The federal government wants you to save more for your retirement. At least, that’s the conclusion you should come to based on the U.S. tax code and all of the various ways you can duck paying taxes by contributing to your retirement plan. If you’ve delayed putting serious thought into a retirement plan or just haven’t found room in your budget to save, you should take that to heart. Sure, saving for retirement is hard, but you have allies.
It’s important to know what options are available to you and how they fit into your specific financial situation. Doing so can provide you with a clearer understanding of where your money is going, how it’s working for you and why you made the choices you did. So, keep reading to learn about the best retirement plans available.
- How to Decide Which Retirement Plan Is Best For You
- Employer-Sponsored Retirement
- Self-Employed Retirement
- Nonqualified Deferred Compensation Plans
- Guaranteed Income Annuities
- Cash Value Life Insurance Plan
- Social Security
- Real Estate
While a lot of the general rules for retirement saving can prove valuable to just about anyone, it’s important to remember that the type of accounts you’re steering your money into can also play a major role in how successful you are. This is not to say that there are profound negative consequences to the wrong choice — you’re almost always going to be better off saving for retirement in the wrong type of account than not saving at all — but you might be able to get more with the right plan.
The first thing to consider is your employer, as there are account types you can only access through an employer. This isn’t to say that you can’t find similar options if you’re self-employed, but there are often major benefits to opting to participate in your employer’s plan rather than forging your own path. Additionally, just because you’re taking advantage of that plan doesn’t mean you can’t also hedge your bets and combine employer-sponsored and self-directed options. This brings up another important point: you absolutely aren’t limited to just one plan. By blending two or three options, you can develop a more diverse portfolio of assets that will give you significantly more flexibility as you age.
Ultimately, the most important part of deciding on a retirement plan is to actually think about what you want from your golden years. And if you don’t know — because everyone can’t say for sure what they’ll want when they’re 65, and because you can’t avoid unexpected financial pitfalls — you can still reflect on what’s most important to you. Even broad strokes like “I want to live near family” or “I like to travel” can help you shape a plan, which you can refine later as you can get more specific.
Among the most common and flexible options for retirement plans are individual retirement accounts (IRAs). These are opened and owned entirely by you and offer basic tax advantages to grow your savings. There’s essentially no downside to having an IRA, so it’s likely a smart plan to open one (or two) regardless of what your other retirement plans look like. That said, there are different types of IRAs that can serve different purposes in your portfolio.
The IRA doesn’t offer unlimited benefits. Both traditional and Roth IRAs limit your annual contributions to $6,000 a year, with options to make “catch-up” contributions of an additional $1,000 a year after you turn 50. What’s more, you’re only allowed to contribute to a Roth IRA in years where your income is below $122,000 (or $193,000 for a married couple filing jointly). Those caps on contributions also mean that the sooner you start, the more money you can contribute in total — allowing you to get the most of the available tax benefits.
- Traditional IRA: With a traditional IRA, you avoid paying taxes on your contributions until you’re actually retired. You can report anything you contribute to your traditional IRA on your taxes at year-end and reduce your taxable income by that much. The one catch is that you will have to take required minimum distributions (RMDs) after you reach age 70 1/2, even if that means pushing your income into a new tax bracket.
- Roth IRA: A Roth IRA essentially offers reversed tax benefits to a traditional IRA — that is, you pay taxes now. But, you can make withdrawals tax-free once you reach retirement, and you’ll avoid paying capital gains taxes on the growth in the account. A Roth and traditional IRA can work especially well in tandem, allowing you to strategically draw from each account in a way that limits your taxable income in retirement while still taking any required distributions.
- Spousal IRA: A spousal IRA is an account for single-income families that lets a working spouse open an IRA in the other spouse’s name and make contributions. It allows a married couple to boost the total amount they can contribute to their IRAs in a given year from $6,000 to $12,000 (or $24,000 if each spouse has both a traditional and Roth IRA).
|IRA Type||Pros||Cons||Best For|
|Traditional||Reduces taxable income||Steep tax penalties for failing to take RMDs; withdrawals in retirement are taxable income||People currently paying a higher tax rate than they expect in retirement; people trying to balance their Roth IRA or 401(k)|
|Roth||Tax-free growth in funds, no taxes on withdrawals and no RMDs||Contributions come from after-tax income||People currently paying a low tax rate; people trying to balance their traditional 401(k) or IRA|
|Spousal||Married couples can make larger annual contributions||Only available to single-income families||Single-income married couples interested in doubling their allowable contributions|
Check Out: The Best IRA Providers of 2019-2020
While an IRA is held by you and you alone, the most common retirement plan is one jointly administered by you and your employer. Employer-sponsored retirement plans come with plenty of benefits for both employer and employee.
