Thinking long term: The 5 most common retirement accounts
Written by Jenesy Gabrielle Burkett Fox
It’s hard to think about saving money for the future when you’re worried about today. Especially if you're concerned about managing current expenses and paying off debts, but it's never too early to think about retirement. Whether you’re barely scraping by or have a reliable stable income, the best time to start saving for your retirement is now. If you put $25 a paycheck toward your retirement, that is $25 a paycheck that will grow over time with investing and compound interest. You can always increase your monthly contributions in the future.
When choosing what kind of retirement fund to invest in, it’s important to know the different advantages associated with each. Some offer tax benefits when you put money into the account or withdraw. Some allow you to contribute more to your retirement fund each year than others. There are also different options available to you if you're self-employed or employed in the private versus public sector. Though, all of these retirement funds function on the same basic principle: you set aside money now, choose an investment option (usually a mutual fund) and the money grows over time so you have enough money to retire. Here are five of the most common retirement plans and their different characteristics:
Note: All of these retirement plans are U.S.-based. The content of this article does not apply outside of the U.S.
401k
A 401k is the standard employee retirement plan. If you’re employed by a for-profit company that offers a retirement plan, they are most likely offering a 401k. These are the most convenient because they are easy to set up and manage and you decide how much money you want to divert from your paycheck each month. The amount of income you pay toward your 401k is non-taxable until you withdraw it. So, if you make $60,000 a year and put $5,000 into your 401k, the $5,000 won’t be taxed. When you go to withdraw from your 401k at age 59 1/2, it will be taxed as income.
In 2022, contribution limits for 401k’s are $20,500 and if you’re 50 years or older, the contribution limit is $27,000. Starting in 2023, the IRS announced that the maximum contribution will be raised to $22,500, and to $30,000 for those 50 and older.
If your company has 401k matching, maximize on the matching. If your company will match up to 5% with the requirement that you contribute at least 6% of each paycheck, do it. That's free money.
Traditional IRA
An Individual Retirement Adjustment (IRA) is a tax favored savings plan opened and managed by an individual person.There are two key differences between an IRA and a 401k. First, because they are managed by the individual and not the employer, there is no employer matching of contributions. Second, the contribution limits are much lower.
In 2022, the contribution limits for IRA’s are $6,000 or $7,000 if you’re 50 years or older. Starting in 2023, that limit will be raised to $6,500, and $7,500 for those 50 years or older.
A traditional IRA allows you to contribute some pre-tax dollars as well as post-tax dollars but you pay income tax when you withdraw from the fund.
Roth IRA
A Roth IRA is very similar to the traditional IRA. The fundamental difference being that contributions are exclusively post-tax dollars. The advantage being that your money grows tax free and you withdraw from the fund, it is penalty free.
SEP
A Simplified Employee Pension (SEP) plan is common among self-employed professionals and small business owners. It operates similarly to an IRA fund with a higher contribution limit. In 2022, self-employed individuals or employers can contribute up to 25% of each employee’s pay up to a limit of $61,000 to an SEP plan. Employer contributions are 100% vested in the employee so even if you leave the company after any amount of time, you keep the funds your employer contributed to the SEP fund.
PERS
Public Employee Retirement System. Each state has a different system for funding retirement plans for their state employees. Most state funded retirement plans require you to be employed by the state for a minimum amount of time before they will contribute to the fund.
Header graphic by Monstera
Jenesy Gabrielle Burkett Fox
