If you are already saving for your retirement in the United States, keep doing it! If you’re not already saving, now’s the time to start. The earlier you start contributing to your retirement, the more time your money will have to grow. Remember, it’s never too early or too late to start planning for your retirement.
The United States offers different types of retirement accounts, the most common are the 401(k), Traditional IRA, Roth IRA, SEP IRA, Simple IRA, and Simple 401(k). If you wonder what these accounts are, what benefits they have and which one is the best for you, keep reading!
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How are retirement plans different?
Although each plan has its particularities, there are three points that make a big difference between them:
- Tax advantages: you will pay taxes on this money when you start your retirement plan or when you withdraw the money
- Contribution limits: the maximum amount you can save each year
- Withdrawal rules: are the regulations to withdraw the money without penalty or with penalties for an early withdrawal
Also read: How to plan your retirement in the United States
401(k): The ‘Standard’ Employee Retirement Plan
Pros:
- An easy option if you are an employee
- Employer matching contributions
- High contribution limits
Cons:
- Limited investment options within the plan such as mutual funds.
- It may take several years before you own your employer’s matching contributions
This is one of the most used plans by companies and the discount is made directly from your salary. The money you accumulate in your 401(k) grows tax-free since taxes are paid when you withdraw it.
One of the most striking characteristics of 401(k) plans is that many employers provide contributions equivalent to what you are contributing to your pension, however, so that you can keep that money, the companies establish a minimum time in which you must continue as an employee for that contribution to be yours, if you quit early, you may receive only a portion of your employer’s contributions.
Another draw to 401(k) plans is the relatively high contribution limit: You can contribute up to $20,500 in 2022, or $27,000 if you’re age 50 or older. The total contribution limit, including employer and employee contributions, is $61,000 (or $67,500 for those aged 50 and older).
Traditional IRA: A Retirement Plan for Everyone
Pros:
- available to anyone
- Many plans and investment options
Cons:
- Low contribution limits
An Individual Retirement Arrangement (IRA) is a good option when you don’t have an employer, as it is a self-managed savings plan. The tax advantages are similar to those of the 401(k). Likewise, taxes are paid when withdrawing the money.
Contribution limits are much lower: $6,000 in 2022, or $7,000 if you’re age 50 or older. You can choose from many IRAs from different financial services companies, and each plan can include a much broader range of investment options, including stocks and mutual funds.
In some cases, you may be able to contribute to an IRA and a 401(k) at the same time, but be aware that your IRA contributions may not be tax deductible unless your income falls below a certain amount. .
Roth IRA: A Different Kind of Retirement Plan Tax Advantage
Pros:
- You could pay fewer taxes
- You can withdraw your retirement savings tax-free
- The contribution and withdrawal age limits are more flexible
Cons:
- There is no tax relief for contributions
- income restrictions
- Low contribution limits
The biggest difference between a Roth IRA and a traditional IRA is when you get the tax benefits. With a traditional IRA, you don’t pay income taxes on your contributions, but you do pay taxes when you withdraw the money. With a Roth IRA, it’s the exact opposite: You pay taxes on the money you contribute, but you can withdraw money tax-free in retirement, so every dollar in your account goes into your pocket.
Should you choose a traditional or Roth IRA?
An important factor is that you don’t know if you will pay taxes at a higher or lower rate when you retire. Many people expect a lower tax rate after retirement because their income is lower. If you’re one of them, a traditional IRA may be better for you, otherwise, you might pay fewer income taxes overall with a Roth IRA.
Also read: Businesses you can have while retired
Other differences between a Roth IRA and a traditional IRA
For example, you do not have to wait to withdraw money at the age of 72 since you can access certain amounts before that age without penalties, you should keep in mind that there are some restrictions. Also, you can only contribute to a Roth IRA if your income is below a specified threshold, unlike a traditional IRA. In other ways, including contribution limits, Roth IRAs are similar to traditional IRAs. To explore the similarities and differences in more detail, check out the IRS comparison chart.
SEP IRA: For Small Business Owners and Self Employed
Pros:
- High contribution limits
- For employees, the immediate award can be an advantage
Cons:
- For employers, the immediate vesting of employees can be a disadvantage
A SEP IRA (SEP stands for Simplified Employee Pension) is a specialized type of IRA used primarily by self-employed individuals or small business owners, although it can technically be used by businesses of any size. For employers, these retirement plans can be easier and cheaper to operate than traditional 401(k) plans.
In some ways, a SEP IRA works similarly to a traditional IRA. But a big advantage of a SEP IRA is its higher annual capacity to accumulate retirement savings than a traditional IRA. An employer can contribute up to 25% of each employee’s earnings for a maximum of $61,000 in 2022. If you are self-employed, you can contribute up to 25% of net earnings up to the same limit. Unlike a 401(k), employees always get 100% of the employer’s contributions immediately, which could be seen as an advantage if you’re an employee or a disadvantage if you’re an employer trying to maximize employee loyalty.
Simple IRA: A Simpler Retirement Plan for Small Businesses
Pros:
- easy to set up
- For employees, contributions are matched or guaranteed
Cons:
- Contribution limits are lower than with SEP IRA or 401(k) plans
A simple IRA is another type of employee retirement plan for small businesses with up to 100 employees. If you participate in the Simple IRA as a worker, you will generally receive some contributions from your employer.
The Simple IRA stands for “Employee Savings Incentive Matching Plan”; Employers must match employee contributions up to 3% of an employee’s salary, or contribute 2% of an employee’s salary, regardless of any employee contribution. Employees are always fully vested: they can keep employer contributions whenever they leave the company. Employees can contribute up to $14,000 of their salary in 2022, or $17,000 if they are over 50 years old.
Also read: The importance of Passive Incomes
401(k) only: For business owners with no employees
Pros:
You may be able to contribute more than with other individual retirement plans. Some plans allow traditional before-tax or Roth (after-tax) contributions.
Cons:
- Limited investment options, such as regular 401(k) plans
- Can be more complicated to set up than IRAs
Solo 401(k) plans, also known as individual or single-participant 401(k) plans, can help maximize retirement savings for self-employed individuals and business owners who don’t have employees. This plan is very similar to a regular 401(k), except you can increase your savings by contributing as both an employer and an employee.
As an employee, you can contribute up to 100% of self-employment earnings, up to a maximum of $20,500 in 2022 or $27,000 if you’re age 50 or older. Likewise, you can change it to an employer and contribute up to an additional 25% of the income of your business. Depending on your income level, this double contribution formula allows you to contribute more than other retirement plans, such as SEP IRAs, although the maximum contribution limits are the same ($61,000 if you are 50 or younger/$67,500 if you are older).
While this information is important for you to decide on the right direction, you’ll need a lot more information. Talk to your employer, your bank, your union, and/or a financial advisor. We recommend you get more information on the IRS websiteand that you start planning your future as soon as possible.