Understanding the Different Types of Retirement Plans

Types of Retirement Plans and Which to Consider

Retirement will likely be the most significant 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 or spending time with your grown children and grandkids. A retirement savings plan can help you achieve these financial goals and stay on track.

There are all types of retirement plans you may consider to help you build your wealth, from 401(k) to Individual Retirement Accounts (IRAs) to annuities. Understanding the nuances of these different retirement plans, like their tax benefits and various drawbacks, may help you choose the right mix of plans to achieve your financial goals.

Key Points

•   There are various types of retirement plans, including traditional and non-traditional options, such as 401(k), IRA, Roth IRA, SEP IRA, and Cash-Balance Plan.

•   Employers offer defined contribution plans (e.g., 401(k)) where employees contribute and have access to the funds, and defined benefit plans (e.g., Pension Plans) where employers invest for employees’ retirement.

•   Different retirement plans have varying tax benefits, contribution limits, and employer matches, which should be considered when choosing a plan.

•   Individual retirement plans like Traditional IRA and Roth IRA provide tax advantages but have contribution restrictions and penalties for early withdrawals.

•   It’s possible to have multiple retirement plans, including different types and accounts of the same type, but there are limitations on tax benefits based on the IRS regulations.

Types of Retirement Accounts

There are several different types of retirement plans, including some traditional plan types you may be familiar with as well as non-traditional options.

Traditional retirement plans can be IRAs or 401(k)s. These tax-deferred retirement plans allow you to contribute pre-tax dollars to an account. With a traditional IRA or 401(k), you only pay taxes on your investments when you withdraw from the account.

Non-traditional retirement accounts can include Roth 401(k)s and IRAs, for which you pay taxes on funds before contributing them to the account.

Here’s information about some of the most common retirement plan types:

•   401(k)

•   403(b)

•   Solo 401(k)

•   SIMPLE IRA (Savings Incentive Match Plan for Employees)

•   SEP Plan (Simplified Employee Pension)

•   Profit-Sharing Plan (PSP)

•   Defined Benefit Plan (Pension Plan)

•   Employee Stock Ownership Plan (ESOP)

•   457(b) Plan

•   Federal Employees Retirement System (FERS)

•   Cash-Balance Plan

•   Nonqualified Deferred Compensation Plan (NQDC)

•   Multiple Employer Plans

•   Traditional Individual Retirement Accounts (IRAs)

•   Roth IRAs

•   Payroll Deduction IRAs

•   Guaranteed Income Annuities (GIAs)

•   Cash-Value Life Insurance Plan

This article is part of SoFi’s Retirement Planning Guide, our coverage of all the steps you need to create a successful retirement plan.


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💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Retirement Plans Offered by Employers

There are typically two types of retirement plans offered by employers:

•   Defined contribution plans (more common): The employee invests a portion of their paycheck into a retirement account. Sometimes, the employer will match up to a certain amount (e.g. up to 5%). In retirement, the employee has access to the funds they’ve invested. 401(k)s and Roth 401(k)s are examples of defined contribution plans.

•   Defined benefit plans (less common): The employer invests money for retirement on behalf of the employee. Upon retirement, the employee receives a regular payment, which is typically calculated based on factors like the employee’s final or average salary, age, and length of service. As long as they meet the plan’s eligibility requirements, they will receive this fixed benefit (e.g. $100 per month). Pension plans and cash balance accounts are common examples of defined benefit plans.

Let’s get into the specific types of plans employers usually offer.

401(k) Plans

A 401(k) plan is a type of work retirement plan offered to the employees of a company. Traditional 401(k)s allow employees to contribute pre-tax dollars, where Roth 401(k)s allow after-tax contributions.

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

•   Contribution Limit: $22,500 in 2023 and $23,000 in 2024 for the employee; people 50 and older can contribute an additional $7,500.

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

•   Cons: With a 401(k) plan, you are largely at the mercy of your employer — there’s no guarantee they will pick plans that you feel are right for you or are cost effective for what they offer. Also the value of a 401(k) comes from two things: the pre-tax contributions and the employer match, if your employer doesn’t match, a 401(k) may not be as valuable to an investor. There are also penalties for early withdrawals before age 59 ½, although there are some exceptions, including for certain public employees.

•   Usually best for: Someone who works for a company that offers one, especially if the employer provides a matching contribution. A 401(k) retirement plan can also be especially useful for people who want to put retirement savings on autopilot.

•   To consider: Sometimes 401(k) plans have account maintenance or other fees. Because a 401(k) plan is set up by your employer, investors only get to choose from the investment options they provide.

💡 Recommended: Roth 401(k) vs Traditional 401(k): Which Is Best for You?

403(b) Plans

A 403(b) retirement plan is like a 401(k) for certain individuals employed by public schools, churches, and other tax-exempt organizations. Like a 401(k), there are both traditional and Roth 403(b) plans. However, not all employees may be able to access a Roth 403(b).

•   Income Taxes: With a traditional 403(b) plan, you contribute pre-tax money into the account; 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 403(b); the money will grow tax-deferred and you will not have to pay taxes on withdrawals in retirement. You should check with your employer to see if those are options.

•   Contribution Limit: $22,500 in 2023 and $23,000 in 2024 for the employee; people 50 and older can contribute an additional $7,500 in both of those years. The maximum combined amount both the employer and the employee can contribute annually to the plan is generally the lesser of $66,000 in 2023 and $69,000 in 2024, or the employee’s most recent annual salary.

•   Pros: Money is deducted from your paycheck, automating the process of saving. Some companies offer a company match. Also, these plans often come with lower administrative costs because they aren’t subject to Employee Retirement Income Security Act (ERISA) oversight.

•   Cons: A 403(b) account generally lacks the same protection from creditors as plans with ERISA compliance.

•   To consider: 403(b) plans offer a narrow choice of investments compared to other retirement savings plans. The IRS states these plans can only offer annuities provided through an insurance company and a custodial account invested in mutual funds.

Solo 401(k) Plans

A Solo 401(k) plan is essentially a 1-person 401(k) plan for self-employed individuals or business owners with no employees, in which you are the employer and the employee. Solo 401(k) plans may also be called a Solo-k, Uni-k, or One-participant k.

•   Income Taxes: The contributions made to the plan are tax-deductible.

•   Contribution Limit: $22,500 in 2023 and $23,000 in 2024, or 100% of your earned income, whichever is lower, plus “employer” contributions of up to 25% of your compensation from the business. The 2023 total cannot exceed $66,000, and the 2024 total cannot exceed $69,000. (On top of that, people 50 and older are allowed to contribute an additional $7,500 in 2023 and 2024.)

•   Pros: A solo 401(k) retirement plan allows for large amounts of money to be invested with pre-tax dollars. It provides some of the benefits of a traditional 401(k) for those who don’t have access to a traditional employer-sponsored 401(k) retirement account.

•   Cons: You can’t open a solo 401(k) if you have any employees (though you can hire your spouse so they can also contribute to the plan as an employee — and you can match their contributions as the employer).

•   Usually best for: Self-employed people with enough income and a large enough business to fully use the plan.

SIMPLE IRA Plans (Savings Incentive Match Plans for Employees)

A SIMPLE IRA plan is set up by an employer, who is required to contribute on employees’ behalf, although employees are not required to contribute.

•   Income Taxes: Employee contributions are made with pre-tax dollars. Additionally, the money will grow tax-deferred and employees will pay taxes on the withdrawals in retirement.

•   Contribution Limit: $15,500 in 2023 and $16,000 in 2024. Employees aged 50 and over can contribute an extra $3,500 in 2023 and in 2024, bringing their total to $19,000 in 2023 and $19,500 in 2024.

