – typically up to 6% of income – which is free money on the table that goes to your retirement account. It is worth noting that some employee contributions may vest – vesting is the process of earning an asset over a present time period – in order to incentivize you to stay with the company. However, all contributions you make are always yours.
Finally, there are some other tax items to remember when it comes to your 401(k). First, the IRS does set contribution limits every year, although limits for 401(k) plans are more generous than those for other plans. This year, the limit was $19,000 for those under 50. For those over 50, the limit is $25,000. Secondly, there are big penalties to pay if you withdraw funds from a 401(k) plan before age 59½. You pay a 10% penalty on the amount withdraw right off the bat, and it could be subject to federal and state income taxes.
ARE 401(K) THE ONLY TYPE OF EMPLOYER RETIREMENT ACCOUNT?
No. While 401(k)s are the most common retirement account offered by companies, there are other variations out there. For example, 403(b) accounts are offered to educators and nonprofit employees, while 457(b) plans are available to government workers. They work very much like 401(k) accounts.
Additionally, if you work for a small business with fewer than 100 employees, your employer might offer a Savings Incentive Match for Employees (SIMPLE) Individual Retirement Account. Similar to a 401(k) account, you make pre-tax contributions from your paycheck, and you will not have to pay taxes until you take distributions in retirement. But there are some differences from a 401(k). You pay a much higher tax if you pull money out before you are 59½ – a whopping 25%! Also, you cannot temporarily borrow from your SIMPLE IRA like you can from a 401(k).
WHAT ACCOUNTS ARE AVAILABLE OUTSIDE OF EMPLOYERS?
You have a couple options if your employer doesn’t offer retirement accounts, Skip, all of which are versions of Individual Retirement Accounts, or IRAs. A normal IRA is an investment account that allows you to invest in stocks and other types of investments. With an IRA you are able to make investments decisions yourself, but I would recommend you use a financial advisor or an investment firm like my firm, Ariel Investments. Like 401(k) accounts, there are contribution limits on standard IRAs – $6,000 this year, or $7,000 if you are over 50. IRAs also have some tax advantages similar to 401(k)s. For example, your investment gains are not taxed annually, and your contributions to your IRA can be deducted from your taxes IF you do not have an employer-sponsored retirement account. But remember, just like a 401(k), any distributions you take from your standard IRA before 59½ will result in a 10% tax, as well as state and federal tax rates.
Another type of IRA is a Roth IRA. Contributions to this type of retirement account are made with income that was subject to taxes. In other words, it doesn’t reduce your tax burden today. But the money you make through investments in your Roth IRA is not subject to tax dollars ever again. Additionally, you can withdraw money without being taxed before you retire as long as you wait at least 5 years after your contribution – although you should not be withdrawing money from your retirement accounts, Skip! Roth IRAs do have contribution limits, currently set at $6,000.
ARE THERE ANY OPTIONS FOR OUR LISTENERS WHO ARE SELF-EMPLOYED?
Absolutely, Skip. For those who are self-employed and have no employees, a Simplified Employee Pension (SEP) IRA is a great option. This type of IRA allows you to contribute a portion of your income to your own retirement account if you’re work alone. The maximum annual contribution limits are higher than other retirement accounts – $56,000 or 25% of income, whichever is less – and you can fully deduct these contributions from your taxable income.
Sole proprietors can also set up a Solo 401(k), an individual 401(k) that allows them to make contributions as the employee AND the employer. These accounts also have a contribution cap of $56,000 this year.
THIS IS ALL GREAT INFORMATION, MELLODY, BUT IT IS A LOT TO DIGEST. WHERE SHOULD WE GO IF WE STILL HAVE QUESTIONS?
It can be overwhelming, Skip. There is a lot of information available on the internet if you want to learn more about the types of accounts. You can also reach out to an investment firm like mine! If you give us a call or contact us through our website at Ariel, we would be happy to help you understand what accounts could work best for you!
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