For a beginner, retirement planning and investing can be understandably intimidating tasks. After all, there are a wide variety of types of retirement plans. So how do you know which one is best for you, and what approaches you should take when choosing your retirement plan?
Here’s a quick overview of the various types of common retirement plans to help you make your decision.
Individual retirement accounts (IRAs) can be established by any person at a financial institution, such as a brokerage firm or bank. These accounts hold various investments (mutual funds, stocks, bonds, cash) for your retirement.
IRAs are subject to federal limitations for how much you can contribute each year. There are seven total types of IRAs, and the one you choose determines how the funds will be taxed (or protected from potential taxation). For example, Roth IRAs are funded with post-tax dollars and are not taxed at distribution, while traditional IRAs are funded with pre-tax dollars and have taxed distributions.
IRAs are beneficial in that they provide a wider range of investment choices than workplace-sponsored plans, and they give you more control over when and how you get tax breaks. The drawbacks are that the contribution limits are lower than what you’d get in most workplace accounts—401(k) accounts have maximums that are several times what you can contribute to an IRA each year. In addition, the ability to deduct contributions can be limited if you have work-sponsored retirement plans as well.
There are a variety of employer-sponsored retirement plans, of which the most common, by far, is the 401(k).
A 401(k) is a type of defined contribution plan. In this type of plan, employers establish the plan to allow employees to contribute to their accounts via payroll deduction. Companies may match a certain percentage of contributions dollar for dollar, allowing you to get more for your money out of these contributions.
Defined contribution plans are easy to set up and keep going. The matching from employers essentially gives you free money with each contribution. There are no income restrictions for Roth 401(k)s, unlike Roth IRAs, and you will have much higher contribution limits.
There are some drawbacks, though. You won’t have as many choices with regard to your investment funds as you would with an IRA. Newer employees might not be able to begin contributing to plans immediately depending on company policy. The fees for management of the 401(k) could be high in some cases, which can lead to lower returns.
We strongly recommend talking to an investing advisor to determine which approach to retirement investing is best for you. You might even have both an employer-sponsored and individual retirement account.
If you’re self-employed or run a small business, there are other types of retirement plans available specifically for your type of situation.
For more information about your retirement planning options and what will be the best approach to choosing your retirement plan, reach out to Fiduciary Advisors, Ltd. to set up a consultation.