Planning for retirement does not have to be complicated. The numerous retirement plans available are simpler to grasp than you would imagine, albeit each has restrictions. Some of these restrictions are based on your modified adjusted gross income, while others entail a yearly contribution limit.
The tax treatment of withdrawals, as well as the age at which you can and must take withdrawals without penalty, can differ between plans. A comparison can assist you in determining which is ideal for you.
1. 401(k) Programs
A 401(k) plan is a workplace retirement account that is provided as part of an employee savings plan. This account lets you to invest a portion of your pre-tax income in tax-deferred accounts. This lowers the amount of income on which you must pay taxes that year. 1 For instance, if you make $75,000 and contribute $5,000 to your 401(k), you will only be taxed on $70,000.
Investment gains compound tax-free until withdrawn in retirement. If you remove funds from the plan before the age of 59 1/2, you may be liable to a 10% penalty as well as federal and state income taxes. However, some plans enable 401(k) loans if you are in a financial emergency.
Some firms match their employees’ 401(k) contributions up to 6%. However, it is possible that you will not be fully “vested” in your plan for several years. That is, if you leave the company before the specified length of time has passed, you will be unable to take your employer’s contributions with you. Your contributions to the plan, on the other hand, are always yours.
If you do not contribute enough to the corporate match, you may be foregoing a valuable employee perk. That match is basically free money. Employers who provide these plans are frequently willing to allow you to contribute through automated paycheck deductions, which can make saving easier.
These plans’ investment options are frequently limited, and management and administrative fees can be costly. The IRS enforces annual contribution restrictions, while limits for 401(k) plans are higher than those for other plans: $20,500 in 2022 (an increase from $19,500 in 2021). This amount rises to $26,000 if you are 50 or older and make the $6,500 catch-up payment.
Variations of this sort of account include the 403(b), a comparable retirement plan available to educators (e.g., in public schools), clergy, and employees of 501(c)-3 tax-exempt organizations; and 457(b) plans, which are available to state or local government employees.
2. Individual Retirement Accounts (IRAs)
This is a type of tax-advantaged investment account. After you deposit money into the account, you can use it to invest in stocks, bonds, mutual funds, ETFs, and other sorts of assets. You make the investing decisions yourself unless you wish to employ someone to do so for you. If your workplace does not have a retirement plan or if you have exhausted your 401(k) contributions for the year, you may want to explore investing in a traditional IRA.
In 2022, you can donate up to $6,000 per year. This amount rises to $7,000 if you are 50 or older. 5 This limit remains unaltered from the limits in 2021. You will pay no taxes on investment gains each year, allowing them to grow faster.
Many people can deduct IRA payments on their income tax returns if they do not also have a 401(k) retirement account, lowering their taxable income for the year. There are several income-based limits. 6 Income taxes are levied on contributions as well as earnings when the money is taken in retirement.
You can purchase and sell stocks within the IRA, but taking money out before the age of 59 1/2 is known as a “early distribution,” and you’ll almost certainly have to pay a 10% penalty fee, just like with a 401(k).
The withdrawal will also be subject to federal, state, and income taxes.
3. Roth IRAs
Roth IRA donations, unlike standard IRA contributions, are made after-tax monies, but any money created within the Roth is never taxed again.
You can withdraw Roth IRA contributions made before retirement age without penalty if five years have passed since your first deposit. Unlike typical IRAs, 401(k)s, and other retirement savings plans, you are not currently obligated to begin taking withdrawals at the age of 72.
Note
If you’re just starting out and expect your income to rise, putting money in a Roth is a terrific location to put additional money. You can even contribute to both an IRA and a Roth IRA, but your total contributions to both plans cannot exceed the $6,000 annual contribution limit, or $7,000 if you are 50 or older.
4. Roth 401(k)
A Roth 401(k) combines aspects of a Roth IRA and a 401(k). It is a sort of account offered by businesses that was introduced in 2006. Contributions are made from your after-tax paycheck rather than your pre-tax wages, as with a Roth IRA. If you stay in the Roth for at least five years, your contributions and earnings are never taxed again.
The best thing about a Roth 401(k) is that it has no income cap, unlike a Roth IRA. The annual contributions are also the same as in a typical 401(k), but they are made after-tax. Withdrawals are the same as with a Roth IRA, but distribution rules are similar to those of a standard 401(k).
5. SIMPLE IRA
Small firms with up to 100 employees can offer the Savings Incentive Match for Employees (SIMPLE) IRA. It functions similarly to a 401(k).
Note:
Contributions are made with pre-tax paycheck deductions, and the funds grow tax-free until retirement.
However, early distributions can result in a severe penalty. Unless you qualify for an exception, the amount you remove from your SIMPLE IRA (equivalent to Traditional IRAs and 401(k) plans) will be subject to an additional 10% tax. If you withdraw within two years of beginning participating in the SIMPLE IRA plan, the additional tax rises to 25%. You cannot borrow from a SIMPLE IRA in the same manner that you can from a 401(k).
6. SEP IRA
A self-employed person with no employees, a Simplified Employee Pension (SEP) IRA allows you to contribute a portion of your salary to your own retirement account. These contributions are fully deductible from your taxable income.
The maximum annual contribution limits for 2022 are higher than those for most other tax-favored retirement accounts: $61,000 (up from $58,000 in 2021), or 25% of income, whichever is less.
Commonly Asked Questions (FAQs)
How much money should I put aside for retirement?
The amount you should save for retirement is determined by your current cost of living and pay. If you want to save for retirement, aim for 15% of your annual salary, including employer contributions.
Can I have multiple IRA accounts?
You can have multiple IRA accounts, but this does not modify the annual contribution limit, which is $6,000 if you are under 50 and $7,000 if you are 50 or over.
Is there a deadline for withdrawing funds from an IRA?
There is no necessary minimum distribution for a Roth IRA, but for a regular IRA, you must begin withdrawing funds by April 1 of your 72nd year, and by December 31 of each year after that. If you attain that age before January 1, 2020, it is reduced to 70 1/2.