Creating a retirement plan early in your career is essential if you want to have a financially stable retirement. Just by diverting some of your paycheck to a tax-advantaged retirement savings plan, you can grow your wealth exponentially to achieve some peace of mind.
But there may be other options depending on what your employer offers. In addition, all working Americans can set up their own individual retirement accounts, which have a lot of tax benefits. Believe it or not, Uncle Sam wants you to save for retirement. That’s why the government offers these tax benefits.
What are your retirement options?
There are tax advantages in almost all retirement plans, whether you’re saving or withdrawing. A traditional 401(k) contribution reduces your taxable income since pre-tax dollars are used. The Roth 401(k) plan, on the other hand, uses after-tax dollars for funding, but withdrawals are tax-free.
Employers may also contribute to retirement savings plans through matching contributions, such as 401(k) and 403(b) plans. In your decision between investing in a 401(k) and an individual retirement account (IRA), go with the 401(k) if your company matches your contributions.
Consider increasing your annual contribution, since many plans start you off at a deferral level that is not enough to ensure retirement security. 401(k) plans are currently available at many companies, but you are not usually automatically enrolled.
An AARP survey this year concluded that nearly half of all workers in the U.S. don’t have access to retirement plans at work. That comes out to around 57 million private sector workers between the ages of 18 – 64.
There are also retirement savings options for self-employed people. Roth IRA and traditional IRA plans, which have smaller annual contribution limits than most other plans, are also available to rank-and-file workers, entrepreneurs, and professionals who meet certain income limits. SEP IRAs, SIMPLE IRAs, and solo 401(k) plans are also available to you.
Retirement Plans for Individuals
As long as you have taxable (earned) income, you can open an independent retirement plan like an IRA. The same applies to employer-sponsored retirement plans. Traditional IRAs, Roth IRAs, and other independent retirement plans can be opened regardless of the type of retirement plan you already have.
It is possible for anyone who earns taxable income to open a traditional IRA. The contributions you make to a traditional IRA are tax-deductible if you don’t have a retirement plan through work. Traditional IRAs allow investors to invest in a variety of different assets, such as mutual funds and ETFs, for tax-deferred growth. Your IRA distributions are taxed as ordinary income once you start making withdrawals after age 59 ½.
In 2023, you’re allowed to contribute $6,500 to a Traditional IRA. The maximum contribution you can make is $7,500 if you are 50 years old or older.
Pros. In addition to offering some significant tax benefits, traditional IRAs allow you to invest almost limitlessly in stocks, bonds, CDs, real estate, and more. Most importantly, you won’t owe any taxes on the money until you withdraw it at retirement.
Cons. Taxes and additional penalties can make it costly to remove money from a traditional IRA if you need it. You are responsible for investing the money yourself in an IRA, whether it is in a bank, stocks, bonds, or something else entirely. Even if it’s just asking an adviser to invest the money, you must decide where and how to invest the money.
If you don’t earn too much, a Roth IRA is a great retirement option. Although Roth IRA contributions aren’t tax deductible today, you won’t be taxed once you retire when you withdraw money from a Roth IRA. A Roth IRA also doubles as an emergency fund in times of need because you can take out your contribution amount (money you put in) before retirement without paying a penalty.
There are income thresholds that limit who can contribute directly to a Roth IRA, and the maximum contribution limit for a Roth IRA is the same as for a traditional IRA. If your income in tax year 2022 is less than $144,000 or $214,000 if you’re married and file a joint tax return, you may contribute directly to a Roth IRA. As of 2023, the threshold for individuals will be $153,000, while for couples, it will be $228,000.
Pros. In retirement, Roth IRAs offer several benefits, such as the ability to avoid taxes on all money withdrawn. You can also take withdrawals from Roth IRAs at any time without penalty or tax if you make contributions, not earnings.
Cons. Unlike a traditional IRA, a Roth IRA allows you to choose how to invest your money. This means you will need to decide how to do it or hire someone to help you. Roth IRAs are limited by income.