•   Pros: Employers contribute to eligible employees’ retirement accounts at 2% their salaries, whether or not the employees contribute themselves. For employees who do contribute, the company will match up to 3%.

•   Cons: The contribution limits for employees are lower than in a 401(k) and the penalties for early withdrawals — up to 25% for withdrawals within two years of your first contribution to the plan — before age 59 ½ may be higher.

•   To consider: Only employers with less than 100 employees are allowed to participate.

💡 Recommended: Comparing the SIMPLE IRA vs. Traditional IRA

SEP Plans (Simplified Employee Pension)

This is a 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: For 2023, whichever is lower: $66,000 or 25% of earned income; for 2024, $69,000 or 25% of earned income, whichever is lower.

•   Pros: Higher contribution limit than IRA and Roth IRAs, and contributions are tax deductible for the business owner.

•   Cons: These plans are employer contribution only and greatly rely on the financial wherewithal and available cash of the business itself.

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

•   To consider: Because you’re setting up a retirement plan for a business, there’s more paperwork and unique rules. When opening an employer-sponsored retirement plan, it generally helps to consult a tax advisor.

Profit-Sharing Plans (PSPs)

A Profit-Sharing Plan is a retirement plan funded by discretionary employer contributions that gives employees a share in the profits of a company.

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

•   Contribution Limit: The lesser of 25% of the employee’s compensation or $66,000 in 2023. (On top of that, people 50 and older are allowed to contribute an additional $7,500 in 2023.) In 2024, the contribution limit is $69,000 or 25% of the employee’s compensation, whichever is less. Those 50 and up can contribute an extra $7,500 in 2024.

•   Pros: An employee receives a percentage of a company’s profits based on its earnings. Companies can set these up in addition to other qualified retirement plans, and make contributions on a completely voluntary basis.

•   Cons: These plans put employees at the mercy of their employers’ profits, unlike retirement plans that allow employees to invest in securities issued by other companies.

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

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

Defined Benefit Plans (Pension Plans)

These plans, more commonly known as pension plans, are retirement plans provided by the employer where an employee’s retirement benefits are calculated using a formula that factors in age, salary, and length of employment.

•   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 payout upon retirement that many retirees find desirable.

•   Cons: These plans are increasingly rare, but for those who do have them, issues can include difficulty realizing or accessing benefits if you don’t work at a company for long enough.

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

•   To 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)

An Employee Stock Ownership Plan is 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 typically a vesting schedule where employees gain access to shares in one to six years.

•   Pros: Could provide tax advantages to the employee. ESOP plans also align the interests of a company and its employees.

•   Cons: These plans concentrate risk for employees: An employee already risks losing their job if an employer is doing poorly financially, by making some of their compensation employee stock, that risk is magnified. In contrast, other retirement plans allow an employee to invest in stocks in other securities that are not tied to the financial performance of their employer.

457(b) Plans

A 457(b) retirement plan is 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. Some employers also allow you to make after-tax or Roth contributions to a 401(k).

•   Contribution limits: The lesser of 100% of employee’s compensation or $22,500 in 2023 and $23,000 in 2024; some plans allow for “catch-up” contributions.

•   Pros: Plan participants can withdraw as soon as they are retired at any age, they do not have to wait until age 59 ½ as with 401(k) and 403(b) plans.

•   Cons: 457 plans do not have the same kind of employer match as a 401(k) plan. While employers can contribute to the plan, it’s only up to the combined limit for individual contributions.

•   Usually best for: Employees of governmental agencies.

Federal Employees Retirement System (FERS)

The Federal Employees Retirement System (FERS) consists of three government-sponsored retirement plans: Social Security, the Basic Benefit Plan, and the Thrift Savings Plan.

The Basic Benefit Plan is an employer-provided pension plan, while the Thrift Savings Plan is most comparable to what private-sector employees can receive.

•   Income Taxes: Contributions to the Thrift Savings Plan are made before taxes and grow tax-free until withdrawal in retirement.

•   Contribution Limit: The contribution limit for employees is $22,500 in 2023, and the combined limit for all contributions, including from the employer agency, is $66,000. In 2024, the employee contribution limit is $23,000, and the combined limit for all contributions, including those from the employer, is $69,000. Also, those 50 and over are eligible to make an additional $7,500 in “catch-up” contributions in both 2023 and 2024.

•   Pros: These government-sponsored plans are renowned for their low administrative fees and employer matches.

•   Cons: Only available for federal government employees.

•   Usually best for: Federal government employees who will work at their agencies for a long period; it is comparable to 401(k) plans in the private sector.

Cash-Balance Plans

This is another type of pension plan that combines features of defined benefit and defined contribution plans. They are sometimes offered by employers that previously had defined benefit plans. The plans provide an employee an “employer contribution equal to a percent of each year’s earnings and a rate of return on that contribution.”

•   Income Taxes: Contributions come out of pre-tax income, similar to 401(k).

•   Contribution Limit: The plans combine a “pay credit” based on an employee’s salary and an “interest credit” that’s a certain percentage rate; the employee then gets an account balance worth of benefits upon retirement that can be paid out as an annuity (payments for life) or a lump sum. Limits depend on age, but for those over 60, they can be more than $250,000.

•   Pros: Can reduce taxable income.

•   Cons: Cash-balance plans have high administrative costs.

•   Usually best for: High earners, business owners with consistent income.

Nonqualified Deferred Compensation Plans (NQDC)

These are plans typically designed for executives at companies who have maxed out other retirement plans. The plans defer payments — and the taxes — you would otherwise receive as salary to a later date.

•   Income Taxes: Income taxes are deferred until you receive the payments at the agreed-upon date.

•   Contribution Limit: None

•   Pros: The plans don’t have to be entirely geared around retirement. While you can set dates with some flexibility, they are fixed.

•   Cons: Employees are not usually able to take early withdrawals.

•   Usually best for: Highly-paid employees for whom typical retirement plans would not provide enough savings compared to their income.

Multiple Employer Plans

A multiple employer plan (MEP) is a retirement savings plan offered to employees by two or more unrelated employers. It is designed to encourage smaller businesses to share the administrative burden of offering a tax-advantaged retirement savings plan to their employees. These employers pool their resources together to offer a defined benefit or defined contribution plan for their employees.

Administrative and fiduciary responsibilities of the MEP are performed by a third party (known as the MEP Sponsor), which may be a trade group or an organization that specializes in human resources management.

Compare Types of Retirement Accounts Offered by Employers

To recap retirement plans offered by employers:

Retirement Plans Offered by Employers

Type of Retirement Plan

May be Funded By

Pro

Con

401(k) Employee and Employer Contributions are deducted from paycheck Limited investment options
Solo 401(k) Employee and Employer Good for self-employed people Not available for business owners that have employees
403(b) Employee and Employer Contributions are deducted from paycheck Usually offer a narrow choice of investment options
SIMPLE IRA Employer and Employee Employer contributes to account High penalties for early withdrawals
SEP Plan Employer High contribution limits Contributions are at the mercy of financial wherewithal of the employer
Profit-Sharing Plan Employer Can be paired with other qualified retirement plans Plan is at the mercy of an employer’s profits
Defined Benefit Plan Employer Fixed payout upon retirement Can be difficult to access benefits
Employee Stock Ownership Plan Employer Aligns interest of a company and its employees Risky for employees
457 Employee You don’t have to wait until age 59 ½ to withdraw Does not have same employer match possibility like a 401(k)
Federal Employees Retirement System Employee and Employer Low administrative fees Only available for federal government employees
Cash-Balance Plan Employer Can reduce taxable income High administrative costs
Nonqualified Deferred Compensation Plan Employer Don’t have to be retirement focused Employees are not usually able to take early withdrawals

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Retirement Plans Not Offered by Employers

Traditional Individual Retirement Accounts (IRAs)

Individual retirement accounts (IRAs) are managed by the individual policyholder.

