Planning well requires knowing what options are available, and this is as true for retirement as for anything else. Understanding the various types of retirement accounts is crucial for building a robust retirement savings plan. Each type of retirement account has its own eligibility requirements, features, and benefits. By familiarizing yourself with these options, you can design a strategic retirement savings plan that leverages the most advantageous accounts for your financial goals.
1. Individual Retirement Accounts (IRAs)
Perhaps the most well-known retirement savings account is the individual retirement account (IRA). This is a personal long-term savings account that’s available to anyone with earned income. It’s one of the most common accounts that’s not employer-sponsored.
An IRA is primarily intended for retirement. Funds can be invested anytime you have earned income, and the same account can continue to be used even if you switch employers. Contributions and potential gains can compound over years and decades, possibly growing to be a significant nest egg by retirement age. Retirement age is defined as 59½ for the purposes of this account.
Withdrawals can be made from the account without penalty beginning at age 59½. Any withdrawals before then will likely be subject to a 10% penalty (in addition to taxes).
Non-penalized withdrawals are also permitted in select other situations, such as paying health insurance premiums when unemployed, paying for qualified higher education expenses, purchasing a first home, and some other situations. These are intended to help with major costs or during difficult times, however, and not meant to be the main purpose. An IRA generally should be thought of as savings specifically for retirement.
Since 1998, individuals have been able to use two different types of IRAs: Traditional IRA and Roth IRA. These differ most significantly in how funds are taxed:
– Traditional IRA
Contributions generally aren’t taxed when they’re made, but withdrawals are taxed. This allows for a larger starting balance that can be invested.
This provides two potential benefits. First, the higher starting balance can hopefully yield more investment returns than a smaller, taxed balance would. Second, many individuals pay a lower tax rate during retirement because their income drops. This can mean that the tax rate paid is lower than it would be if taxed as income when working.
– Roth IRA
Contributions generally are taxed when they’re made, but withdrawals aren’t taxed if used for qualified purposes (e.g. retirement). This allows for untaxed growth throughout the life of the account. Over time, the fund may grow to be multiples of what the taxed contributions total.
Roth IRAs usually also aren’t subject to mandatory withdrawal requirements, which Traditional IRAs usually do come with. This tends to be a somewhat lesser consideration for most people, however. The tax benefits are the biggest factor to consider when selecting an account.
Investment advisors frequently recommend a Roth IRA if you have any significant amount of time before retirement. It’s important to review your specific situation with a qualified advisor, however, as each situation has different factors to consider. A qualified advisor will be able to make an informed recommendation as to which type of IRA would be best for you.
Both types of IRAs are subject to the same maximum contribution limits. The 2024 limits are $7,000 if under age 50, and $8,000 if 50 years or older. This is per person, so married couples could each open an account and contribute the maximum amount.
2. Employee-Sponsored Retirement Accounts
Employee-sponsored retirement accounts are accounts that employers may make available to employees as one of their benefits. Employees can contribute funds directly from their paycheck if one of these accounts is available to them. Most accounts offer some tax advantage. Some employers still provide a partial or full match on funds invested (up to a maximum amount).
Each of these employee-sponsored retirement accounts can only be used if your employer offers it.
– 401(k) Plans
401(k) plans are the most common employee-sponsored retirement account offered by private sector employers (i.e. companies and businesses). Employees contribute a percentage of their income from the employer, and the employer might offer a match on the amount the employee invests. Employer matches are slowly becoming less common.
Like with a Traditional IRA, contributions to a 401(k) are made with pre-tax income. The contributions aren’t taxed at the time, thus allowing for a larger initial balance in the account. Withdrawals later on normally are taxed.
In addition to a possible employer match, 401(k) plans also have a few other notable points of differentiation from IRAs. Most 401(k) plans allow you to take a loan against the account, which normally isn’t recommended but might be necessary during times of financial hardship.
401(k)s also come with much higher contribution limits. The main contribution limit is $23,000 for 2024, although employees age 50 and older can make an additional $7,500 in catch-up contributions. The combined maximum of employee and employer contributions is $69,000 or the employee’s salary (plus catch-up contributions if old enough).
The funds within a 401(k) can only be invested through one of the options that the employer offers. Most employers offer a good variety of bonds, stocks, mutual funds, and other assets, however, so this typically isn’t an issue.
– Roth 401(k) Plans
A Roth 401(k) plan functions much like a 401(k), but is taxed like a Roth IRA. Contributions are taxed when made, but withdrawals generally aren’t if used for qualified purposes. Other details (e.g. employer match, contribution limits, etc.) broadly follow the 401(k) plan.
A minority of employers offer Roth 401(k) plans, but this is slowly growing in popularity.
– 403(b) Plans
403(b) plans are similar to 401(k) plans, but are specifically designed for employees of non-profit organizations, public schools, and certain religious institutions. They largely follow 401(k) plans with regard to potential match, pre-tax contributions, contribution limits, and other details.
Sometimes the investment options available through a 403(b) are a little narrower than those through a 401(k). This isn’t always the case, however.
– 457 Plans
457 plans are available to state and local government employees, including police officers, firefighters, and other civil servants. These plans are similar to 401(k) plans in many ways, but there’s one very important distinction.
