Many of us worry if we will have the funds we need in retirement. In fact, the 33rd annual Retirement Confidence Survey (RCS) showed a decline in the confidence Americans feel in having enough money to live comfortably throughout their retirement years. It’s not an unfounded fear, but it’s one that you can do something about by learning about different types of retirement accounts and making a plan.
Why is having a retirement plan important?
In the Employee Benefit Research Institute’s (EBRI) 2023 RCS, confidence among both workers and retirees dropped. The percentage of workers feeling “very or somewhat confident” in their retirement finances fell from 73 percent in 2022 to 64 percent. Among retirees, there was a drop from 77 percent to 73 percent. The EBRI and Greenwald Research had not seen a decline like this since 2008’s global financial crisis.
Inflation is an issue. Not having enough in savings is also a concern. The EBRI’s Retirement Security Projection Model projects an estimated 40.6% of all U.S. households headed by someone aged 35 to 64 will run short of money during retirement.
Making a retirement plan now can:
- Provide financial security in retirement.
- Take advantage of compound interest to grow your saving faster and larger over time.
- Offer tax benefits, such as tax-deferred contributions or tax-free withdrawals in retirement, which can reduce your tax burden over time.
- Give you access to employer matching contributions to increase your retirement savings even more.
- Let you avoid short-term financial decisions that negatively impact your retirement savings.
- Lower your stress over financial issues, which can improve your health.
Why should I consider retirement accounts?
Taking advantage of retirement accounts helps you save and invest money for your retirement, which ensures that you have a steady stream of income when you’re no longer working. This helps you maintain your standard of living and avoid financial hardship in your golden years.
Leveraging retirement accounts can also help your asset diversification and let you take advantage of tax benefits and compound interest. There are many different retirement account types to consider.
Types of retirement accounts
The importance of starting your saving for retirement as early as possible is common knowledge. The earlier you begin, the longer you give your savings to grow and help ensure that you have enough money to cover your expenses in retirement.
What is not so widely known is the differences between the many types of retirement accounts out there. The following provides the basics about myriad offerings and shares the pros and cons for each.
1. Individual Retirement Account (IRA)
An IRA allows you to save and invest for your retirement with tax benefits. The amount you can contribute to an IRA varies based on your age, income level, and the type of IRA account. For example, SEP IRA contribution limits are based on a percentage of your income. You can choose among four main types.
a. Traditional IRAs:
Contributing to a Traditional IRA reduces your taxable income in that year. Then, the investments in your account grow, tax-deferred. You will pay taxes when you withdraw the funds in retirement. The money is taxed as ordinary income. Any withdrawals made before age 59 ½ are subject to a 10% penalty, in addition to ordinary income taxes.
| Advantages | Disadvantages |
| Anyone can access Many plan choices | – Contribution limits can be low – Minimum withdrawals are required starting at age 73 |
b. Roth IRAs
Your contributions to a Roth are not tax-deductible, but the investments in the account grow tax-free. This means that you don’t pay taxes on the earnings when you withdraw the money in retirement. Additionally, qualified withdrawals from a Roth IRA are tax-free, which can be a significant benefit for retirees.
| Advantages | Disadvantages |
| Contributions can be withdrawn whenever you need without penaltyDistributions aren’t taxed | You’re paying tax on your contributions, so this only provides tax benefit if you expect a higher tax rate in retirementLow contribution limits |
c. SEP IRAs
A Simplified Employee Pension (SEP) IRA is a retirement plan designed for self-employed individuals or small business owners. Contributions to a SEP IRA are tax-deductible and the investments grow tax-deferred. When the money is withdrawn in retirement, it is taxed as ordinary income.
| Advantages | Disadvantages |
| – High contribution limits – Tax deductions on contributions | Catchup contributions are not allowed |
Savings Incentive Match Plan for Employees (SIMPLE) IRAs
This type of plan is designed for small businesses with fewer than 100 employees. Employers are required to make either a matching contribution or a non-elective contribution to their employees’ SIMPLE IRA accounts. The matching contribution is typically 3% of the employee’s compensation, while the non-elective contribution is a flat 2% of the employee’s compensation. Employees can make tax-deductible contributions to their SIMPLE IRA accounts through salary deferrals.
| Advantages | Disadvantages |
| -Employees can contribute up to 100% of compensation up to the account contribution limit – Your contributions are either matched or guaranteed by the employer | – Lower contribution levels are allowed than for other accounts – Withdrawals made before age 59 ½ are subject to a 10% penalty, in addition to ordinary income taxes |
2. Employer-sponsored retirement accounts
There are many ways employers of various types can encourage their employees to save for retirement. The main types of employer-sponsored retirement accounts include the following.
a. 401k
A 401(k) is an employer-sponsored retirement plan that allows employees to contribute a portion of their salary on a pre-tax basis. Many employers match a portion of the employee’s contributions. Contributions and investment earnings grow tax-free until retirement, at which point withdrawals are taxed as income. Employers can choose among traditional 401(k) plans, safe harbor 401(k) plans, and SIMPLE 401(k) plans. Different rules apply to each.