With an IRA, you open and fund the IRA yourself. As the name suggestions, it is a retirement plan for individuals. This is not a plan you join through an employer.

•   Income Taxes: You may receive an income tax deduction on contributions (depending on your income and access to another retirement plan through work). The balance in the IRA will always grow tax-deferred, and withdrawals will be taxed (the amount will vary depending on whether contributions were deductible or non-deductible).

•   Contribution Limit: $6,500 in 2023, or $7,500 for people age 50 or over. In 2024, the contribution limit is $7,000, or $8,000 for people 50 and older.

•   Pros: You might be able to lower your tax bill if you’re 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 no income limits for contributing to a traditional IRA.

•   Cons: Traditional IRAs come with a number of restrictions, including how much can be contributed and when you can start withdrawals without penalty. Traditional IRAs are also essentially a bet on the tax rate you will be paying when you begin withdrawals after age 59 ½, as the accounts grow tax-deferred but are taxed upon withdrawal. Also, traditional IRAs generally mandate withdrawals starting at age 73.

•   Usually best for: People who can make deductible contributions and want to lower their tax bill, or individuals who earn too much money to contribute directly to a Roth IRA. Higher-income earners might not get to deduct contributions from their taxes now, but they can 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.

•   To consider: You may be subject to a 10% penalty for withdrawing funds before age 59 ½. As a single filer, you cannot deduct IRA contributions if you’re already covered by a retirement account through your work and earn more (according to your modified gross adjusted income) than $83,000 in 2023 (with a phase-out beginning at $73,000 in 2023) and more than $87,000 in 2024, with a phase-out starting at $77,000.

Roth IRAs

A Roth IRA is another retirement plan for individuals that is managed by the account holder, not an employer.

•   Income Taxes: Roth IRA contributions are made with after-tax money, which means you won’t receive an income tax deduction for contributions. But your balance will grow tax-free and you’ll be able to withdraw the money tax-free in retirement.

•   Contribution Limit: $6,500 in 2023, or $7,500 for people age 50 or over. In 2024, the contribution limit is $7,000, or $8,000 for those 50 and up.

•   Pros: While contributing to a Roth IRA won’t lower your tax bill now, having the money grow tax-free and being able to withdraw the money tax-free down the road provides value in the future.

•   Cons: Like a traditional IRA, a Roth IRA has tight contribution restrictions. Unlike a traditional IRA, it does not offer tax deductions for contributions. As with a traditional IRA, there’s a penalty for taking some kinds of distributions before age 59 ½.

•   Usually best for: Someone who wants to take advantage of the flexibility to withdraw from an account during 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.

•   To consider: To contribute to a Roth IRA, you must have an earned income. Your ability to contribute begins to phase out when your income as a single filer (specifically, your modified adjusted gross income) reaches $138,000 in 2023 and $146,000 in 2024. As a joint filer, your ability to contribute to a Roth IRA phases out at $218,000 in 2023 and at $230,000 in 2024.

Payroll Deduction IRAs

This is either a traditional or Roth IRA that is funded through payroll deductions.

•   Income Taxes: For a Traditional IRA, you may receive an income tax deduction on contributions (depending on 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, contributions are made with after-tax money, your balance will grow tax-free and you’ll be able to withdraw the money tax-free in retirement.

•   Contribution Limit: $6,500 in 2023, or $7,500 for people age 50 or over. In 2024, the limit is $7,000, or $8,000 for those 50 and older.

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

•   Cons: The employee must do the work of setting up a plan, and employers can not contribute to it as with a 401(k). Participants cannot borrow against the retirement plan or use it as collateral for loans.

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

•   To consider: These have the same rules as a Traditional IRA, such as a 10% penalty for withdrawing funds before age 59 ½. Only employees can contribute to a Payroll Deduction IRA.

Guaranteed Income Annuities (GIAs)

Guaranteed Income Annuities are products sold by insurance companies. They are similar to the increasingly rare defined benefit pensions in that they have a fixed payout that will last until the end of life. These products are generally available to people who are already eligible to receive payouts from their retirement plans.

•   Income Taxes: If the annuity is funded by 401(k) benefits, then it is taxed like income. Annuities purchased with Roth IRAs, however, have a different tax structure. For “non-qualified annuities,” i.e. annuities purchased with after-tax income, a formula is used to determine the taxes so that the earnings and principal can be separated out.

•   Contribution Limit: Annuities do not have contribution limits.

•   Pros: These allow for payouts until the end of life and are fixed, meaning they’re not dependent on market performance.

•   Cons: Annuities are expensive; to buy an annuity, you’ll likely pay a high commission to a financial advisor or insurance salesperson.

•   Usually best for: People who have high levels of savings and can afford to make expensive initial payments on annuities.

Cash-Value Life Insurance Plan

Cash-value life insurance covers the policyholder’s entire life and has tax-deferred savings, making it comparable to other retirement plans. Some of the premium paid every month goes to this investment product, which grows over time.

•   Income Taxes: Taxes are deferred until the policy is withdrawn from, at which point withdrawals are taxed at the policyholder’s current income tax rate.

•   Contribution Limit: The plan is drawn up with an insurance company with set premiums.

•   Pros: These plans have a tax-deferring feature and can be borrowed from.

•   Cons: While you may be able to withdraw money from the plan, this will reduce your death benefit.

•   Usually best for: High earners who have maxed out other retirement plans.

Compare Types of Retirement Accounts Not Offered by Employers

To recap retirement plans not offered by employers:

Retirement Plans Not Offered by Employers

Type of Retirement Plan

Pro

Con

IRA Contributions may be tax deductible Penalty for withdrawing funds before age 59 ½
Roth IRA Distributions are not taxed Not available for individuals with high incomes
Payroll Deduction IRA Automatically deposits money from your paycheck into the account Participants can’t borrow against the plan
Guaranteed Income Annuity Not dependent on market performance Expensive fees and commissions
Cash-Value Life Insurance Plan Tax-deferred savings May be able to withdraw money from the plan, but this will reduce death benefit

Specific Benefits to Consider

As you’re considering the different types of retirement plans, it’s important to look at some key benefits of each plan. These include:

•   the tax advantage

•   contribution limits

•   whether an employer will add funds to the account

•   any fees associated with the account



💡 Quick Tip: How much does it cost to set up an IRA? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

Determining Which Type of Retirement Plan Is Best for You

Depending on your employment circumstances, there are many possible retirement plans in which you can invest money for retirement. Some are offered by employers, while other retirement plans can be set up by an individual.

Likewise, the benefits for each of the available retirement plans differ. Here are some specific benefits and disadvantages of a few different plans to consider.

With employer-offered plans like a 401(k) and 403(b), you have the ability to:

Take them with you. If you leave your job, you can roll these plans over into a plan with a new employer or an IRA.

Possibly earn a higher return. With these plans, you typically have more investment choices, including stock funds.

With retirement plans not offered by employers, like a SEP IRA, you may get:

A wider variety of investment options. You could have even more options to choose from with these plans, including those that may offer higher returns.

You may be able to contribute more. The contribution limits for some of these plans tend to be higher.

Despite their differences, the many different types of retirement accounts all share one positive attribute: utilizing and investing in them is an important step in saving for retirement.

Because there are so many retirement plans to choose from, it may be wise to talk to a financial professional to help you decide your financial plan.

Can You Have Multiple Types of Retirement Plans?