The term rollover IRA refers to an IRA created by moving a retirement account, such as a 401(k) or IRA, to a new one. By rolling over money from one account to the rollover IRA, you keep all of the tax advantages that an IRA offers. An IRA rollover can be established at any institution that permits it, and it can be either a traditional IRA or a Roth IRA. And your rollover IRA can contain as much or as little money as you wish.
You can also convert a traditional 401(k) to a Roth IRA using a rollover IRA. Such transfers, however, can lead to tax consequences, so it’s critical to understand the consequences.
Pros. If you are leaving a former employer’s 401(k) plan for whatever reason, you can still take advantage of attractive tax benefits with a rollover IRA. When changing IRA providers, you can transfer your existing IRA account to the new provider. In all IRAs, you can invest in a variety of assets.
Cons. Some people may have difficulty deciding how to invest their IRA money, which is a common problem with IRAs. The tax implications of rolling over your money are important to consider since they can be significant. This typically occurs when you convert a traditional account to a Roth.
Best Employer-Sponsored Retirement Plans
You can contribute pre-tax dollars to a 401(k) plan if your employer offers one. Investments grow tax-deferred, which means that you don’t have to pay taxes until you withdraw the proceeds in retirement.
Incentives such as matching contributions to 401(k) plans may be used by employers to motivate employees to contribute to their plans. 401(k) account contributions are limited to $20,500 for 2022 ($22,500 for 2023) or 100% of your salary. It depends on which is less. The catch-up contribution for people 50 and older is $6,500 in 2022 ($7,500 in 2023). Be aware that these limits do not apply to employer contributions.
It’s important to know that 401(k) plans can only be participated in by employees who are 21 years old and have worked for your employer for at least one year.
Pros. 401(k) plans are a convenient way to save for retirement because the money comes out of your paycheck and is automatically invested. Stocks are a wise choice, as they offer high returns as well as no taxes until the money is withdrawn — or if it is a Roth 401(k). As an additional benefit, many employers will match your contributions.
Cons. If you withdraw money from your 401(k) during an emergency, you may be subject to a penalty. The existence of a loan option in your employer’s plan does not guarantee that you will be able to borrow from it for qualified reasons. You may not be able to invest in what you want because the funds available in your employer’s 401(k) program are limited.
As part of their 401(k) plans, many employers offer Roth 401(k) options. Just like with traditional 401(k)s, Roth 401(k) contributions are after-tax, and withdrawals are not taxed when you withdraw them in retirement.
As with traditional 401(k) accounts, Roth 401(k) accounts have the same contribution limits. Despite contributing to a Roth 401(k), you can still receive a matching contribution from your employer if they offer a 401(k) match. You will, however, receive it in a traditional 401(k) in accordance with federal regulations.
In order to decide whether a Roth is better than a traditional 401(k), you need to decide whether taxes will be lower now or at the time of retirement.
If you think you’re paying more taxes today, consider contributing to a traditional 401(k) account and benefiting from lower retirement taxes. Roth 401(k) accounts are a better option if you think you’re likely to be in a lower tax bracket in retirement.
It’s important to know that 401(k) plans can only be participated in by employees who are 21 years old and have worked for your employer for at least one year.
Pros. Like Roth IRAs, you contribute to Roth 401(k)s with already-taxed money. When you retire, all of your earnings grow tax-free, and you don’t pay taxes on withdrawals.
Cons. Missing out on tax deferral is a big problem. Most people prefer to pay more tax later rather than now, hence the low participation rate for Roth 401(k)s.
Public schools and non-profit organizations may offer 403(b) plans to their employees. Contributions are made from your paychecks pre-tax, and your savings grow tax-free until you withdraw them in retirement. Roth accounts are allowed in some 403(b) plans, just as Roth 401(k)s are.
As of 2022, the 403(b) contribution limit is $20,500 ($22,500 in 2023), or 100% of your compensation, whichever is lower. In 2023, you will be able to contribute an additional $7,500 if you are 50 or older. You may also receive contributions from your employer like in a 401(k).
The 403(b) plan allows employees with 15 years of service with the same organization to contribute $3,000 a year for a lifetime total of $15,000 in bonus catch-up contributions.