For example, one of the biggest benefits of a 401(k) over an IRA is the much higher cap for annual contributions. You can direct as much as $19,000 a year into your 401(k), with catch-up contributions of $6,000 after you turn 50. That essentially means you can reap tax benefits on more than three times your savings as you can through an IRA.
- 401(k): The 401(k) plan is one of the most common methods for saving for retirement. It functions mostly the same as an IRA. You’ll avoid paying taxes on contributions until you’re actually retired while enjoying tax-free growth along the way. And, because it’s offered through your employer, you can set the account up to automatically deduct a certain percentage of your paycheck and route it directly to your 401(k). Additionally, many employers will offer to match your 401(k) contributions dollar for dollar up to a certain percentage (usually 3%-5%, but it can vary). In that case, you’re not only avoiding taxes but essentially doubling your money. If your employer offers a 401(k) and matches funds dollar for dollar, there’s no reason why you shouldn’t take advantage of it.
- Roth 401(k): The difference here is pretty much the same here as it is for an IRA. If you have a Roth 401(k), you’ll pay taxes now but won’t owe them when you ultimately start drawing on the account in retirement. Again, if your employer offers both a Roth and a traditional 401(k), opening and contributing to both will give you a lot more flexibility in avoiding taxes in retirement. Likewise, if your employer only offers one, you can balance it with an IRA — using a Roth IRA to complement a traditional 401(k) and vice versa.
- 457(b): The only major difference between a 401(k) and 457(b) plan is who offers them. A 457(b) plan is only available to state and local governments. In most cases, it will function just like a 401(k), but there are some options for 457(b) plans that aren’t available for a 401(k). One is that you can rollover contribution limits, meaning if you contribute $5,000 less than the legal limit in one year you can go $5,000 over the limit in the next. Similarly, there’s a “double catch-up” provision that allows contributions of twice the normal legal limit for those within three years of the normal retirement age.
- Defined Benefit Plan: In most cases, there’s a lot of uncertainty surrounding the performance of your retirement plan. Markets are chaotic, and you can’t know for sure what sort of return to expect over the years. A defined benefit plan essentially guarantees a set income level in retirement, based on how long they worked for a company and how much they earned. Contributions to the plan are combined in an investment fund managed by the employer, but they’re legally obligated to make up any shortfalls should their investments not pan out. With clear definitions of what your annual income will be in retirement, you can start making more concrete plans earlier on. However, it’s worth noting that if markets outperform expectations, it won’t mean you’ll get better returns.
- Thrift Savings Plan: A thrift savings plan (TSP) is essentially the 401(k) option for federal employees and our men and women in uniform. Much like a 401(k), employees can make tax-deductible contributions and automate those contributions. Many agencies will match contributions up to a certain level, and there are traditional and Roth options. Unlike 401(k)s, TSPs limit participants to just six basic, broad-based investments.
|Employer-Sponsored Retirement Plans|
|Plan Type||Pros||Cons||Best For|
|401(k)||Reduces taxable income in the present||Steep tax penalties for failing to take RMD; withdrawals in retirement are taxable income||Employees with access to a 401(k), particularly if your company matches contributions|
|Roth 401(k)||Tax-free growth in funds, no taxes on withdrawals and no RMDs||Contributions come from after-tax income||Employees with a traditional 401(k) or IRA; employees with lower tax rates at present|
|457(b)||Can roll over unused space under contribution limits||Only available to state and local government employees||Employees of state and local governments offering a 457(b) plan|
|Defined Benefit Plan||Benefits are clearly defined and predictable; eliminates market risks for employee||Won’t have access to additional growth provided by strong market returns||Retirement investors interested in predictable benefits without being exposed to market risk|
|Thrift Savings Plan||Option to automate contributions||Limited number of funds available for investment||Employees of the federal government or uniformed personnel|
Contract employees or part-time workers may look at the massive difference between the contribution limits on a 401(k) and an IRA and might feel as if they’re being punished for working freelance. However, there are a number of plans designed specifically to give business owners, contract employees and self-employed workers the same opportunities to save for retirement as those working a typical 9-to-5 job.
- SEP IRA: Technically, any business can set up a Simple Employee Pension (SEP) IRA, but it’s typically favored by smaller companies in need of a plan that’s easier to administer and more flexible in its rules. All contributions to a SEP IRA are made by the employer — for which they get a tax break — with annual caps set at the lesser of either $56,000 or 25% of compensation. These plans are much easier to set up and cheaper to run than a 401(k), making them ideal for smaller businesses with fewer resources to commit to human resources. What’s more, the contributions do not have to be consistent, allowing employers the flexibility to increase contributions when business is up and lower them during hard times. Even if you’re the only employee of your business, you can set up a SEP IRA and make larger annual contributions than you could with a traditional or Roth IRA.