You can have multiple retirement savings plans, whether employer-provided plans like a 401(k), IRAs, or annuities. Having various plans can let you take advantage of the specific benefits that different retirement savings plans offer, thus potentially increasing your total retirement savings.

Additionally, you can have multiple retirement accounts of the same type; you may have a 401(k) at your current job while also maintaining a 401(k) from your previous employer.

Nonetheless, there are limitations on the tax benefits you may be allowed to receive from these multiple retirement plans. For example, the IRS does not allow individuals to take a tax deduction for traditional IRA contributions if they also have an employer-sponsored 401(k).

Opening a Retirement Investment Account With SoFi

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FAQ

Why is it important to understand the different types of retirement plans?

Understanding the different types of retirement plans is important because of the nuances of taxation in these accounts. The various rules imposed by the Internal Revenue Service (IRS) can affect your contributions, earnings, and withdrawals. And not only does the IRS have rules around taxation, but also about contribution limits and when you can withdraw money without penalties.

Additionally, the various types of retirement plans differ regarding who establishes and uses each account and the other plan rules. Ultimately, understanding these differences will help you determine which combination of retirement plans is best for you.

How can you determine which type of retirement plan is best for you?

The best type of retirement plan for you is the one that best meets your needs. Many types of retirement plans are available, and each has its own benefits and drawbacks. When choosing a retirement plan, some factors to consider include your age, investing time horizon, financial goals, risk tolerance, and the fees associated with a retirement plan.


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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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What Is a Salary Reduction Contribution Plan?

What Is a Salary Reduction Contribution Plan?

A salary reduction contribution plan allows employees to reduce their taxable income by investing for retirement. With this type of plan, an employee’s salary isn’t really reduced; rather the employer deducts a percentage of their salary and deposits the funds in a retirement savings plan where the money can grow tax deferred.

Common employer-sponsored retirement plans include 401(k)s, 403(b)s, and SIMPLE IRAs. Employee contributions — also called elective deferral contributions — are typically made with pre-tax money, effectively reducing the participant’s taxable income and often lowering their tax bill. Some plans feature an after-tax Roth contribution option, too.

You may already be contributing to a salary reduction contribution plan, although your company may not call it that. These plans can be a valuable way to boost your retirement savings, and offer you a tax break. Here’s what you need to know.

Salary Reduction Contribution Plans Explained

A salary reduction contribution plan helps workers save and invest for retirement through their employer via several types of retirement accounts. Money is typically deposited in a retirement account such as a 401(k), 403(b), or SIMPLE IRA on a pre-tax basis through recurring deferrals (aka contributions) on behalf of the employee.

Employees typically select the percentage they wish to deposit, e.g. 3%, 10%, or more. That percentage is deducted from an employee’s paycheck automatically, and deposited in their retirement account. Sometimes a specific dollar amount is established as the salary reduction contribution amount.

The upshot for the worker is that they can delay paying taxes on the amount of the salary reduction for many years, until they withdraw money from the account during retirement. Like a traditional 401(k) or 403(b), these accounts can be tax deferred; Roth options are considered after tax (because you deposit after-tax funds, but pay no tax on withdrawals). Retirement contributions may offer decades of compounded investment returns without taxation. Essentially, retirement contributions through an employer’s plan means saving money from your salary.

There are also SIMPLE IRA salary reduction agreements sometimes offered by small businesses with 100 or fewer employees: “SIMPLE” is short for “Savings Incentive Match Plan for Employees.”

A Salary Reduction Simplified Employee Pension Plan (SARSEP), on the other hand, is a simplified employee pension plan established before 1997.


💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

How Salary Reduction Contribution Plans Work

Salary reduction contribution plans are established between a worker and their employer. The two parties agree to have a set percentage or a dollar amount taken from the employee’s salary and deposited into a tax-advantaged retirement plan. That money can then be invested in stock or bond mutual funds, or other investments offered by the plan.

With pre-tax contributions, the employee has a reduced paycheck but gets current-year tax savings. With after-tax contributions, as in a Roth account, taxes are paid today while the account can potentially grow tax-free through retirement; withdrawals from a Roth account are tax free.

Example of a Salary Reduction Contribution Plan

Here’s an example of how a salary reduction contribution plan agreement might work:

Let’s say an employee at a university has a $100,000 salary and wishes to save 10% of their pay in a pre-tax retirement account. The school has a 403(b) plan in place. The worker contacts their Human Resources department to ask about submitting a salary reduction agreement form. On the form, the worker chooses an amount of their salary to defer into the 403(b) plan (10%).

Typically they also select investments from a lineup of mutual funds or exchange-traded funds (ETFs).

Come payday, the employee’s paycheck will look different. If the usual biweekly gross earnings amount is $3,846 ($100,000 salary divided by 26 pay periods, per year), then $384.60, or 10% of earnings, is deducted from the employee’s paycheck and deposited into the 403(b) and invested, assuming the employee has selected their desired investment options.

Depending on other deductions, the employee’s new taxable income might be $3,461.40. The contribution effectively reduced the worker’s salary, potentially lowering their tax bill at the end of the year.

If the worker is in the 22% marginal income tax bracket, the $10,000 annual deferral amounts to an annual federal income tax savings of $2,200 per year.

Bear in mind that withdrawals from the 403(b) plan are taxable with pre-tax salary reductions. We’ll look at salary reduction plan withdrawal rules later.

Pros & Cons of Salary Reduction Contribution Plans

Although your employer may offer a salary reduction contribution plan like a 401(k) or SIMPLE IRA salary reduction agreement for retirement, it’s not required to participate. Before deciding whether you want to join your organization’s plan, here are some advantages and disadvantages to consider.

Pros

A salary reduction contribution offers employees the chance to reduce their current-year taxable income. A lower salary defers taxation on the money you save, until retirement. For young workers, that could mean decades of compounding returns without having to pay taxes along the way.

For those who have the option of choosing a Roth account, taxes are paid in the current year, but withdrawals are tax free (as long as certain criteria are met). Also, contributions to a Roth 401(k) or Roth 403(b) plan can grow tax-free through retirement.

What’s more, the employer might offer their own contribution such as a matching contribution. Typically, an employer might match employees’ contributions up to a certain amount: e.g. they’ll match 50 cents for every dollar an employee saves, up to 6% of their salary.

Another upside is that lowering one’s salary through automated savings can help an individual live on less money and avoid spending beyond their means — which may help establish long-term savings habits. Thus, contributing to a salary reduction plan can be a step toward creating a financial plan.

Cons

Like many aspects of personal finance, salary reduction contributions can be a balancing act between meeting your obligations today and providing for your future self.

Saving for the future can mean forgoing some pleasure in the present, similar to the concept of delayed gratification. Maybe you decide to postpone a vacation or purchase of a new car in exchange for a more robust retirement account balance.

Employees should also weigh the likelihood of needing money in the event of an emergency. Taking early withdrawals or borrowing from your 401(k) account can be costly, or may come with penalties, versus having extra cash in a checking or savings account. In most cases if you take out a loan from an employer-sponsored plan, you would have to repay the loan in full if you left your job.


💡 Quick Tip: The advantage of opening a Roth IRA and a tax-deferred account like a 401(k) or traditional IRA is that by the time you retire, you’ll have tax-free income from your Roth, and taxable income from the tax-deferred account. This can help with tax planning.

Salary Reduction Contribution Limits

Annual salary reduction contribution limits can change each year. The Internal Revenue Service (IRS) determines the yearly maximum contribution amount. For 2024, the most a worker can contribute to a 401(k) or 403(b) is $23,000. For those age 50 and older, an additional $7,500 contribution is permitted.

