Unless you plan to work for the rest of your life, retirement planning is a critical part of your future goals. Each retirement plan is unique and specific to the individual. It’s not a one-size-fits-all sort of deal. That said, you want to make sure you do your research to figure out what retirement account you should open. By planning, you can better prepare yourself for the future you dream of living. The list of different retirement accounts can seem extensive and overwhelming. Let us relieve you of some of that stress, and let’s take a look at a few key retirement accounts and what they have to offer.
401ks and Other Employer-sponsored Retirement Plans
401ks are usually offered through your employer, so you’ll need to check if your workplace offers it. In 2021, the IRS allows you to contribute up to $19,500 to a 401(k) if you’re under 50 years old. If you are age 50 or older, you can put up to $26,000 in the account. Sometimes, your employer may match a percentage of your contributions. This falls under the category of a defined contribution plan.
Defined Contribution Plans
These are some of the most common workplace retirement plans – such as a 401k or 403b. These plans enable employees to contribute to an individual account through a payroll deduction. With most plans, starting at the age of 72, you’ll need to start taking out withdrawals. These are known as required minimum distributions. Most plans will penalize you for withdrawing before the age of 59. Now that you understand what a 401k entails, let’s list out the pros and cons.
Pros of Defined Contribution Plans
- Most employers offer an automatic payroll deduction for plan deposits which makes for easy setup and maintenance.
- Your employer may match a portion of your contribution
- 401k contribution limits are higher than IRA contribution limits
- No income restrictions
Cons of Defined Contribution Plans
- Investment choices contain a limit to certain funds
- Management and administration fees can be high and affect your investment returns over time
- New employees may have a waiting period before contributions
- Employer contributions may only be eligible after the employee has worked for the company for a certain amount of time
One of the most popular retirement accounts is an IRA. It’s only suitable for those with an earned income. Currently, the contribution limit for the year 2021 is $6000 for those under 50 and $7000 for those 50 or older. Similar to a 401k, a tax deduction applies to the money you contribute to an IRA. You’ll also need to withdraw funds after turning 72, and those funds will be considered taxable income. There are two main types of IRA – traditional and Roth. Let’s go into the Roth IRA a little deeper.
Just like an IRA, you can only be eligible for a Roth IRA if you have earned income. The amount you contribute to your account can not be more than the amount you make. However, unlike a traditional IRA, you will have to pay taxes on the amount you contribute to your Roth IRA. The money will grow tax-free in the account, and there are no required distributions in retirement. In retirement, no income tax will be due on your Roth IRA. Just like we did for the 401k, let’s list out the pros and cons of traditional and Roth IRAs.
Pros of IRA
- You have the freedom to choose the bank or brokerage to handle all the investment decisions.
- Whether you choose to go with Roth or traditional IRA, you decide how and when you get a tax break.
- If you qualify for both a Roth and traditional IRA account in the same year, you can contribute to both.
- You get a broader range of investment options than defined contribution plans.
Cons of IRA
- You have lower annual contribution limits than most workplace retirement plans.
- Your eligibility to contribute phases out based on income.
- Your ability to deduct contributions may be limited if your spouse (or you) also has a retirement plan at work. If you do, check out the IRA contribution limits.
- Roth accounts seem to be the better choice for most people.
Now that you better understand the different retirement account options, you can start thinking about what plan best suits your needs. It’s never too late or too early to start planning for a better future. Of course, it’s always great to do research on your own and make your own financial decisions. However, it’s also super helpful to have an advisor or IRA custodian to guide you. At RITA, we have a fantastic team of experts to help you come to the best decision for your future. Click here to find an IRA custodian to get your plan started. Soon enough, you’ll feel safe and prepared for your future.