Choosing the right retirement plan can often feel overwhelming. Each type of plan has a unique set of requirements, benefits and outcomes.
While some plans allow employers to match employee contributions, others may have better tax breaks. Understanding a few key factors can simplify the process and help you choose a plan that best suits your needs.
Unlike the standard pensions of the past, some retirement plans today allow their participants to gain more control in their investments. Before you begin looking for a plan, you should ask yourself how involved you wish to be in the fund itself.
The Employee Retirement Income Security Act (ERISA) does not force an employer to offer retirement plans to its employees. While the law sets certain standards on these plans, employers may have their own requirements that can affect your decision, such as restrictions on part-time employees or when you can begin participating in the plan.
Most plans fall under two categories: defined benefit plans and defined contribution plans. Both of these options have benefits and restrictions. You should take into consideration your long-term goals, salary or place of work, when deciding which of these two categories is right for you.
Defined benefit plans are generally paid for by the employer, and the employer or company guarantees a specific monthly amount to be released upon your retirement. For example, a set dollar amount or percentage of your salary will be issued each month once you retire. This amount is usually predetermined and is the responsibility of the employer to ensure its delivery. There are risks with this type of plan. If a company files for bankruptcy it might be unable to pay its employees their promised retirements. An example of a defined benefit plan is a traditional pension.
In a defined contribution plan, both the employee and the employer pay into the fund. The account balance is then released in full upon retirement. Essentially, these plans are investment portfolios that allow participants to make tax-free contributions. Unlike the defined benefit plan, this option does not guarantee a set amount when you retire. The account balance is dependent on the success of its investments, and most plans impose penalties on early withdrawals.
One of the first things to consider when selecting a plan is your employment situation. Although retirement plans are available to everyone, those who are self-employed and those who are employed by a company face different options. If you are employed by a company, talk to your employer about the plans they offer. If they don’t offer the plan you want, there are alternative plans you can choose from, regardless of your employer’s involvement.
If you are self-employed, you have slightly different options available to you, such as IRAs or a solo-401(k). While you cannot enjoy the benefits of an employee-sponsored plan like matched contributions, you can enroll in a plan that offers better investment opportunities with less restrictions. If you are newly self-employed, you can roll a 401(k) received from a previous job into an IRA.
Once you have a clear understanding of your employment situation, long-term goals and retirement priorities, you will find it easier to select the right plan for you. Listed below are some of the available plans for both employees and self-employed individuals. Whether you work for yourself, a large company or a government organization, there is a plan for you.
Individual Retirement Arrangements (IRAs) can be setup by anyone wishing to contribute a portion of his or her income to an investment account for their retirement. They are considered very easy to establish and are used by a variety of entities. There are two main types of IRAs to choose from, traditional and Roth.
Traditional IRAs can be established by almost anyone. They offer tax-deductions early on, but charge income tax when money is withdrawn at retirement. This option might be for you if your tax bracket is high at the start of your career, and lower towards the end. Roth IRAs have income limits, meaning those who are above a certain income level cannot contribute. The money withdrawn at the end is tax free, meaning this option to good for those who retire in a higher income bracket than in their working years.
Smaller companies with less than 100 employees use Savings Incentive Match Plans for Employees (SIMPLE IRAs). They are easy to set up and cannot be used if a company has another retirement plan in place. The employee can opt to match an employee’s contribution or make his or her own contributions, regardless of whether an employee contributes.
Simplified Employee Pension Plans (SEP) allow employers to make contributions to individual retirement accounts for their employees. Employees do not make contributions to the plan, but self-employed individuals can use this type of plan, too. Salary Reduction Simplified Employee Pension Plans (SARSEP) are SEP plans that were established before 1997. These plans allow the employee to make contributions from his or her paycheck.
401(k) and Roth 410(k) plans are employer-sponsored plans that allow employees to make tax-free or taxed contributions during their employment. Some plans allow these contributions to be matched by an employer. In some cases, early withdrawals are penalized. There are different types of 401(k) and Roth 401(k) plans available. The benefits, rules and regulations of each depend on the details of the plan.
Profit Sharing Plans allow an employer to contribute part of their profits to the plan, which can then be used as a retirement for its employees. There is also a great deal of flexibility on how much they can contribute each year. These plans can be used in conjunction with another plan, such as a 401(k). Money Purchase Plans are slightly stricter that profit sharing plans. They require an employer to contribute an agreed set amount each year. Employees are also allowed to contribute a portion of their paychecks.
Employee Stock Ownership Plans (ESOPs) are primarily comprised of a company’s stock. These types of plans can incentivize employees to aid in the growth of the business, as their retirement funds are tied to the success of the company.
Governmental Plans, 403(b) and 457 Plans are available to those who work for governmental departments, charitable organizations, public schools, churches, Indian tribal governments and certain tax-exempt entities.