In 2023, a worker can contribute up to $22,500 to a 401(k) or 403(b), and those 50 and older can contribute an additional $7,500 in catch-up contributions.

A SIMPLE IRA salary reduction agreement has different limits. For 2024, a SIMPLE IRA’s annual maximum contribution is $16,000 with a catch-up contribution of up to $3,500 for those age 50 and older. For 2023, the annual maximum SIMPLE IRA contribution limit is $15,500 and $3,500 for those 50 and up.

Salary Reduction Contribution Plan Withdrawal Rules

There are many rules regarding salary reduction contribution plan withdrawals.

At a high level, when an employee withdraws money from a tax-deferred retirement account, they will owe income tax on the money. If you withdraw money before age 59 ½, a 10% early-withdrawal tax might be applied.

There can be some exceptions to these rules, but it’s best to consult with a professional.

Should you withdraw money when you leave your employer? While taking a lump sum is possible under those circumstances, it may not be your best choice: You’d owe taxes on the full amount, and you’d risk spending money that’s meant to support you when you’re older.

The standard rule of thumb is that individuals who are leaving one employer should consider rolling over their retirement account to an IRA, or their new employer’s plan. In that case there are no penalties or taxes owed, and the money is once again secured for the future.

The Takeaway

Salary reduction contribution plans can help workers save money for retirement on a pre-tax or after-tax basis. Steadily putting money to work for your future is a major step toward building a solid long-term financial plan. And in many cases you will reap a tax advantage in the present — or in the future.

That said, there are important pros and cons to weigh when deciding whether you should contribute via a salary reduction plan. You may have another strategy. But if you don’t, you might want to consider opting into your employer’s plan for the benefits it can provide.

An important point to know: Even when you join a salary reduction plan, you can still open up an IRA to boost your savings. And if you leave your job, you can roll over your salary reduction retirement account to an IRA without paying taxes or penalties.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Easily manage your retirement savings with a SoFi IRA.

FAQ

Does a 401(k) reduce salary?

Not really. Contributions toward a traditional 401(k) retirement plan are a tax-deductible form of savings that effectively reduce an individual’s taxable income. In that regard, making retirement contributions on a pre-tax basis can reduce someone’s salary (but you still have the money in your retirement account).

Also, some plans allow for after-tax contributions which also reduce the size of your paycheck, but are not tax deductible.

What does employee salary reduction mean?

Employee salary reduction means that money is automatically deducted from an employee’s paycheck and contributed to a retirement plan. Money moves into a plan such as a 401(k), 403(b), or a SIMPLE IRA. The account is in the employee’s name, and they decide how to invest the funds.

What is the difference between SEP and SARSEP?

A SEP is known as a Simplified Employee Pension Plan. A SEP plan allows employers to contribute to traditional IRAs (called SEP IRAs) for their employees. The IRS states that a business of any size, even self-employed, can establish a SEP. These plans are common in the small business world.

A SARSEP, on the other hand, is a simplified employee pension plan established before 1997. A SARSEP includes a salary reduction arrangement. The employee can choose to have the employer contribute a portion of their salary to an IRA or annuity. Per the IRS, a SARSEP may not be established after 1996.


Photo credit: iStock/visualspace

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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Default Deferral Rate 401(k) Explained

Default Deferral Rate 401(k) Explained

Your 401(k) deferral rate is the amount that you contribute to the plan via your paychecks. Many companies have a default deferral rate on 401(k) plans, in which they automatically direct a certain amount of your paycheck to your 401(k) plan. This occurs automatically, unless you opt out of participation or select a higher default rate.

The default deferral rate on 401(k) plans varies from one plan to another (and not all plans have a default rate), though the most common rate is 7%. If you’re currently saving in a 401(k) plan or will soon enroll in your employer’s plan, it’s important to understand how automatic contributions work.

What Is a 401(k) Deferral Rate?

A deferral rate is the percentage of salary contributed to a 401(k) plan or a similar qualified plan each pay period. Each 401(k) plan can establish a default deferral percentage, which represents the minimum amount that employees automatically contribute, unless they opt out of the plan.

For example, someone making a $50,000 annual salary would automatically contribute a minimum of $1,500 per year to their plan if it had a 3% automatic deferral rate.

Employees can choose not to participate in the plan, or they can contribute more than the minimum deferral percentage set by their plan. They may choose to contribute 10%, 15% or more of their salary into the plan each year, and receive a tax benefit up to the annual limit. Again, the more of your income you defer into the plan, the larger your retirement nest egg may be later.

There are several benefits associated with changing your 401(k) contributions to maximize 401(k) salary deferrals, including:

•   Reducing taxable income if you’re contributing pre-tax dollars

•   Getting the full employer matching contribution

•   Qualifying for the retirement saver’s credit

If you qualify, the Saver’s Credit is worth up to $1,000 for single filers or $2,000 for married couples filing jointly. This credit can be used to reduce your tax liability on a dollar-for-dollar basis.


💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Average Deferral Rate

Studies have shown that more employers are leaning toward the higher end of the scale when setting the default deferral rate. According to research from the Plan Sponsor Council of America (PSCA), for instance, 32.9% of employers use an automatic default deferral rate of 6% versus 29% that set the default percentage at 3%.

In terms of employer matching contributions, a recent survey from the PSCA found that 96% of employers offer some level of match. The most recent data available from the Bureau of Labor suggests that the average employer match works out to around 3.5%. Again, it’s important to remember that not every employer offers this free money to employees who enroll in the company’s 401(k).

Research shows that higher default rates result in higher overall retirement savings for participants.

What Is the Actual Deferral Percentage Test?

The actual deferral percentage (ADP) test is one of two nondiscrimination tests employers must apply to ensure that employees who contribute to a 401(k) receive equal treatment, as required by federal regulations. The ADP test counts elective deferrals of highly compensated employees and non-highly compensated employees to determine proportionality. A 401(k) plan passes the ADP test if the actual deferral percentage for highly compensated employees doesn’t exceed the greater of:

•   125% of the ADP for non-highly compensated employees, or the lesser of

•   200% of the ADP for non-highly compensated employees or the ADP for those employees plus 2%

If a company fails the ADP test or the second nondiscrimination test, known as actual contribution percentage, then it has to remedy that to avoid an IRS penalty. This can mean making contributions to the plan on behalf of non-highly compensated employees.

How Much Should I Contribute to Retirement?

If you’re ready to start saving for retirement, using your employer’s 401(k), one of the most important steps is determining your personal deferral rate. The appropriate deferral percentage can depend on several things, including:

•   How much you want to save for retirement total

•   Your current age and when you plan to retire

•   What you can realistically afford to contribute, based on your current income and expenses

A typical rule of thumb suggested by financial specialists is to save at least 15% of your gross income toward retirement each year. So if you’re making $100,000 a year before taxes, you’d save $15,000 in your 401(k) following this rule. But it’s important to consider whether you can afford to defer that much into the plan.

Using a 401(k) calculator or retirement savings calculator can help you to get a better idea of how much you need to save each year to reach your goals, based on where you’re starting from right now. As a general rule, the younger you are when starting to invest for retirement the better, as you have more time to take advantage of the power of compounding returns.

If you don’t have a 401(k), you can still save for retirement through an Individual Retirement Account (IRA) and set up automatic deposits to mimic paycheck deferrals and give you the benefit of dollar-cost averaging.


💡 Quick Tip: How much does it cost to set up an IRA? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

Contribution Limits

It’s important to keep in mind that there are annual contribution limits for 401(k) plans. These limits determine how much of your income you can defer in any given year and are established by the IRS. The IRS adjusts annual contribution limits periodically to account for inflation.

