The Many Types of Retirement Savings Accounts
There are literally hundreds of different variations of retirement savings accounts available to U.S. citizens. It’s important to make a distinction between accounts that are set up and managed by individuals and accounts that are “employee-sponsored.” An entire body of law covers the way such accounts can be created, funded, administered, rolled over, withdrawn from and closed.
In general, to get a clear understanding of retirement savings accounts and how they work, it’s helpful to look at the nine basic types of arrangements, each one of which is discussed below in brief form.
401k FAQs
In general: Created by a 1981 federal law, 401(k) plans are set up by your employer so you can contribute pre-tax earnings into a designated account that earns interest until you withdraw the funds.
Most employers will make you wait up to a year before you can contribute, so you need to speak with a human resources person to find out your company’s specific rules about waiting periods, contribution limits, what the plan invests in, how long it takes before you’re fully vested and other particulars.
-Contributions: For 2019, limits on individual contributions to 401(k) plans are $19,000 annually for those under the age of 50 and $25,000 for workers who are 50 or older. Keep in mind that many companies offer a matching provision for 401(k) contributions.
That simply means that the employer contributes a fixed percentage to the account, based on what the worker puts into it. A 50 percent matching provision, for example, would mean your employer contributed $1 to your 401(k) for every $2 that you contribute.
-Vesting: There are rules that govern when you have full “ownership” of all the funds in your 401(k) account. These “vesting” guidelines are typically set up to reward workers who remain at the company for a certain amount of time. Vesting is usually a gradual process, with workers owning an ever-greater percentage of their 401(k) as each year passes. Eventually, when the point of 100 percent vesting is reached, you fully own the money in your 401(k) account.
Note: The concept of vesting usually applies just to the employer’s contributions in a plan. You always own your own contributions.
-Rollovers: If you leave your job and go to work for another company or for yourself, you’ll need to move the 401(k) into another type of tax-deferred retirement account in order to avoid paying a hefty penalty and income tax on the distribution. Fortunately, it’s easy to roll over the funds into your new employer’s 401(k) or into an IRA, depending on our new work situation.
When you do a rollover of the funds, there’s no need to worry about paying taxes or penalties on the distribution because you really haven’t “taken the money out” of the tax-deferred account. You merely moved it from one retirement account to another.
In general: The Roth 401(k) has only been around for less than two decades. A 2001 law created this hybrid form of retirement account that lets workers contribute after-tax income into the plan. The primary difference between the Roth 401(k) and the standard 401(k) is the funding mechanism. For Roth accounts, after-tax money is used.
For many people, especially young employees who are in very low tax brackets, it usually makes sense to opt for a Roth 401(k), given the choice, because you will not have to pay tax on the withdrawal of the contributions after your retire. There’s still a need to pay tax on whatever earnings the fund accrues.
Contributions: Contribution limits for Roth 401(k) plans are the same as for standard 401(k): $19,000 for those under 50 and $25,000 for those who are 50 or older.
Vesting: There’s no essential difference in the vesting of Roth 401(k)s and standard 401(k) accounts.
Rollovers: Rollover rules for both types of 401(k)s are the same.
The key point to remember is that a Roth 401(k) is funded with after-tax earnings, which can be a big advantage to people who are young or in a low tax bracket. The single most advantageous aspect of putting money into an IRA is that the growth of the fund is tax-deferred. For most working adults, their tax bracket is much lower after they reach retirement years, so savings can be substantial.
This retirement plan is very similar to 401(k) arrangements but is specifically designed, by a 2001 federal law, for people who work for non-profit organizations. This sort of plan is typically offered to those who are employed with government organizations, school districts, public hospitals, and religious groups.
The contribution limits, vesting rules, and rollover provisions are the same as for 401(k) plans offered by private employers. One thing to remember about 403(b) programs is that they usually have lower administration costs, which is always a good thing for workers who contribute pre- or after-tax earnings into the plan.
If you’ve had your Roth IRA for more than five years and are older than 59 and a half, you can withdraw as much or as little of the account funds as you wish without any tax burden. Nor is there a penalty for “early withdrawal” of the direct contribution amounts to a Roth IRA. Contribution limits and rollover rules are the same for Roth IRAs and traditional IRAs in most cases.
Retirement Savings Accounts – Other types
The federal government began allowing the solo 401(k) in 2001. It’s basically a way for self-employed people to contribute to a 401(k) if they have no employees. It can be set up for a business owner and spouse, or just for the owner. Provisions are similar to those for standard 401(k)s in terms of contributions, rollovers, and withdrawal of funds. Vesting is a moot point with these funds because if you set one up, all of the money in the fund is yours, so there’s no “employer contribution.”
Traditional IRAs have been around, based on federal law, since 1974. Annual contribution limits are much lower than for 401(k) plans. For 2019, you can put up to $6,000 into an IRA, or up to $7,000 if you are 50 or older. Money in an IRA is tax-deferred until you take it out after reaching the age of 59 and a half.
The single most advantageous aspect of putting money into an IRA is that the growth of the fund is tax-deferred. For most working adults, their tax bracket is much lower after they reach retirement years, so savings can be substantial.
Roth IRAs allow for the funding of the account with after-tax dollars. This essentially means you can take out your contributions any time but must wait until after age 59 and a half before you can withdraw any earnings.
If you’ve had your Roth IRA for more than five years and are older than 59 and a half, you can withdraw as much or as little of the account funds as you wish without any tax burden. Nor is there a penalty for “early withdrawal” of the direct contribution amounts to a Roth IRA. Contribution limits and rollover rules are the same for Roth IRAs and traditional IRAs in most cases.
SEP stands for “simplified employee pension.” These IRAs are sometimes a smart choice for self-employed people and owners of small businesses. They allow the business owner to put in up to 25 percent of the worker’s annual income as a direct contribution to the plan. In this way, SEPs are like a hybrid between profit sharing and more traditional IRAs.
Contributions: You can contribute up to 25 percent of your income into a SEP, as long as you don’t put in more than $56,000. There’s no “catch-up” provision, no Roth version of a SEP, and no requirement for annual contributions. For these reasons, SEPs are very flexible, easy to set up and can be combined with your Roth or traditional IRA.
The “savings incentive match plan for employees” is very similar to a 401(k) but with fewer costs and less red tape. Contribution limits for 2019 are $13,000 for those under 50 and $16,000 for those 50 and older.
Only for health-related purposes and not necessarily a “retirement” fund, these accounts can help pay for emergency or non-emergency medical expenses. The key advantage is the accumulation of pre-tax earnings in the fund for people who don’t have a qualifying health insurance policy in effect. In 2020, you can contribute $3,500 to an HSA, or $7,000 if you are contributing as a family unit.