Types of retirement plans

If you want to have a financially secure and worry-free retirement, it is crucial that you begin to plan as early as possible. This article will help you understand your retirement savings options, so you can take the first step toward achieving your long-term financial goals.

The benefits of early retirement planning

When should you start saving for retirement? The answer is almost always “now.” Saving early can have a profound impact on your financial future. Because of the power of compounding interest, a small amount saved now can mean a lot in retirement. Your contributions will grow over time, creating a snowball effect, so even with small contributions you can build a substantial nest egg that will help you achieve the retirement you want. Before we jump into your options, here are a few key reasons retirement planning is important.

Financial security in retirement

Rising living expenses and growing healthcare costs make it critical that you have enough savings to handle the challenges that can arise in retirement. Today, only 31% of non-retirees think they have enough to comfortably retire.¹ If you start to plan now, though, you can reduce financial stress and enjoy peace of mind, knowing that you are better prepared for the future.

Tax advantages of retirement plans

Most retirement savings plans offer tax advantages that incentivize saving. Those advantages can provide a big boost over time and lower your immediate taxes. With pretax contributions to 401(k)s, you can enjoy tax-deferred growth and lower your taxable income in the current year, reducing the year’s tax burden. With Roth IRAs, contributions are after-tax, but withdrawals in retirement will usually be tax free. Understanding these differences can help you make the most of your contributions.

Employer-sponsored vs. individual retirement plans

It’s also essential to weigh the advantages of employer-sponsored plans against individual retirement options. Employer-sponsored plans, such as 401(k)s and 403(b)s, offer attractive benefits, like employer matching contributions. The automatic payroll deduction feature in these plans means you can set it and forget it. If you want to save more, individual plans like Roth IRAs provide additional options to customize your retirement goals.

What is a 401(k)?

With a 401(k), employees can contribute a portion of their pretax income to an employer-sponsored retirement account. The growth in your 401(k) is tax-deferred, meaning you don’t pay taxes until you withdraw the funds in retirement. This has many advantages. One of the most attractive features of a 401(k) plan is that employers may match a percentage of your contributions, accelerating the growth of your overall savings. Plus, with a 401(k), you'll have access to a variety of investment choices like mutual stock or bond funds. That allows you to align your portfolio with your financial goals. If a 401(k) is available to you, it’s often advised that you invest enough to get the maximum company match before you explore other options. Learn more about 401(k)s.

What is a traditional IRA?

A traditional IRA (individual retirement account) is a popular savings option that isn’t connected to your employer. If you meet the age and income eligibility requirements, the contributions you make to a traditional IRA are often tax-deductible, and investments within the IRA grow tax-deferred. That means you won't pay taxes on any gains until you withdraw funds during retirement. However, it's essential that you be aware of required minimum distributions (RMDs), which require you to withdraw a minimum amount annually once you reach age 73. These withdrawals are subject to taxes, and it is crucial that you factor them into your retirement planning. Learn more about all the types of individual retirement accounts (IRAs).

What is a Roth IRA?

A Roth IRA is similar to a traditional IRA, but there are a few key differences. With a Roth IRA, contributions are made with after-tax dollars, meaning you've already paid taxes on the money. However, growth within the account and withdrawals in retirement are entirely tax free. This could save you a significant amount. Roth IRAs don't have required minimum distributions (RMDs) during the account holder's lifetime, which allows you to keep your money invested and growing. It also gives you more control over your retirement income, since you will be paying less in taxes.

Roth conversions

Roth conversions involve converting funds from a 401(k) or traditional IRA to a Roth IRA. This strategic financial move allows individuals to take advantage of the Roth IRA's tax-free growth and withdrawals. Before making a Roth conversion, it's crucial that you discuss your current and future tax situation with a tax professional to determine if this option aligns with your long-term retirement objectives.

What is a SEP IRA?

A SEP (simplified employee pension) IRA is a retirement plan designed for small-business owners and self-employed individuals. It has some of the features of a 401(k) and some of a traditional IRA. Eligibility for a SEP IRA is straightforward, making it an attractive option for businesses seeking to provide retirement benefits to their employees. It also has higher contribution limits compared with traditional and Roth IRAs, enabling more savings.

Employers can contribute to their employees' SEP IRAs, if they wish, providing a valuable incentive for talent retention and loyalty. These employer contributions may be tax-deductible, reducing the overall tax burden for the business. Learn more about SEP retirement plans.

What is a SIMPLE IRA?

A SIMPLE (savings incentive match plan for employees) IRA is a retirement plan designed for small businesses with up to 100 employees. It’s an accessible and cost-effective option for employers, because the lower administrative costs and the ease of setup make the implementation of a SIMPLE IRA quick and efficient. Employees can then contribute a portion of their pretax income into their SIMPLE IRAs via payroll deductions.

Which retirement plan is the best for me?

Determining the right retirement plan is a different process for everyone. It can depend on what you have access to as well as your personal financial goals and desired retirement lifestyle. A qualified financial professional can help you weigh the pros and cons of each retirement plan and develop a personalized strategy tailored to your needs. Remember, everyone's journey toward retirement is unique, and with the right guidance you can confidently pave the way to a fulfilling and financially stable future.

Can life insurance be an effective retirement tool?

Life insurance that has cash value growth can play a vital role in a well-rounded retirement savings strategy. The cash value of such policies grows on a tax-deferred basis, offering a potential source of tax-free income during retirement. Beyond its savings benefits, life insurance also provides valuable protection for your loved ones, making it a versatile and compelling retirement-planning option.

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¹ “Report on the Economic Well-Being of U.S. Households in 2022 – May 2023” U.S. Federal Reserve, June 2023.