You may have heard the proverb, “When you’re a hammer, the whole world looks like a nail.” In other words, sometimes, our approach to solving a problem can be limited by our perspective.
This principle also applies to retirement planning. While there are a number of different possible solutions to the “problem” of making appropriate plans for a financially secure retirement, many people are only aware of a limited number of alternatives.
In this brief article, we’ll take a quick survey of the major types of retirement savings vehicles to provide basic familiarity, then we’ll point out the advantages of certain types for various circumstances.
Individual Plans vs. Group Plans
The first major differentiator for the different types of retirement plans is plans for individuals, as opposed to plans for groups. Let’s take a look at four different types of individual plans.
Individual Retirement Account (IRA).
Possibly the most well-known of the plans, an IRA can be owned by anyone with earned income. Deposits to an IRA may be made on a pre-tax (traditional) basis or an after-tax (Roth) basis. Traditional IRAs provide a deduction to taxable income, and funds inside the plan grow without taxation until they are withdrawn in retirement. Roth IRAs do not provide an immediate tax deduction, but growth in the plan is not taxed, and when funds are withdrawn in retirement, the withdrawals are not counted as taxable income. For some individuals, the pre-tax benefits of a traditional IRA may be more important, but others may benefit more from the Roth provision that allows for non-taxable income upon withdrawal. You should consult with your tax advisor to decide which is best for your circumstances. Also, depending on your level of income, you may or may not be able to make deductible contributions, even to a traditional IRA. There are also income limitations for who can own a Roth IRA. In 2024, you can make contributions of up to $7,000 to an IRA ($8,000 for those 50 and older). Note, however, that individuals who are over the income threshold for contributing to a Roth IRA may still be able to contribute by using an advanced technique called a “backdoor Roth IRA.” If you think this opportunity might be right for you, please consult with your tax and financial advisor to learn more.
Simplified Employee Pension (SEP) IRA.
This individual account is primarily beneficial to self-employed persons or possibly employees of a small business. It works similarly to a traditional IRA, except that the contribution limit is much higher (lesser of 25% of compensation or $69,000 in 2024).
Solo 401(k).
Named for the section of the Internal Revenue Code that authorizes them, 401(k) plans are very popular for businesses with multiple employees. But a solo 401(k) differs slightly in that it is used by a business with only one employee (the owner). In essence, you are allowed to contribute as both an employee (up to $23,000 in 2024) and an owner (25% of compensation, up to $46,000 in 2024). Also, it is possible to add a spouse to a solo 401(k).
Spousal IRA.
A spouse may contribute up to $7,000 to a spousal IRA in 2024, even if they have no earned income. This allows a working spouse to make deposits to an account owned by the non-working spouse.
Group Plans
Now let’s take a look at five plans that may be offered by a company. These may also be referred to as employer-sponsored plans.
401(k) plans.
Probably the most popular group plan, 401(k) plans may be offered by for-profit companies to their employees. Contributions to the plan are typically payroll-deducted, and the employer may also elect to make matching contributions as an incentive for employees. Like IRAs, 401(k)s may either be traditional or Roth plans. In 2024, employees may contribute up to $23,000, and the employer may make matching contributions up to $46,000 (i.e., total contributions between employee and employer cannot exceed $69,000 in 2024).
403(b) plans.
These plans operate very similarly to 401(k) plans, but they are offered only by nonprofit organizations such as public school systems, certain charities, or public colleges and universities. The annual contribution limits and employer match percentages (if offered) are the same as for 401(k)s, and the plans may use either traditional or Roth rules with respect to before- or after-tax treatment of contributions.
457(b) plans.
Also similar to 401(k) and 403(b) plans, these are plans offered by certain governmental entities for the benefit of civil servants such as firefighters, law enforcement officers, and others. They come in both traditional and Roth varieties and may also feature an employer match. One important difference from 401(k)s and 403(b)s, however, is that 457(b) participants may be able to make penalty-free withdrawals from their plan before reaching age 59 ½. (This is because firefighters and police officers are often eligible for retirement at an earlier age than those in other professions.)
SIMPLE 401(k).
This is a special account (“simplified,” as the name implies) for companies with fewer than 100 employees. The key differences between these plans and regular 401(k)s are:
- Employers are required to offer a matching contribution
- Contributions are vested immediately (the employee “owns” the balance of the account, starting from the first contribution)
- The contribution limit is lower than that for a regular 401(k) ($16,000 in 2024).
SIMPLE IRA.
Like the SIMPLE 401(k), this is a plan for smaller companies with 100 employees or less. Employers are required to provide a matching contribution, the contributions vest immediately, and the maximum contribution is $16,000 in 2024. There is no Roth version of this account.
One of the most beneficial aspects of any group retirement plan is the potential for matching contributions from the employer. For those who have access to such a plan, one of the best things you can do for yourself—once your cash flow and debt are under control—is to sign up for at least your employer’s match so that you can take advantage of the “free money” your employer contributes toward your retirement plan.
Please note that this is a very brief summary of retirement planning alternatives; it is not exhaustive by any means. There are other plans not mentioned here that may be more advantageous for various persons and businesses, depending on their specific circumstances. If you believe you would benefit from a plan with different features, our advisors at The Planning Center are eager to meet with you and find out more about your unique needs.
Whichever account is best for you, the most important thing is a commitment to systematic contributions over time. With all of these plans, the “magic” of compounding and growth is amplified by deferral or elimination of taxes for the funds in the account.
At The Planning Center, we are committed to helping each client design a plan for retirement saving that matches their needs, goals, and resources. To learn more, visit our website to read our article, “Taxes and Your Investments: Understanding the Basics.”