- Solo 401(k): A solo 401(k) is a 401(k) plan for sole proprietors and the self-employed. Contribution limits are the same as normal 401(k)s, but since you’re technically also the employer, you can match your own contributions, and enjoy the additional tax benefits employers receive for matching 401(k) contributions of their employees. This can reduce your current-year business taxes significantly. It also allows sole proprietors to increase the amount they can legally put away for retirement than is allowed with just an IRA.
- SIMPLE IRA: SIMPLE, in this case, stands for Savings Incentive Match Plan for Employees. These plans are only available for businesses with 100 or fewer employees, and it’s another example of a retirement plan that’s easy to set up, making it an accessible choice for small businesses. Employers can choose between a set contribution of 2% of employees’ salaries or matching employee contributions up to 3% of their salary, and they can always swap between the two provided they follow the IRS’ rules for doing so. Employee contributions are limited to $13,000 a year, with a $3,000 catch-up contribution after 50. However, business owners are more limited in what they can contribute to these plans, and there’s a two-year waiting period before employees can roll over their savings into a traditional IRA.
- Payroll Deduction IRA: With a payroll deduction IRA, employers set up a payroll deduction IRA program with a financial institution. Employees who opt-in to the program can then deduct whatever amount they want from their paychecks and have that deposited into the IRA automatically. This plan is only for employee contributions and doesn’t require any tax filings from the employer.
- Profit-Sharing: Profit-sharing retirement plans allow companies to share profits with their employees. Typically, this is done on a comp-to-comp method where an employer works out what percentage of the total payroll each salary represents and then divides that year’s contribution in the same proportions. One benefit for employers is that contributions are tied directly to company success. This means employers can both skip the contributions in years where the company takes a loss and motivate employees — and if you’re self-employed, that means you — by tying retirement plan contributions to the overall success of the business. With that said, profit-sharing plans are flexible and can be offered in addition to other retirement plans, meaning employers can define the contributions they want to make and/or offer the plan alongside a more traditional plan like a 401(k).
|Self-Employed Retirement Plans|
|Plan Type||Pros||Cons||Best For|
|SEP IRA||Flexible rules, less expensive to manage||Contributions made solely by employer and don’t have to be consistent||Employees of smaller companies that don’t offer a 401(k); small business owners|
|SIMPLE IRA||Easier for small businesses to manage||Only available for companies with under 100 employees; lower contribution limits and waiting period on rollovers||Small business owners and their employees|
|Payroll Deduction IRA||Employee-controlled IRA; automated contributions||No additional tax benefits to employers matching contributions||Employees of a company that doesn’t have another retirement plan|
|Profit-Sharing||Links team success with retirement saving||Contributions will be lower or non-existent in years when the company struggles||Small companies with highly variable profits|
Keep These in Mind: 35 Retirement Planning Mistakes That Waste Your Money
Pensions were the employer-sponsored retirement plan of choice in both the public and private sectors, but they have become much less common in recent decades. Every plan differs, but they all tend to be employer-administered retirement plans that offer retired employees a fixed income based on their tenure at the company. Employers can essentially batch the entire sum of employee savings together into a single fund and invest collectively with set costs as they pay out their obligations over time.
One of the major issues with pensions, though, is that they leave employees entirely dependent on the employer to administer the fund responsibly. If the company you worked at goes bankrupt, you’re in a much trickier spot than you would be if your retirement savings were solely in a 401(k) account under your name. While most employers carry insurance on their pension plans, you might end up seeing reduced benefits if your employer fails to administer the plan adequately. The flip side of that, though, is pensions typically guarantee income for the rest of your life. So, while you might outlive the savings in your 401(k) or IRA, the regular income from your pension will keep on coming year after year.
All of this said you won’t have a lot of options about choosing to use a pension or not. You can only make use of one if it’s offered by your employer — and outside of some government jobs, very few places still offer pensions — and very few if any companies will offer a pension plan alongside other retirement plan options.
Best for: People with a high salary who have already maxed out contributions to their qualified retirement plans
A nonqualified deferred compensation (NQDC) plan is an agreement between an employer and an employee where the employer defers some portion of the wages owed to that employee to a later date. In exchange, the employee earns a “reasonable” rate of return from the employer. It’s mostly used by executives with high salaries who have maxed out contributions to their other retirement accounts but still want some tax-advantaged retirement savings. By deferring a portion of their income, they can reduce their current-year tax bill — operating on the assumption that their taxable income will be much lower in retirement, in which case they’ll pay a lower rate when they access the cash.
