Understanding the Different Types of Retirement Plans

May 20, 2019 · 8 minute read

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Understanding the Different Types of Retirement Plans

Retirement will likely be the biggest expense of your lifetime, which means saving for retirement is a big job. This is especially true if you envision a retirement that is rich with experiences such as traveling through Europe, spending time with your grown children and grandkids, or turning your home into a Wild Kingdom of rescue animals.

Saving and investing for retirement isn’t always so straightforward, beginning with the question of where to save and invest: There are many different types of retirement plans, and it can be confusing to know which is right for you.

Why Use a Retirement Account over Just Saving

First, it’s important to understand that retirement accounts often have tax advantages as compared to saving within a “regular” savings account or investing with a brokerage account. There can be other benefits to using a retirement account—such as an employer match in a 401(k)—but really, it’s the tax benefits that makes them unique.

Most retirement plans are tax-deferred or otherwise tax advantaged. A discussion of the different types of retirement plans requires an understanding of that taxation, along with who establishes and uses each account, the rules of the plan, and ultimately, which type is best for you.

Different Types of Retirement Accounts

Traditional Individual Retirement Arrangements (IRAs)

An individual retirement account you open and fund yourself (not through an employer).

Income Taxes: You may receive an income tax deduction on contributions (depending on your income and access to a retirement plan through work), the balance in the IRA will always grow tax-deferred, and withdrawals will be taxed (how much is taxed depends on if you made deductible or non-deductible contributions).

Contribution Limit: $6,000 in 2019 , $7,000 if you are age 50 or over.

Pros: You might be able to lower your tax bill if you are eligible to make deductible contributions. Additionally, the money will grow tax-deferred, which can make a difference over a long period of time. Finally, there are not any income limits for contributing to a Traditional IRA, so it is an option for higher income earners that cannot leverage a Roth IRA.

Usually best for: People who can make deductible contributions and want to lower their tax bill, or individuals who earn to much money to contribute directly to a Roth IRA. Sure, higher income earners might not get to deduct contributions from their taxes now, but they can still take advantage of tax-deferred growth between now and retirement. An IRA can also be used for consolidating and rolling over 401(k) accounts from previous jobs.

Also consider: Also consider: There is a 10% penalty for withdrawing funds before age 59½. You cannot deduct IRA contributions if you are already covered by a retirement account through your work and earn more (according to your modified gross adjusted income) than $74,000 (phase out beginning at $64,000).

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Roth IRAs

An individual retirement account that you open and fund yourself.

Income Taxes: You will contribute with after-tax money, which means you will not receive an income tax deduction for contributions. Your balance will grow tax-free and will be able to withdraw the money tax-free in retirement.

Contribution Limit: $6,000 in 2019 , $7,000 if you are age 50 or over.

Pros: You will not lower your tax bill now, but having the money grow tax-free and being to withdraw the money tax-free down the road provides value in the future.

Usually best for: Someone who wants to take advantage of the flexibility to withdraw from an account in retirement without paying taxes. Additionally, it can be especially beneficial for, people who are currently in a low income-tax bracket and expect to be in a higher income tax bracket in the future.

Also consider: To contribute to a Roth IRA, you must have an earned income. Your ability to contribute begins to phase out when your income (specifically, your modified adjusted gross income) reaches $122,000. As a joint filer, your ability to contribute to a Roth IRA phases out at $193,000.

401(k) Plans

A retirement account offered to the employees of a company.

Income Taxes: If you choose to make a pre-tax contribution, your contributions will reduce your taxable income. Additionally, the money will grow tax-deferred and you will pay taxes on the withdrawals in retirement. Additionally, some employers allow you to make after-tax or Roth contributions to a 401k. You should check with your employer to see if those are options.

Contribution Limit: $19,000 in 2019 for the employee, and if you are over the age of 50 you can contribute an additional $6,000 to bring your total to $25,000 in 2019.

Pros: Money is taken from your paycheck, automating the process of saving (a good thing). Some companies offer a company match. There is a significantly higher limit than with Traditional IRA and Roth IRA accounts.

Usually best for: Someone who works for a company that offers one, especially if they provide a match. It can be especially useful, for people who do not have the self-control to save without the money automatically coming out of their paycheck. That is not an insult, rather understand your relationship with money and adjusting accordingly.

Also consider: Sometimes, 401(k) plans have account maintenance or other fees. Because a 401(k) plan is set up by your employer, you have to choose between the investment options they provide.

SIMPLE IRA Plans (Savings Incentive Match Plans for Employees)

Retirement plan that is set up by an employer, and allows employees to contribute but requires employers to contribute.

Income Taxes: Your contributions will reduce your taxable income. Additionally, the money will grow tax-deferred and you will pay taxes on the withdrawals in retirement.

Contribution Limit: $13,000 in 2019 , $16,000 for employees age 50 and over.

Pros: Allows the employer to make tax-deductible contributions to a qualified retirement plan, but with less administrative costs and upkeep as other qualified retirement plans like 401(k) and 401(b) plans.

Usually best for: Small businesses that do not or cannot yet offer a 401(k) or other qualified plans to employees. Generally, business with steady income should consider this option because the employer must either match an employee’s contribution up to 3% or make a 2% nonelective contribution to each eligible employee.

Also consider: Only employers with less than 100 employees are allowed to participate. There are two primary methods for making employer contributions, read more about contribution guidelines here .