For 2023, employees are allowed to contribute $22,500 to their 401(k) plans. An additional catch-up contribution of $7,500 is allowed for employees aged 50 or older. That means older workers may be eligible to make a total contribution of $30,000.

For 2024, employees can contribute $23,000 to their 4091(k), and those 50 and older can make an additional catch-up contribution of $7,500.

The total annual 2023 contribution limit for 401(k) plans, including both employee and employer matching contributions, is $66,000. For 2024, the total annual contribution limit is $69,000.

The money that you contribute to the 401(k) is yours, but you might not own the contributions from your employer until a certain period of time has passed, if your plan uses a 401(k) vesting schedule.

You’re not required to max out the annual contribution limit and employers are not required to offer a match. But the more of your salary you defer to the plan and the bigger the matching contribution, the more money you could end up with once you’re ready to retire.

The Takeaway

Contributing to a 401(k) can be one of the most effective ways to save for retirement but it’s not your only option. If you don’t have a 401(k) at work or you want to supplement your salary deferrals, you can also save using an Individual Retirement Account (IRA).

An IRA allows you to set aside money for the future while snagging some tax breaks. With a traditional IRA, your contributions may be tax-deductible. A Roth IRA, meanwhile, allows for tax-free distributions in retirement.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

What is a good deferral rate for 401(k)?

A good deferral rate for 401(k) contributions is one that allows you to qualify for the full employer match if one is offered, at a minimum. The more money you defer into your plan, the more opportunity you have to grow wealth for retirement.

What is an automatic deferral?

An automatic deferral is a deferral of salary into a 401(k) plan or similar qualified plan through paycheck deductions. Your employer automatically redirects money from your paycheck into your retirement account.

What is the maximum default automatic enrollment deferral rate?

This depends on your employer. Some employers may set the threshold higher to allow employees to make better use of the plan.


Photo credit: iStock/guvendemir

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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403(b) vs Roth IRA: Key Differences and How to Choose

What’s the Difference Between a 403(b) and a Roth IRA?

A 403(b) and a Roth IRA account are both tax-advantaged retirement plans, but they are quite different — especially regarding the amount you can contribute annually, and the tax implications for each.

Generally speaking, a 403(b) allows you to save more, and your taxable income is reduced by the amount you contribute to the plan (potentially lowering your tax bill). A Roth IRA has much lower contribution limits, but because you’re saving after-tax money, it grows tax free — and you don’t pay taxes on the withdrawals.

In some cases, you may not need to choose between a Roth IRA vs. a 403(b) — the best choice may be to contribute to both types of accounts. In order to decide, it’s important to consider how these accounts are structured and what the rules are for each.

Comparing How a 403(b) and a Roth IRA Work

When it comes to a 403(b) vs Roth IRA, the two are very different.

A 403(b) account is quite similar to a 401(k), as both are tax-deferred types of retirement plans and have similar contribution limits. A Roth IRA, though, follows a very different set of rules.

403(b) Overview

Similar to a 401(k), a 403(b) retirement plan is a tax-deferred account sponsored by an individual’s employer. An individual may contribute a portion of their salary and also receive matching contributions from their employer.

An employee’s contributions are deducted — this is known as a salary reduction contribution and deposited in the 403(b) pre-tax, where they grow tax-free, until retirement (which is why these accounts are called “tax deferred”). Individuals then withdraw the funds, and pay ordinary income tax at their current rate.

Although 403(b) accounts share some features with 401(k)s, there are some distinctions.

Eligibility

The main difference between 403(b) and 401(k) accounts is that 401(k)s are offered by for-profit businesses and 403(b)s are only available to employees of:

•   Public schools, including public colleges and universities

•   hurches or associations of churches

•   Tax-exempt 501(c)(3) charitable organizations

Early Withdrawals

Typically, individuals face a 10% penalty if they withdraw their money before age 59 ½. Exceptions apply in some circumstances. Be sure to consult with your plan sponsor about the rules.

Contribution Limits and Rules

There are also some different contribution rules for 403(b) accounts. The cap for a 403(b) is the same as it is for a 401(k): $23,000 in 2024 and $22,500 in 2023. And if you’re 50 or older you can also make an additional catch-up contribution of up to $7,500 in 2024 and 2023.

In the case of a 403(b), though, if it’s permitted by the 403(b) plan, participants with at least 15 years of service with their employer can make another catch-up contribution above the annual limit, as long as it’s the lesser of the following options:

•   $15,000, reduced by the amount of employee contributions made in prior years because of this rule

•   $5,000, times the number of years of service, minus the employee’s total contributions from previous years

•   $3,000

The wrinkle here is that if you’re over 50, and you have at least 15 years of service, you must do the 15-year catch-up contribution first, before you can take advantage of the 50-plus catch-up contribution of up to $7,500.

Roth IRA Overview

Roth IRAs are different from tax-deferred accounts like 403(b)s, 401(k)s, and other types of retirement accounts. With all types of Roth accounts — including a Roth 401(k) and a Roth 403(b) — you contribute after-tax money. And when you withdraw the money in retirement, it’s tax free.

Eligibility

Unlike employer-sponsored retirement plans, Roth IRAs fall under the IRS category of “Individual Retirement Arrangements,” and thus are set up and managed by the individual. Thus, anyone with earned income can open a Roth IRA through a bank, brokerage, or other financial institution that offers them.

Contribution Limits and Rules

Your ability to contribute to a Roth, however, is limited by your income level.

•   For 2024, if you’re married filing jointly, you can contribute the maximum to a Roth if your modified adjusted gross income (MAGI) is less than $230,000. If your income is between $230,000 and $240,000 you can contribute a reduced amount.

•   For single filers in 2024, your income must be less than $146,000 to contribute the maximum to a Roth, with reduced contributions up to $161,000.

•   For 2023, if you’re married filing jointly, you can contribute the maximum to a Roth if your modified adjusted gross income (MAGI) is less than $218,000. If your income is between $218,000 and $228,000 you can contribute a reduced amount.

•   For single filers in 2023, your income must be less than $138,000 to contribute the maximum to a Roth, with reduced contributions up to $153,000.

Is your retirement piggy bank feeling light?

Start saving today with a Roth or Traditional IRA.


Roth 403(b) vs Roth IRA: Are They the Same?

No. A Roth 403(b) does adhere to the familiar Roth structure — the individual makes after-tax contributions, and withdraws their money tax free in retirement — but otherwise these accounts are similar to regular 403(b)s.

•   The annual contribution limits are the same: $23,000 with a catch-up contribution of $7,500 for those 50 and older for 2024; $22,500 with a catch-up contribution of $7,500 for those 50 and older for 2023.

•   There are no income limits for Roth 403(b) accounts.

Also, a Roth 403(b) is like a Roth 401(k) in that both these accounts are subject to required minimum distribution rules (RMDs), whereas a regular Roth IRA does not have RMDs.

One possible workaround: You may be able to rollover a Roth 403(b)/401(k) to a Roth IRA — similar to the process of rolling over a regular 401(k) to a traditional IRA when you leave your job or retire.

That way, your nest egg wouldn’t be subject to 401(k) RMD rules.

Finally, another similarity between Roth 403(b) and 401(k) accounts: Even though the money you deposit is after tax, any employer matching contributions are not; they’re typically made on a pre-tax basis. So, you must pay taxes on those matching contributions and earnings when taking retirement withdrawals. (It sounds like a headache, but your employer deposits those contributions in a separate account, so it’s relatively straightforward to know which withdrawals are tax free and which require you to pay taxes.)


💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Which Is Better, a 403(b) or Roth IRA?