NQDCs come with significant risks. Most notably, since the money you’ve deferred is effectively part of the company’s assets, it could all go to creditors in the event of a bankruptcy.
- Can defer income to avoid a higher tax bill in the current year
- Potential to lose all of your funds if your company goes bankrupt
Best for: Investing novices who would prefer simplicity and peace of mind and are willing to pay extra for it
Guaranteed income annuities are financial products that offer an ongoing income stream in exchange for a lump-sum payment. It’s basically a way that investors can protect themselves from the markets and, well, themselves. You can essentially use some portion of your retirement savings to purchase the annuity and then rely on a check every month for the rest of your life. For many, that’s important to their peace of mind, and it does insulate you from the risks posed by swings in the market and/or burning through your savings too fast. What’s more, even if the rest of your retirement savings expire before you do, you can still count on a consistent income stream.
That said, there’s a reason why investment companies are so keen to lock you into annuities: they’re a great deal for them. The typical rate of return on your money in an annuity is going to trail the market. In addition, any investor can set up a plan for slowly drawing down their retirement savings in a responsible manner while still allowing them to receive the full benefit of the investment returns on their money. On top of that, the annuity industry has long been fairly shady, many times offering large commissions to financial advisors for steering clients into annuities even when it’s not necessarily in their clients’ best interests.
- Peace of mind
- You’ll likely accept lower returns than the market
- Often rely on high commissions to secure sales
Best for: People who want permanent life insurance paired with a cash value option
Cash value life insurance is essentially a life insurance plan that covers you in perpetuity — unlike term life insurance that covers you for a set number of years. The “cash value” refers to the way these accounts function, essentially like a combination savings account and insurance policy. A portion of your premiums will go towards your policy, but some will be set aside to earn interest. You can then withdraw those funds later on as needed — though that will usually result in a decrease in your benefit — or take out a loan against it. Also, should you hit a cash crunch, the cash value can be used to pay premiums. It’s a simple plan that provides a guaranteed death benefit with a way to save cash while you’re paying for it. That said, unless you’re getting an incredibly high interest rate on that cash value, you probably can’t rely on a plan like this alone to fund a comfortable retirement.
- Guaranteed death benefit
- No access to significant investment returns
Best for: Low-income workers who were unable to save, poor savers who failed to put away money for retirement and those looking to supplement retirement income from other sources
Social Security is the federal pension system that supplies a guaranteed income to retirees across the country. This is one plan that you’re probably getting one way or another, and it’s important to factor that regular income stream into your retirement planning. After all, you can see just how much the government is pulling out of every paycheck — money you’re paying now so that you and the rest of your fellow Americans will have a minimum level of retirement income. What’s more, it does provide a safety net to those people who couldn’t (or didn’t) save for retirement. While your monthly benefits aren’t going to be substantial, it’s certainly more than possible to get by on Social Security alone — and many do. But, you can expect your options in retirement will be a lot more limited.
- Guaranteed income for all retired workers
- Social Security alone likely won’t fund a comfortable retirement for many
Find Out: How To Apply For Social Security
Best for: Homeowners who haven’t been able to save elsewhere and experienced real estate investors
For a large subsection of the American public, homes are the primary retirement plan along with Social Security benefits. After all, retirement often means you can sell your house to move into a smaller living space or potentially take out a home equity line of credit or reverse mortgage to cover living expenses. Beyond that, if you’re not so sure about the stocks and bonds that make up financial markets, you might secure income streams by buying up properties and renting them out or flipping them for profit. That said, it’s important to remember that real estate can be an extremely risky investment. While housing prices tend to rise, there’s really no guarantee. What’s more, relying on the cash value of your primary residence to supply income for your retirement can backfire — if something unexpected happens to your home, you could be putting yourself in jeopardy.
- Diversifies your retirement portfolio
- Potential for cash flow from rental income
- High levels of risk, depending on your strategy
You have an abundance of options for saving for retirement, many of which offer you a chance to dramatically decrease your tax burden even as you’re lining the nest egg that will carry you through your golden years. And, there aren’t a lot of limitations on which options you can use in tandem. While some are only available through an employer, many others are an option for anyone and can be used together to save more and get better tax benefits in retirement. So, rather than concern yourself with getting the one plan that’s just right, consider opening several different accounts so you’ll have more flexibility to save as much as possible.
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