Understanding 6 Types of Retirement Plans
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Your financial wellness isn’t just about being prepared now. It’s about being prepared for the future, too. That means setting up a retirement plan and making consistent contributions. But if you’re new to retirement accounts, it can all look like a confusing mix of numbers and letters (mostly because it refers to the tax code). We share six different types of retirement plans and what to consider before getting started.
6 different types of retirement plans
Whether you have a 9 to 5 or are self-employed, there are different types of retirement plans available to you. Many of them have eligibility requirements you must meet.
Some may be offered through your employer while others you set up yourself. Also, you may be able to have multiple retirement accounts — such as a 401(k) plan through your employer and a Traditional or Roth IRA that you set up. While there are many different types of retirement plans, here are six common ones available and who is eligible for them.
1. 401(k) plan
- 401(k) plans are popular retirement accounts offered by employers.
- A 401(k) allows employees to invest some of their pre-tax salary toward retirement.
- A 401(k) retirement account may help reduce tax liability by lowering taxable income.
- Employers may provide a 401(k) match, up to a specific percentage of your salary.
- In 2024, the max you can contribute to a 401(k) is $23,000.
- Contributions and earnings are tax-deferred with a 401(k), meaning you defer taxes and pay later, typically when you retire and withdraw funds.
2. 403(b) plan
- A 403(b) plan is a retirement account that is similar to a 401(k) but is for non-profit, school, or church employees.
- A 403(b) gives employees the opportunity to invest some of their pre-tax salary toward retirement.
- A 403(b) retirement account may help reduce tax liability by lowering taxable income.
- Employers may provide a 403(b) match.
- In 2024, the max you can contribute to a 403(b) is $23,000.
- Contributions and earnings are tax-deferred with a 403(b), so you pay taxes upon withdrawal.
3. Traditional IRA
- Anyone who earns income is eligible to open a Traditional IRA — IRA stands for Individual Retirement Arrangement and is sometimes called Individual Retirement Account.
- You can open a Traditional IRA at a brokerage or other financial institution.
- All or a portion of your contributions to a Traditional IRA may be tax-deductible if you meet eligibility requirements.
- You pay taxes on contributions and earnings upon withdrawal with a Traditional IRA.
- In 2024, the max you can contribute to a Traditional IRA is $7,000.
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4. Roth IRA
- There are income restrictions to qualify for a Roth IRA.
- To qualify for a Roth IRA, you must earn less than $144,000 with a tax filing status of single and head of household and less than $214,000 if married filing jointly.
- You can open a Roth IRA at a brokerage or other financial institution.
- After-tax funds are used to contribute to a Roth IRA.
- Contributions to a Roth IRA aren’t tax-deductible.
- Contributions and earnings are tax-free upon withdrawal with a Roth IRA.
- In 2024, the max you can contribute to a Roth IRA is $7,000.
5. SEP IRA
- A SEP IRA is short for a Simplified Employee Pension plan and is set up as a Traditional IRA.
- A SEP IRA is one of the retirement accounts available to self-employed people and business owners.
- Contribution limits for a SEP IRA can’t exceed 25% of compensation for up to $345,000 or $69,000 — whatever is the lesser of the two.
- Contributions to a SEP IRA are tax-deductible up to a limit, based on a formula for business owners and self-employed individuals.
- Contributions are pre-tax and tax-deferred, with taxes paid upon withdrawal with a SEP IRA.
6. Solo 401(k)
- A Solo 401(k) is a retirement plan for one person and is set up as a 401(k) plan.
- Solo 401(k) retirement accounts are available to solo business owners with no employees.
- Contributions to a Solo 401(k) can be made as an employer and employee and are tax-deferred.
- Contributions to a Solo 401(k) as the employer may be deducted from business income.
- In 2024, total contributions to a Solo 401(k) retirement plan can’t exceed $69,000.
- Taxes are paid upon withdrawal with a Solo 401(k).
Tax benefits and consequences
You may be eligible for several different types of retirement plans. When choosing the right retirement plan for you, it’s key to consider the tax benefits and consequences.
The main question when looking at retirement accounts — should I pay taxes now or later? For example, there are tax-deferred retirement accounts such as a 401(k) plan and a Traditional IRA. To “defer” is to handle something at a later date. So in this case, that means putting off paying taxes until funds are withdrawn in retirement.
The Roth IRA retirement plan is tax-exempt. In other words, it’s exempt from taxes upon withdrawal. Your contributions are made with after-tax funds, so you avoid taxes later.
You also want to see if your contributions are tax-deductible and if so, to what amount. Having a mix of taxed-advantaged (aka accounts that offer tax advantages) retirement accounts may give you the best of both worlds.
Start contributing
Once you have a retirement plan in place, start contributing. Some retirement accounts may be more hands-on than others. For example, you must take steps to contribute to a Roth IRA or Traditional IRA retirement plan. This means finding a brokerage, opening an account, transferring funds, and managing contributions.
Contributing to a 401(k) is more hands-off as money is deducted from your paycheck to fund the retirement plan. If your employer offers a match, it’s a no-brainer and should be considered part of your overall compensation.
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Consider risk tolerance
Typically, retirement accounts will make you choose the types of investments you want your money to go toward. Before setting up your investments, evaluate your risk tolerance.
Though all investing has a layer of risk, it’s important to know how much risk you can stomach. That will help inform your investment strategy.
Review asset allocation
After everything is set up and you have regular contributions, check in with your retirement accounts every six to 12 months. If your portfolio has veered off track from where you want it to be, consider rebalancing.
Your asset allocation — or what percentage you have in stocks, bonds, and cash — should be based on your risk tolerance. As things grow and change in your portfolio, you’ll need to rebalance to get back to your desired asset allocation. This can involve buying or selling certain investments and may come with fees and taxes.
If you have questions about getting started with a retirement plan or your tax strategy, talk to a financial professional who can guide you.
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