It’s not a matter of which is “better” — as discussed above, the accounts are quite different. Deciding which one to use, or whether to combine both as part of your plan, boils down to your tax and withdrawal strategies for your retirement.

To make an informed decision about which retirement plan is right for you, it can be helpful to conduct a side-by-side comparison of both plans. This chart breaks down some of the main differences, giving you a better understanding of these types of retirement plans, so that you can weigh the pros and cons of a Roth IRA vs. 403(b).

403(b)

Roth IRA

Who can participate? Employees of the following types of organizations:

•   Public school systems, if involved in day-to-day operations

•   Public schools operated by Indian tribal governments

•   Cooperative hospitals and

•   Civilian employees of the Uniformed Services University of the Health Sciences

•   Certain ministers and chaplains

•   Tax-exempt charities established under IRC Section 501(c)(3)

Individuals earning less than the following amounts:

•   Single filers earning less than $146,000 for 2024 (those earning $146,000 or more but less than $161,000 may contribute a reduced amount)

•   Married joint filers earning less than $230,000 for 2024 (those earning $230,000 or more but less than $240,000 may contribute a reduced amount)

•   Single filers earning less than $138,000 for 2023 (those earning $138,000 or more but less than $153,000 may contribute a reduced amount)

•   Married joint filers earning less than $218,000 for 2023 (those earning $218,000 or more but less than $228,000 may contribute a reduced amount)

Are contributions tax deductible? Yes No
Are qualified distributions taxed? Yes No (if not qualified, distribution may be taxable in part)
Annual individual contribution limit $23,000 for 2024 (plus catch-up contributions of $7,500 for those 50 and older)

$22,500 for 2023 (plus catch-up contributions up to $7,500 for those age 50 and older)

$7,000 for 2024 (individuals 50 and older may contribute $8,000)

$6,500 for 2023 (individuals 50 and older may contribute $7,500)

Are early withdrawals allowed? Depends on individual plan terms and may be subject to a 10% penalty Yes, though account earnings may be subject to a 10% penalty if funds are withdrawn before account owner is 59 ½
Plan administered by Employer The individual’s chosen financial institution
Investment options Employee chooses based on investments available through the plan Up to the individual, though certain types of investments (collectibles, life insurance) are prohibited
Fees Varies depending on plan terms and investments Varies depending on financial institution and investments
Portability As with other employee-sponsored plans, individual must roll their account into another fund or cash out when switching employers Yes
Subject to RMD rules Yes No

Pros and Cons of a 403(b) and a Roth IRA

There are positives to both a 403(b) and a Roth IRA — and because it’s possible for qualified individuals to open a Roth IRA and a 403(b), some people may decide that their best strategy is to use both. Here’s a side-by-side comparison of a 403(b) vs. a Roth IRA:

403(b)

Roth IRA

Pros

•   Contributions are automatically deducted from your paycheck

•   Earning less during retirement may mean an individual pays less in taxes

•   Employer may offer matching contributions

•   Higher annual contribution limit than a Roth IRA

•   More investment options to choose from

•   Withdrawal of contributions are not taxed; withdrawal of earnings are not taxed under certain conditions and/or after age 59 ½

•   Account belongs to the owner

Cons

•   May have limited investment options

•   May charge high fees

•   There may be a 10% penalty on funds withdrawn before age 59 ½

•   Has an income limit

•   Maximum contribution amount is low

•   Contributions aren’t tax deductible

Pros of 403(b)

•   Contributions are automatically deducted by an employer from the individual’s paycheck, which can make it easier to save.

•   If an individual earns less money annually in retirement than during their working years, deferring taxes may mean they ultimately pay less in taxes.

•   Some employers offer matching contributions, meaning for every dollar an employee contributes, the employer may match some or all of it, up to a certain percentage.

•   Higher annual contribution limit than a Roth IRA.

Pros of Roth IRAs

•   Individuals can invest with any financial institution and thus will likely have many more investment options when opening up their Roth IRA.

•   Withdrawal of contributions are not taxed; withdrawal of earnings are not taxed under certain conditions and/or after age 59 ½.

•   Account belongs to the owner and is not affected if the individual changes jobs.

There are also some disadvantages to both types of accounts, however.


💡 Quick Tip: How much does it cost to set up an IRA? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

Cons of 403(b)s

•   There are limited investment options with 403(b)s.

•   Some 403(b) plans charge high fees.

•   Individuals typically pay a 10% penalty on funds withdrawn before age 59 ½. However, there may be some exceptions under the rule of 55 for retirement.

Cons of Roth IRAs

•   There’s an income limit to a Roth IRA, as discussed above.

•   The maximum contribution amount is fairly low.

•   Contributions are not tax deductible.

Choosing Between a Roth IRA and 403(b)

When considering whether to fund a 403(b) account or a Roth IRA, there’s no right choice, per se — the correct answer boils down to which approach works for you. You might prefer the automatic payroll deductions, the ability to save more, and, if it applies, the employer match of a 403(b).

Or you might gravitate toward the more independent setup of your own Roth IRA, where you have a wider array of investment options and greater flexibility around withdrawals (Roth contributions can be withdrawn at any time, although earnings can’t).

Or it might come down to your tax strategy: It may be more important for you to save in a 403(b), and reduce your taxable income in the present. Conversely, you may want to contribute to a Roth IRA, despite the lower contribution limit, because withdrawals are tax free in retirement.

Really, though, it’s possible to have the best of both worlds by investing in both types of accounts, as long as you don’t exceed the annual contribution limits.

Investing With SoFi

Because 403(b)s and Roth IRAs are complementary in some ways (one being tax-deferred, the other not), it’s possible to fund both a 403(b) and a Roth IRA.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here.)

Easily manage your retirement savings with a SoFi IRA.

FAQ

Which is better: a 403(b) or a Roth IRA?

Neither plan is necessarily better. A 403(b) and a Roth IRA are very different types of accounts. A 403(b) has automatic payroll deductions, the possibility of an employer match, and your contributions are tax deductible. A Roth IRA gives you more control, a greater choice of investment options, and the ability to withdraw contributions (but not earnings) now, plus tax free withdrawals in retirement. It can actually be beneficial to have both types of accounts, as long as you don’t exceed the annual contribution limits.

Should you open a Roth IRA if you have a 403(b)?

You can open a Roth IRA if you have a 403(b). In fact it may make sense to have both, since each plan has different advantages. You may get an employer match with a 403(b), for instance, and your contributions are tax deductible. A Roth IRA gives you more investment options to choose from and tax-free withdrawals in retirement. In the end, it really depends on your personal financial situation and preference. Be sure to weigh all the pros and cons of each plan.

When should you convert your 403(b) to a Roth IRA?

If you are leaving your job or you’re at least 59 ½ years old, you may want to convert your 403(b) to a Roth IRA to avoid taking the required minimum distributions (RMDs) that come with pre-tax plans starting at age 73. However, because you are moving pre-tax dollars to a post-tax account, you’ll be required to pay taxes on the money. Speak to a financial advisor to determine whether converting to a Roth IRA makes sense for you and ways you may be able to minimize your tax bill.


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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What Is a Non-Deductible IRA?

What Is a Non-Deductible IRA?

A non-deductible IRA is an IRA, or IRA contributions, that cannot be deducted from your income. While contributions to a traditional IRA are tax-deductible, non-deductible IRA contributions offer no immediate tax break.

In both cases, though, contributions grow tax free over time — and in the case of a non-deductible IRA, you wouldn’t owe taxes on the withdrawals in retirement.

Why would you open a non-deductible IRA? If you meet certain criteria, such as your income is too high to allow you to contribute to a traditional IRA or Roth IRA, a non-deductible IRA might help you increase your retirement savings.

