Retirement Plans

Regardless of your income level, career or age, it is important to save for your future.

 

From traditional savings accounts to employee-sponsored plans, the ways in which you can save for your retirement are varied and ever-changing. Experts project that retirees will need to save 70 to 90 percent of their current annual income for each year after they retire. These numbers may vary depending on your projected standards of living during retirement. With Social Security only covering an estimated 40 percent of your income in retirement, many consider it not enough to retire on. Enrolling in a retirement plan can help you build a substantially larger nest egg then traditional savings accounts, allowing you to retire with more security and less uncertainty.

Choosing A Plan

Many employees seek retirement plans through their place of work. Advantages of these plans include tax breaks and matched contributions from your employer. The Employee Retirement Income Security Act (ERISA) does not require an employer to offer a retirement plan. The type of plan available to you through your employer is entirely dependent on which plan they choose to enroll in. With that being said, there are retirement plans for those who are self-employed or looking for an alternative from their workplace plan. Although the options are vast, your individual situation may only leave you with a few choices. Therefore, it is important to understand what the market offers so you can know how to choose a retirement plan that best suits your needs.

Pensions

Traditional pensions fall under the category of defined benefit plans. This means that the employer is responsible for contributing to the plan and the employee receives a set monthly payout during retirement until his or her death. These distributions are based on an employee’s salary and the number of years he or she has worked for the company. The employer regardless of how well the investments perform in the fund guarantees the monthly payments.

The traditional pension is not necessarily the only, or best, option for every employee. These plans are slowly being replaced by employee-sponsored plans that offer more control and full ownership over the investment fund. A lower risk is associated with this type of plan but there are also fewer opportunities for growth or control. Yet, there are some advantages to a traditional pension that should not be overlooked. A few plans allow employees to withdraw a lump sum instead of opting for ongoing annuity payments. However, it is then up to the employee to make those funds last until his or her death.

401(k) and 403(b) Plans

The shift away from traditional pensions has given rise to employee-sponsored plans, such as 401(k)s. These plans are called defined contribution plans. Instead of guaranteeing a set monthly payment, these plans distribute the entire fund to the employee after a certain age. The balance on the account is dependent on the performance of the investments. Both the employer and employee can contribute. These plans are varied in their tax benefits, investment control and contribution limits. The 403(b) plan is very similar but is restricted to charities, public school employees and churches.

IRAs

Unlike a traditional 401(k), individual retirement arrangements are available through an employee as well as to those who are self-employed. These plans work very similar but have different contribution limits than 401(k)s and offer a much larger choice in investment possibilities.

Investment Accounts and Other Retirement Plans

There are alternatives to a 401(k), an IRA or a pension plan. Personal investment accounts are not typically used for retirement savings but offer a greater variety of investment opportunities than other plans. The risks involved in these accounts are markedly higher than retirement plans protected by ERISA. You are fully responsible for these funds and subsequently, the security of your retirement.

Health savings accounts can also be used as a viable retirement plan option. These accounts have stricter eligibility rules and health care benefits that others do not. Profit sharing plans focus on company stocks, while government plans are only available for those who work in the public sector. It is important to note that restrictions and penalties apply to early withdrawals and excessive contributions on most retirement plans on the market.

401(k) and 403(k) Plans in More Depth

The most common employee-sponsored plan on the market is the 401(k). There are three main types of 401(k) plans including traditional, safe harbor and SIMPLE, each varying slightly in their rules and benefits. Under these plans, a portion of pre-taxed money from your paycheck is held back by the employer and contributed into an investment fund. An employer can also make contributes by matching your payments or donating a separate amount of its own choosing. Depending on the plan details, the control you have over where the funds are invested varies. The main benefits of this plan can be broken down into two parts.

 

  • Tax Benefits – The opportunity to contribute a pre-tax portion of your paycheck lowers your gross income amount and, therefore, creates tax breaks during the year you contribute. Under a Roth 401(k) plan, participants can contribute taxed portions of their income, receiving tax-free withdrawals when they retire.
  • Matched Contributions – An employee can match your contributions up to a certain amount per year. However, there are restrictions on these types of contributions. Some employers require an employee to work for a minimum length of time before they can be fully vested in these funds.

Limitations apply to all plans and how to manage a 401(k) plan may differ depending on the specific plan you are enrolled in. In 2018, an individual cannot contribute more than $12,500 to a traditional 401(k) plan per year. An employer is capped at $36,500 per year, which includes matched contribution. These limits may be lower depending on which plan you are enrolled in.

Individual Retirement Arrangements (IRAs) in More Depth

IRAs are a popular choice for those who are self-employed or have maxed out their 401(k) contributions and looking to invest more. There are two types of IRAs to choose from. The traditional IRA operates in the same way as a 401(k). Pre-tax contributions are made from an employee’s paycheck, which are then taxed when he or she retires. Roth IRAs operate slightly differently, they allow participants to contribute post-tax portions of their paycheck to the fund. These withdrawals are tax-free when distributed at retirement. Deciding which plan is right for you depends on your income level and your projected tax rate at the time you retire.

Although these plans do not offer matched contribution from an employer, the investment opportunities are far greater. A participant is able to invest in stocks and bonds, as well as larger funds if they wish. These plans are not allowed to invest in life insurance or collectibles.

The limits set on how much a participant can contribute to an IRA are higher than a 401(k) and early withdrawals are penalized. The annual contribution limit for an individual is set at $5,500 in 2018. This limit may be lower depending on your income and if you are enrolled in other workplace retirement plans.

 

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