Pros. Saving for retirement with a 403(b) is an effective and popular method, and if you schedule automatic deductions from your paycheck, you can save more efficiently. There are many investment options available, such as annuities and high-return assets, such as stock funds, and no taxes will be due until withdrawal. In addition, some employers may offer matching contributions to your 403(b) plan.
Cons. 401(k) plans are also difficult to access unless you qualify for an emergency. 403(b) plans are similar. Taking a loan from your 403(b) will probably cost you additional penalties and taxes, but if you do not have an emergency, you can still access the money. Investing in what you want may be impossible since the plan’s investment choices are limited.
In a 457(b) plan, employees of state and local governments can invest their paychecks in retirement accounts pre-tax to save for retirement.
In retirement, withdrawals from the account are tax-free since contributions and earnings are tax-deferred. It is possible to open Roth accounts in some 457(b) plans, which work like Roth 401(k)s.
Contributions in 2022 can reach $20,500 ($22,500 in 2023), or 100% of your salary, the lower of the two amounts. Catch-up contributions of $6,500 are available for older employees in 2022 and $7,500 in 2023. A 457(b) plan allows you to contribute up to 100% of your salary in the three years before retirement.
Pros. The tax advantages of 457(b) plans make them a viable option for retirement savings. There are some catch-up savings provisions in the plan, as well, that aren’t available in other plans for older workers. Unlike 403(b) plans, withdrawals from the 457(b) are not subject to the 10 percent penalty imposed on withdrawals before 59 112.
Cons. There is no employer match in a 457(b) plan, so it is much less attractive than a 401(k). In addition, emergency withdrawals from a 457(b) plan are more difficult than from a 401(k).
Thrift Savings Plan
Members of the uniformed services and federal employees are eligible to participate in the Thrift Savings Plan (TSP). A TSP account works much like a 401(k) plan. Until you withdraw your money in retirement, your contributions to a TSP will grow tax-deferred. In some TSPs, Roth accounts can be set up similarly to Roth 401(k)s.
Contributions to the TSP are limited in 2022 to $20,500 ($22,500 in 2023). An additional $6,500 can be contributed to your account in 2022 ($7,500 in 2023) if you are over 50.
Pros. Federal employees are automatically enrolled in TSPs, which is one of their biggest advantages. Participation is optional, but they still have to decide how much of their pay to contribute. Employers automatically deduct 1% of employees’ pay from the retirement account, even if employees do not choose to participate. Employees are not deducted from their paychecks for these contributions.
Cons. There are limited investment options available in TSP plans. Funds range from government bonds to international equities, and four target-date funds are available to participants.
Best Retirement Plans for Small Businesses & the Self-Employed
Many Americans are turning to self-employment. According to the Bureau of Labor Statistics, in September 2022 over 16.5 million Americans reported being self-employed. This represents more than 10 percent of all Americans who are employed.
Saving for retirement can be challenging when you’re a small business owner or a solo entrepreneur. The fact that you don’t have an employer-sponsored retirement plan doesn’t mean you can’t benefit from at least some of the benefits though.
These retirement plans are right for small businesses or solo freelancers.
Don’t be confused by the name. SEP plans are defined-contribution retirement plans, not pensions. If you’re a small business owner, you can open a Simplified Employee Pension plan, also known as a SEP IRA. SEP IRAs are established for self-employed individuals and small business owners under simplified employee pension plans.
In order to qualify for this plan, employers must:
- Offer SEP IRAs to all employees who are 21 years or older.
- Earn at least $600 a year from the business.
- Have worked for the company for a minimum of three years out of the previous five.
SEP IRAs are not accessible to employees; only employers can contribute. Depending on the amount of compensation an employee receives, employers can contribute up to 25% ($61,000 in 2023), or $61,000 ($66,000 in 2022).
You must contribute the same percentage to all of your employees’ SEP IRAs if you are a business owner contributing to your own SEP IRA. Also, you can deduct business contributions from your taxes.
Pros. As a free retirement account, this is an excellent option for employees. In comparison to regular IRAs, self-employed individuals have much higher contribution limits.
Cons. As a result of this plan, employees do not know how much they will be able to accumulate. Money can also be accessed more easily. In some ways, this is a positive thing, but it’s often viewed negatively.