457 plans usually don’t have withdrawal penalties if employment ends before retirement age. After leaving a government position, funds may be withdrawn without penalty even if the individual isn’t 59½. Withdrawing early from a retirement account still generally isn’t recommended unless absolutely necessary.
Other details are mostly the same as a 401(k), although matches from government employers are much less common.
3. Self-Employed Retirement Accounts
Self-employed individuals and small business owners may qualify for either of two other IRA plans. These specialized IRAs are for specific situations where a 401(k) or similar plan isn’t available.
– SEP IRA
Simplified Employee Pension (SEP) IRAs are for self-employed business owners. The account functions much like a Traditional IRA, and has mostly the same features and requirements.
The difference is that a SEP IRA allows for a much higher maximum contribution. Business owners can contribute up to $69,000 in 2024, or 25% of their self-employment income if that’s lower. This is on par with 401(k) maximum contributions.
– Roth SEP IRA
The Roth SEP Ira is new in 2023, and not too well known yet. It functions like a SEP IRA, but is subject to Roth taxation. Contributions are taxed, but withdrawals aren’t subject to taxes.
– SIMPLE IRA
Savings Incentive Match Plan for Employees (SIMPLE) IRAs fulfill the role of a 401(k) for small businesses that have 100 or fewer employees. The biggest change is that the plan administration is much easier.
The other major difference is that the 2024 maximum employee contribution for SIMPLE IRAs is $16,000, with a $3,500 catch-up allowance for those 50 and older. Most other details follow a 401(k): taxes are assessed on withdrawals, employers can match, and funds are intended for retirement.
4. Health Savings Accounts (HSAs)
Health savings accounts are for medical expenses, and can be used for both today’s and tomorrow’s medical bills. They’re available to anyone with a high-deductible health plan (HDHP).
HSAs essentially combine the tax advantages of both traditional and Roth accounts. Contributions aren’t taxed, growth isn’t taxed, and withdrawals aren’t taxed if used for qualified medical expenses. There’s no requirement to use withdrawals for medical expenses once you reach age 65.
The 2024 contribution limit for individuals with HDHP coverage just for themselves is $4,150. Limits for those with family coverage through a HDHP is $8,300.
It’s important to note that a HSA is technically separate from a HDHP, and must be set up separately.
5. Other Retirement Savings Options
Along with those discussed above, there are a few less common retirement savings options.
– Thrift Savings Plans
Thrift savings plans (TSPs) are available to federal government employees and uniformed service members. These are similar to a 401(k) plan, in that there can be a government match, contributions can be pre-tax (Traditional) or post-tax (Roth), and several investment options are available.
The 2024 maximum contribution is $23,000, with a $7,500 additional catch-up allowance for those 50 and older.
– Deferred Compensation Plans
Deferred compensation plans withhold a portion of an employee’s pay until a future date, which is typically retirement. While 401(k) and 403(b) plans are technically examples of deferred compensation plans, the term is often colloquially used to refer to non-qualified plans.
A non-qualified deferred compensation plan usually doesn’t have the same features as a qualified 401(k), 403(b), or similar. Deferring compensation can still have benefits for executives and extremely high-income earners, though.
Before agreeing to a deferred compensation plan, high-income earners should consult with a tax professional and a qualified investment advisor.
– Cash Balance Plans
Cash balance plans are more familiarly simply called “pensions.” These are defined plans that pay a portion of an employee’s salary plus interest, and they pay at a predetermined time (usually retirement).
Pensions are managed by employers, so contributions, returns, and investments are the employer’s decisions. Employees receive a set amount according to the plan’s calculations.
Choosing the Right Retirement Account for You
Which of these retirement accounts best meets your situation and goals depends on many factors, not the least of which is your employment situation. A qualified investment advisor and/or tax professional can help you sort through the various factors that can affect which account(s) you should use.
Factors to Consider When Selecting a Retirement Account
- Eligibility Requirements: You must meet any applicable employment, income, or other eligibility requirements.
- Contribution Limits: You might use multiple different types of retirement accounts if you’re able to exceed one account type’s maximum contribution limit.
- Tax Benefits: Whether you should choose a traditional or Roth account depends largely on your investment timeline.
- Withdrawal Rules: Make sure you understand the rules and restrictions governing withdrawals from an account, including early withdrawal penalties.
Summary Table of Features of Retirement Accounts
| Feature | Traditional IRA | Roth IRA | 401(k) | Roth 401(k) | 403(b) | 457 | SEP IRA | SIMPLE IRA | HSA |
| Employer-Sponsored | No | No | Yes | Yes | Yes | Yes | No | Yes | No |
| Pre-Tax Contributions | Yes | No | Yes | No | Yes | Yes | Yes | Yes | Yes |
| Tax-Free Withdrawals | No | Yes | No | Yes | No | No | No | No | Yes |
| Income Limits | Yes | Yes | No | Yes | No | No | No | Yes | Yes |
| Contribution Limits | Low | Low | High | High | High | High | High | Low | Low |
Consult a Financial Advisor to Find the Best Retirement Account
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