| Advantages | Disadvantages |
| – The high annual contribution limit – Matching funds | – You may have limited options – Higher account fees are possible – Fees on early withdrawals |
b. 403(b)
A 403(b) retirement plan is available to employees of certain non-profit organizations, such as schools, hospitals, and charitable organizations. It is also sometimes referred to as a tax-sheltered annuity plan (TSA). Withdrawals from a 403(b) plan are subject to the same rules as Traditional IRAs. However, there are certain exceptions to the penalty for certain qualifying events, such as disability or death.
| Advantages | Disadvantages |
| – Higher limits for employer matching – Optional catchup contributions allowed up to $ 15,000-lifetime max | Investment options may be limited |
c. 457(b)
A 457(b) plan is available to employees of state and local governments, as well as certain tax-exempt organizations, such as some non-profit organizations. These can include employees of public schools, police departments, and non-profit hospitals, among others. Your contributions are pre-taxable and employers can also make contributions to the plan. There are different withdrawal rules for 457(b) plans. However, withdrawals are subject to ordinary income taxes.
| Advantages | Disadvantages |
| Employees who separate from service may be able to make penalty-free withdrawals before age 59 ½ | No qualified early withdrawals allowed |
3. Thrift Savings Plan (TSP)
TSPs are available to government workers and members of the military. They offer tax-deferred contributions and employer-matching contributions. Withdrawals from a TSP are generally subject to ordinary income taxes and may be subject to a 10% penalty if taken before age 59 ½. However, there are some exceptions, such as penalty-free withdrawals for those over the age of 55 if the employee has left federal service. Further, TSP accounts can be rolled over into other qualified retirement plans, such as an IRA or a 401(k) plan offered by a private employer.
| Advantages | Disadvantages |
| Employees get employer contributions even if they don’t make their contribution | Limited investment options |
4. Taxable brokerage accounts
A taxable brokerage account is an investment account that you open with a brokerage firm or investment company. You can buy and sell a variety of investment assets, such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). You make contributions with after-tax dollars, which means you are taxed on any income earned and capital gains realized within the account. The length of time you’ve held the investment can impact the amount of capital gains taxed.
Taxable brokerage accounts can be owned individually, jointly, or by a trust or an organization. Some individuals will transfer their brokerage accounts to a trust to help beneficiaries avoid probate and receive their inheritance faster if they die.
| Advantages | Disadvantages |
| – No contribution limits – You can buy and sell assets at any time – No withdrawal restrictions | – You’re subject to taxes on any dividends or interest income earned within the account – You may be subject to capital gains taxes on any profit you earn – Brokerages charge fees for managing these accounts |
5. Pensions
Pensions, another one of the type of retirement accounts, can provide a guaranteed income in retirement for employees. Employers make contributions on the employee’s behalf and work to ensure the pension is sufficiently funded to pay out the promised benefits.
A pension typically provides you with a regular, fixed income determined by the pension plan’s formula, which takes into account your salary and years of service. Usually, you have to work for the employer for a set number of years before you will be considered “vested” in the plan. (Vested means they have earned the right to receive retirement benefits from the plan.)
However, pensions have grown less common as more employers move to 401(k) plans or other types of plans that place more risk on the individual investor.
| Advantages | Disadvantages |
| – Payable for life – Replaces a percentage of your pay based on your tenure and salary | – Changing jobs near the end of your career can negatively impact your benefits as pensions are not portable – If the plan is terminated before your retirement, you may also get less than expected |
6. Social Security
The federal government’s Social Security program provides eligible individuals with retirement, disability, and survivor benefits. The program, funded by payroll taxes paid by employees and employers, as well as self-employed individuals, is paid out of the Social Security trust fund. The amount of your benefit is determined by your earnings history.
The full retirement age for Social Security is currently 67 for those born in 1960 or later. However, individuals can choose to start receiving retirement benefits as early as age 62, although their benefit amount will be reduced.
| Advantages | Disadvantages |
| – Benefits are adjusted each year to keep up with inflation, based on the Consumer Price Index – Social Security provides survivor benefits to eligible family members (including a surviving spouse, children, and dependent parents) | – The future solvency of the Social Security trust fund is a concern – High earners may see their benefits subject to income limits |
Learn more about this type of account in our Guide to Social Security During Retirement.
Setting up your retirement account
The steps you take will vary depending on the type of account you’re setting up. Still, you can generally expect to have to do the following once you have determined the right accounts for you and chosen the financial institution where you will open your account.
- Fill out an application: This may require personal information, such as your name, address, Social Security number, and employment information.
- Choose your investments: You may need to select your stocks, mutual funds, exchange-traded funds (ETFs), or other investment options.
- Set up contributions: Maximize the benefits by contributing regularly. Setting up automatic contributions from your paycheck can help keep you consistent.
- Review your investments: Regularly review and adjust your investments to ensure your portfolio remains aligned with your goals and risk tolerance.
You might want to work with a financial advisor to set up your retirement accounts. Find out more about the different types of experts available to work with you. Read What are a CFP, CFA, and CPA?
Next Steps
Now that you have a basic understanding of the basic types of retirement accounts, you can make more informed decisions. You may also want to get expert insights to select the best retirement plans for your unique needs. Read our informative articles, such as Why Hire a Wealth management firm during Retirement, to learn even more about this essential part of your planning for a comfortable financial future.