It helps to understand how non-deductible contributions work, what the rules and restrictions are, as well as the potential advantages and drawbacks.

Who Is Eligible for a Non-Deductible IRA?

Several factors determine whether an individual is ineligible for a traditional IRA, and therefore if their contributions could fund a non-deductible IRA. These include an individual’s income level, tax-filing status, and access to employer-sponsored retirement plans (even if the individual or their spouse don’t participate in such a plan).

If you and your spouse do not have an employer plan like a 401(k) at work, there are no restrictions on fully funding a regular, aka deductible, IRA. You can contribute up to $7,000 in 2024; $8,000 if you’re 50 and older. In 2023, you can contribute up to $6,500; $7,500 if you’re 50 or older. And those contributions are tax deductible.

However, if you’re eligible to participate in an employer-sponsored plan, or if your spouse is, then the amount you can contribute to a deductible IRA phases out — in other words, the amount you can deduct gets smaller — based on your income:

•   For single filers/head of household: the 2024 contribution amount is reduced if you earn more than $77,000 and less than $87,000. Above $87,000 you can only contribute to a non-deductible IRA. (For 2023, the phaseout begins when you earn more than $73,000 and less than $83,000. If you earn more than $83,000, you can’t contribute to a traditional IRA.)

•   For married, filing jointly:

◦   If you have access to a workplace plan, the phaseout for 2024 is when you earn more than $123,00 and less than $143,000. (For 2023, the phaseout is when you earn more than $116,000, but less than $136,000.)

◦   If your spouse has access to a workplace plan, the 2024 phaseout is when you earn more than $230,000 and less than $240,000. (For 2023, the phaseout is when you earn more than $218,000 but less than $228,000.)



💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Non-Deductible IRA Withdrawal Rules

The other big difference between an ordinary, deductible IRA and a non-deductible IRA is how withdrawals are taxed after age 59 ½. (IRA withdrawals prior to that may be subject to an early withdrawal penalty.)

•   Regular (deductible) IRA: Contributions are made pre-tax. Withdrawals after 59 ½ are taxed at the individual’s ordinary income rate.

•   Non-deductible IRA: Contributions are after tax (meaning you’ve already paid tax on the money). Withdrawals are therefore not taxed, because the IRS can’t tax you twice.

To make sure of this, you must report non-deductible IRA contributions on your tax return, and you use Form 8606 to do so. Form 8606 officially documents that some or all of the money in your IRA has already been taxed and is therefore non-deductible. Later on, when you take distributions, a portion of those withdrawals will not be subject to income tax.

If you have one single non-deductible IRA, then the process is similar to a Roth IRA. You deposit money you’ve paid taxes on, and your withdrawals are tax free.

It gets more complicated when you mix both types of contributions — deductible and non-deductible — in a single IRA account.

Here’s an example of different IRA withdrawal rules:

Let’s say you qualified to make deductible IRA contributions for 10 years, and now you have $50,000 in a regular IRA account. Then, your situation changed — perhaps your income increased — and now only 50% of the money you deposit is deductible; the other half is non-deductible.

You contribute another $50,000 in the next 10 years, but only $25,000 is deductible; $25,000 is non-deductible. You diligently record the different types of contributions using Form 8606, so the IRS knows what’s what.

When you’re ready to retire, the total balance in the IRA is $100,000, but only $25,000 of that was non-deductible (meaning, you already paid tax on it). So when you withdraw money in retirement, you’ll owe taxes on three-quarters of that money, but you won’t owe taxes on one quarter.

Contribution Limits and RMDs

There are limits on the amount that you can contribute to an IRA each year, and deductible and non-deductible IRA account contributions have the same contribution caps. People under 50 years old can contribute up to $7,000 for 2024, and those over 50 can contribute $8,000 per year. People under 50 years old can contribute up to $6,500 for 2023, and those over 50 can contribute $7,500 per year.

IRA account owners are required to start taking required minimum distributions (RMDs), similar to a 401(k), from their account once they turn 73 years old. Prior to that, account holders can take money out of their account between ages 59 ½ and 73 without any early withdrawal penalty.

Individuals can continue to contribute to their IRA at any age as long as they still meet the requirements.

Benefits and Risks of Non-Deductible IRA

While there are benefits to putting money into a non-deductible IRA, there are some risks that individuals should be aware of as well.

Benefits

There are several reasons you might choose to open a non-deductible IRA. In some cases, you can’t make tax-deductible contributions to a traditional IRA, so you need another retirement savings account option. Though your contributions aren’t deductible in the tax year you make them, funds in the IRA that earn dividends or capital gains are not taxed, because the government doesn’t tax retirement savings twice.

Another reason people use non-deductible IRAs is as a stepping stone to a Roth IRA. Roth IRAs also have income limits, but they come with additional choices. High income earners can start by contributing funds to a non-deductible IRA, then convert that IRA into a Roth IRA. This is called a backdoor Roth IRA.

One thing to keep in mind with a backdoor Roth is that the conversion may not be entirely tax free. If an IRA account is made up of a combination of deductible and non-deductible contributions, when it gets converted into a Roth account some of those funds would be taxable.

Risks

The primary benefits of non-deductible IRAs come when used to later convert into a Roth IRA. It can be risky to keep a non-deductible IRA ongoing, especially if it’s made up of both deductible and non-deductible contributions, which can be tricky to keep track of for tax purposes. You can keep a blended IRA, it just takes more work to keep track of the amounts that are taxable.

As noted above, it requires dividing non-deductible contributions by the total contributions made to all IRAs one has in order to figure out the amount of after-tax contributions that have been made.

Non-Deductible IRA vs Roth IRA

With a non-deductible IRA, you contribute funds after you’ve paid taxes on that money, and therefore you’re not able to deduct the contributions from your income tax. The contributions that you make to the non-deductible IRA earn non-taxable interest while they are in the account. The money isn’t taxed when it is withdrawn later.

Roth IRA contributions are similarly made with after-tax money and one can’t get a tax deduction on them. Also, a Roth IRA allows an individual to take out tax-free distributions during retirement.

Unlike other types of retirement accounts, a Roth IRA doesn’t require the account holder to take out a minimum distribution amount.

There are income limits on Roth IRAs, so some high-income earners may not be able to open this type of account. The non-deductible IRA is one way to get around this rule, because an individual can start out with a non-deductible IRA and convert it into a Roth IRA.


💡 Quick Tip: Want to lower your taxable income? Start saving for retirement with a traditional IRA. The money you save each year is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).

How Can I Tell If a Non-Deductible IRA Is the Right Choice?

Non-deductible IRAs can be a way for high-income savers to make their way into a backdoor Roth account. This strategy can help them reduce the amount of taxes they owe on their savings. However, they may not be the best type of account for long-term savings or lower-income savers.

The Takeaway

For many people, contributing to an ordinary IRA is a clearcut proposition: You deposit pre-tax money, and the amount can be deducted from your income for that year. Things get more complicated, however, for higher earners who also have access (or their spouse has access) to an employer-sponsored plan like a 401(k) or 403(b). In that case, you may no longer qualify to deduct all your IRA contributions; some or all of that money may become non-deductible. That means you deposit funds post tax and you can’t deduct it from your income tax that year.

In either case, though, all the money in the IRA would grow tax free. And the upside, of course, is that with a non-deductible IRA the withdrawals are also tax free. With a regular IRA, because you haven’t paid taxes on your contributions, you owe tax when you withdraw money in retirement.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Invest with as little as $5 with a SoFi Active Investing account.


Photo credit: iStock/Drazen Zigic

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

SOIN0124129

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