If you are just getting started with retirement planning, it can be difficult to determine what type of retirement savings account is right for you. Between employer-sponsored, self-directed, tax-deferred, tax-exempt, pre-tax and after-tax plans, it can sometimes seem like your options are endless. In this guide, we provide an overview of several popular retirement plan types and tips for helping you determine which savings vehicle makes the most sense for you.
Employer-sponsored retirement plans
Participating in your employer-sponsored retirement plan is a great way to start saving for retirement. Typically, you can elect an automatic payroll deferral straight to your account, which makes it easy and convenient to save for retirement. Following are three common types of employer-sponsored retirement plans.
401k
A 401k plan is a popular employer-sponsored retirement plan that allows employees to contribute from each paycheck via automatic payroll deferrals. The employer has the option to match a portion of employees’ contributions, which serves as a valuable benefit in attracting and maintaining a high-quality workforce.
There are two main types of 401ks:
- Traditional – Traditional 401ks are funded with pre-tax money, which lowers the employee’s taxable income in the year contributions are made. Withdrawals are then taxed at ordinary income rates when they are withdrawn in retirement.
- Roth – Contributions to Roth 401ks are made with after-tax funds. While these contributions do not lower the employee’s taxable income during the year in which they are made, withdrawals are typically tax-free.
Intended for: Employees of private, for-profit companies
2024 contribution limits: Employee contributions are limited to $23,000 per year, with an additional $7,500 catch-up contribution permitted for participants 50 and older
Early withdrawal penalties: 10% for withdrawals before age 59 ½
403b
403b plans are essentially a 401k for employees of non-profit organizations. They are typically offered by charities, public schools and other non-profits. Similar to a 401k, 403bs can be either traditional (pre-tax) or Roth (after-tax) accounts, and employers can choose to provide a matching contribution.
Intended for: Employees of non-profit organizations
2024 contribution limits: Employee contributions are limited to $23,000 per year, with an additional $7,500 catch-up contribution permitted for participants 50 and older
457b
457b plans are retirement savings vehicles for employees of state and local governments, including police officers, firefighters and other civil servants. 457bs can also be either traditional or Roth accounts, and employers have the option to match a percentage of employee contributions.
Intended for: Employees of state and local governments
2024 contribution limits: Employee contributions are limited to $23,000 per year, with an additional $7,500 catch-up contribution permitted for participants 50 and older
Early withdrawal penalties: None
Small business retirement plans
While the employer-sponsored plans noted above are effective retirement savings vehicles for larger business owners, they can be costly and complex for small business owners to navigate. The following plans offer alternative retirement savings options for small businesses.
Simplified employee pension plan (SEP) IRA
SEP IRAs allow small business owners to defer up to $69,000 (in 2024) or 25% of an employee’s compensation to retirement savings. To be eligible, an employee must be at least 21 years old, receive a minimum of $750 in annual compensation and have worked at the business for three of the last five years. One caveat to these plans is that contribution rates must be the same for all eligible employees, including the owner. Also, contributions can only be based on the first $345,000 of an employee’s 2024 compensation.
Intended for: Employees/owners of small businesses and self-employed individuals
2024 contribution limits: $69,000 per year or 25% of an employee’s retirement savings
Early withdrawal penalties: 10% for withdrawals before age 59 ½
Savings incentive match plan for employees (SIMPLE) IRA
SIMPLE IRAs give employees the option to make tax-deductible contributions. Employers are required to make contributions on behalf of eligible employees whether or not an individual is contributing. Employers can choose to match up to 3% of employee contributions (they must match at least 1%), or they can make a mandatory 2% contribution to every eligible participant’s account. To be eligible, a business must have 100 or fewer employees. For an employee to participate, he or she must have earned at least $5,000 in eligible compensation in any two previous calendar years and be on track to earn at least $5,000 in the current year.
Intended for: Employees/owners of small businesses and self-employed individuals
2024 contribution limits: Employee contributions are limited to $16,000 per year, with an additional $3,500 catch-up contribution permitted for participants 50 and older
Early withdrawal penalties: 10% for withdrawals before age 59 ½; 25% if the withdrawal is taken during the first two years of plan participation
Savings incentive match plan for employees (SIMPLE) 401k
SIMPLE 401ks are a mix between SIMPLE IRAs and traditional 401ks. They typically work well for smaller companies that do not have the resources to administer a large 401k plan. Similar to SIMPLE IRAs, SIMPLE 401ks are available to businesses with fewer than 100 employees, and employees must receive at least $5,000 in annual compensation to be eligible. With a SIMPLE 401k, the employer can elect to make a matching contribution of up to 3% of an employee’s pay or a non-elective contribution of 2% for every eligible participant.
Intended for: Employees/owners of small businesses
2024 contribution limits: Employee contributions are limited to $16,000 per year, with an additional $3,500 catch-up contribution permitted for participants 50 and older
Early withdrawal penalties: 10% for withdrawals before age 59 ½; 25% if the withdrawal is taken during the first two years of plan participation
Individual retirement accounts (IRAs)
IRAs can be a great way to set aside additional retirement funds outside your employer-sponsored plan.
Traditional IRA
A traditional IRA is a tax-advantaged account that accepts pre-tax contributions that lower an individual’s taxable income in the year the contribution is made. Once contributed, assets in the account grow tax-deferred for retirement and are taxed at ordinary income tax rates when withdrawn during retirement. Anyone of any age with earned income is eligible to establish a traditional IRA. These accounts are subject to required minimum distributions (RMDs), which means retired account holders must begin taking withdrawals each year once they reach age 73.
Intended for: Individuals wishing to save for retirement
2024 contribution limits: $7,000 per year, with an additional $1,000 per year catch-up contribution permitted for individuals 50 and older
Early withdrawal penalties: 10% for withdrawals before age 59 ½
Roth IRA
Similar to traditional IRAs, Roth IRAs allow individuals to save for retirement in a tax-advantaged manner. However, Roth contributions are made with after-tax funds. Although these contributions provide no immediate tax benefit during the year in which they are made, assets within the account are tax-exempt when withdrawn in retirement as long as the account has been open for five years and the account holder has reached age 59 ½. Contributions can also be withdrawn prior to retirement with no taxes or penalties. However, any earnings withdrawn may be subject to a 10% early withdrawal penalty if taken before the account holder reaches age 59 ½. Another benefit to Roth IRAs is that they are not subject to RMDs. That means assets within the account can continue growing throughout the account holder’s retirement.
Intended for: Individuals wishing to save for retirement
2024 contribution limits: $7,000 per year, with an additional $1,000 per year catch-up contribution permitted for individuals 50 and older
Early withdrawal penalties: No penalty for withdrawing contributions; 10% for withdrawals of earnings before age 59 ½
Spousal IRA
Spousal IRAs provide a retirement savings opportunity for stay-at-home or part-time-employee spouses who would otherwise not have access to a retirement account. Both traditional and Roth spousal IRAs are available.
Intended for: Non-working spouses and spouses employed part time
2024 contribution limits: $7,000 per year, with an additional $1,000 per year catch-up contribution permitted for individuals 50 and older
Early withdrawal penalties:
- Traditional spousal IRA – 10% for withdrawals before age 59 ½
- Roth spousal IRA – No penalty for withdrawing contributions; 10% for withdrawals of earnings before age 59 ½
If you could use some guidance in determining what type of retirement account is right for you, we would love to have a conversation. To learn more about how United Capital Financial Advisors can help you plan for the future, please contact us.