Business owners or self-employed individuals without full-time employees may take advantage of solo 401(k) plans. Business owners can contribute twice as much as self-employed individuals since they can contribute as employers and employees — separate contributions may be allowed for spouses as well. In addition, you can make retirement contributions (Roth) either pre or post-tax.
Contribution limits of $22,500 and an additional $7,500 for people over 50 apply to the 2023 tax year. Contributions in 2023 can also reach $66,000 (you could only receive $61,000 in 2022). The total contribution you can make each year as an employer and employee and as a business owner is $66,000. The contribution limit is $73,500 for those aged 50 or older.
Pros. Solo IRAs are better than Simple IRAs if you don’t have any employees. In terms of setup and termination, the SEP is a tad easier. A Solo-k plan, however, can be set up as a Roth, while a SEP cannot.
Cons. A Form 5500-SE must be filed once assets exceed $250,000, and it is a bit more complicated to set up.
You should consider a Simple IRA if you do not provide another retirement plan for your employees. With a Simple IRA, you must contribute for each employee. Contributions must meet at least one of these requirements:
- Contribute 3% of your employees’ total compensation to their retirement plans.
- Make sure employees contribute at least 2% of their salaries, even if they do not make their own contributions.
Simple IRAs provide employees with immediate vested ownership of all funds in their account, which means they are in full control of their funds. You can deduct the contributions your business makes from your taxes. A Simple IRA allows employees to contribute up to $14,000 a year ($15,500 in 2023). For employees over 50, catch-up contributions will be increased from $3,000 per year in 2022 to $3,500 in 2023.
Pros. Unlike traditional IRAs, Simple IRAs typically provide a matching contribution, so workers can defer pre-tax salary and receive a match. As far as the employee is concerned, this plan is similar to a 401(k).
Cons. Employee contributions are capped at $15,500 for 2023.
1. What is the ideal retirement age?
Retirement ages vary from person to person. Maybe a better question is if you have enough to live the way you want for 30 years or more after you retire. In retirement, your income may include your retirement savings plus Social Security benefits, pensions, and annuities – the latter of which can guarantee you income for the rest of your life.
2. How much can I contribute to my retirement plan?
You can start saving for retirement at any age. Saving for retirement can be done in a variety of ways. It depends on your situation and circumstances and how much you contribute. Are you an employee, employer, or individual?
The IRS raised the contribution limit for 401(ks), 403(b)s and IRAs in 2023.
Employer-sponsored plan such as 401(k), 403(b): $22,500
Individual retirement account (IRA): $6,500
Roth IRA: $6,500
For people 50 and older, catch-up contributions to 401(k)s and 403(b)s increased to $7,500, but not to IRAs and Roth IRAs. They’re still $1,000.
3. When should I set up my retirement plan?
Different retirement plans have different set-up dates depending on the type that’s being set up (adopted) by the employer or employee.
Here are the different types of plans:
Defined Benefit (also known as DB Plan), cash balance plans, and defined contribution plans, like 401(k), profit sharing, money purchase, and employee stock ownership plans. By the end of the year, the employer must set up these plans, as well as adopt them.
Non-qualified plans: SEP IRAs: must be set up by the business’s tax-filing deadline. Individuals need to set up their IRAs (Traditional and Roth) by the deadline for filing their taxes, usually 4/15. A Simple IRA must be adopted no later than 10/1 of the year the plan is opened up and doesn’t include extensions.
4. How much money do I need to retire?
Everybody’s retirement savings needs are different. You might want to consider these things when estimating:
How much you make now
Future salary increases
How much you’ve saved so far, and how much you can save
Expenses you’ll have in retirement, like health care, housing, travel, entertainment
5. What’s the right retirement account for me?
That depends on your situation. For example, the options for employees at big companies are different from those for public workers and freelancers. If you’re not sure what to do, you should talk to an investment professional.
No matter what, you should invest 15% of your gross income in growth stock mutual funds for retirement. If you’re out of debt and have an emergency fund, that’s best.
Here’s a good rule of thumb to keep in mind when deciding which retirement account is right for you: Match beats Roth beats traditional.
Disclaimer: I do not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.