SEP Plans (Simplified Employee Pension)

Retirement account established by a small business owner or self-employed person for themselves (and if applicable, any employees).

Retirement account established by a small business owner or self-employed person for themselves (and if applicable, any employees).

Income Taxes: Your contributions will reduce your taxable income. Additionally, the money will grow tax-deferred and you will pay taxes on withdrawals in retirement.

Contribution Limit: Whichever is lower of $56,000 or 25% of compensation per employee.

Pros: Higher contribution limit than IRA and Roth IRAs, and contributions are tax deductible for the business owner. SEP IRA plans are generally easier and cheaper to administer than 401(k) plans.

Usually best for: Self-employed and small business owners who wish to contribute to an IRA for themselves and/or to the IRAs of their employees.

Also consider: Because you are setting up a retirement plan for a business, there’s more paperwork and unique rules. When opening an employer-sponsored retirement plan, consult a tax advisor.

Payroll Deduction IRAs

An individual retirement account that is funded through payroll deductions.

Income Taxes: Taxation is treated the same way as a Traditional IRA or Roth IRA. For a Traditional IRA, you may receive an income tax deduction on contributions (depending on your family’s income and access to a retirement plan through work), the balance in the IRA will always grow tax-deferred, and withdrawals will be taxed (how much is taxed depends on if you made deductible or non-deductible contributions). For a Roth IRA, you will contribute with after tax money, which means you will not receive an income tax deduction for contributions. Your balance will grow tax free and will be able to withdraw the money tax free in retirement.

Contribution Limit: $6,000 in 2019 , $7,000 if you are age 50 or over. (Same as IRAs.)

Pros: Automatically deposits money from your paycheck into a retirement account.

Usually best for: People who do not have access to another retirement plan through their employer.

Also consider: These have the same rules as a Traditional IRA, such as a 10% penalty for withdrawing funds before age 59½. Only employees can contribute to a Payroll Deduction IRA.

Profit-Sharing Plans (PSPs)

A retirement plan funded by discretionary employer contributions that gives employees a share in the profits of a company. An employee receives a percentage of a company’s profits based on its earnings.

Income taxes: Deferred; assessed on distributions from the account in retirement.

Contribution Limit: The lesser of 25% of the employee’s compensation or $56,000.

Pros: Companies can set these up in addition to other qualified retirement plans, and make contributions on a completely voluntary basis.

Usually best for: Companies who want the flexibility to contribute to a PSP on an ad hoc basis.

Also consider: Early withdrawal from the plan is subject to penalty.

Defined Benefit Plans

A retirement plan provided by the employer where an employee’s retirement benefits are calculated using a formula that factors in age, salary, and length of employment. These plans are more commonly known as “pension plans” and are becoming rarer as companies are shifting more toward the 401(k) model.

Income taxes: Deferred; assessed on distributions from the plan in retirement.

Contribution limit: Determined by an enrolled actuary and the employer.

Pros: Provides tax benefits to both the employer and employee and provides a fixed pay-out upon retirement that many retirees find desirable.

Usually best for: Companies that want to provide their employees with a “defined” or pre-determined benefit in their retirement years.

Also consider: These plans are becoming less popular because they cost an employer significantly more in upkeep than a defined contribution plan such as a 401(k) program.

Employee Stock Ownership Plans (ESOPs)

A qualified defined-contribution plan that invests in the stock of the sponsoring employer.

Income taxes: Deferred. When an employee leaves a company or retires, they receive the fair market value for the stock they own. They can either take a taxable distribution or roll the money into an IRA.

Contribution limits: Allocations are made by the employer, usually on the basis of relative pay. There is usually a vesting schedule where employees gain access to shares in one to six years.

Pros: Could provide multiple tax advantages to the employer, as well as tax advantages to the employee and the seller of stock. ESOP plans also align the interests of a company and its employees.

Usually best for: A company that wants to incentivize employees with company stock and use an ESOP as part of its overall tax strategy.

Also consider: These plans are expensive and complicated to set up.

457 Plans

An employer-sponsored deferred compensation plan for employees of state and local government agencies and some tax-exempt organizations.

Income taxes: If you choose to make a pre-tax contribution, your contributions will reduce your taxable income. Additionally, the money will grow tax-deferred and you will pay taxes on the withdrawals in retirement. Additionally, some employers allow you to make after-tax or Roth contributions to a 401k. You should check with your employer to see if those are options.

Contribution limits: $19,000 in 2019 . Some plans allow for “catch-up” contributions.

Pros: Plan participants can withdrawal as soon they are retired, they do not have to wait until age 59½ as with 401(k) and 403(b) plans.

Usually best for: Governmental agencies.

Also consider: These plans are unique and therefore slightly more complicated to administer than a 401(k) or 457(b) plan.

For more information on any of the above types of retirement accounts, see the IRS’s website .

Getting Started on a Retirement Account

If you’re opening your own retirement savings account such as an IRA or Roth IRA, you can do so at a brokerage, bank, mutual fund house, or other financial services company, like SoFi Invest®.

SoFi Invest not only assists you in establishing a retirement account, but we invest your money in accordance with your goals and risk tolerance. And members get complimentary access to a financial advisor.

Sign up for a SoFi Invest account online, in less than five minutes. And if you have any questions or want personalized advice, you can set up a call with a SoFi Invest advisor—it’s absolutely complimentary.


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