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3: Analyze Your Decisions

Typical Retirement Savings Options

Watch this video from the U.S. Department of Labor regarding retirement tips.

 

Source: This video is content of the copyright holder. Any reference to a specific company, commercial product, process or service does not constitute or imply an endorsement or recommendation by Smart About Money

retirement

Many different retirement plans exist for various employment situations and needs. Check to see if your employer has a plan in which you can participate. This section will concentrate on some of the more common retirement plans.

Employer-Sponsored Retirement Plans

Employer-based plans fall into one of two categories:

  • Defined benefit (DB) plans (also called pensions or annuities) provide regular, usually taxable payments over a retiree’s lifetime. Retiree payments are based on formulas using your years of service and some measure of your salary (e.g., the average of the highest three or five years of earnings). Employers generally manage and make contributions on your behalf in DB plans.
  • Defined contribution (DC) plans (e.g., 401(k), 403(b), 457 plans and Thrift Savings Plans) pay a benefit that depends solely on the value of your account at retirement. You make contributions and decide how to invest the money in DC plans. Contributions and earnings in these plans are tax-deferred; however, withdrawals are taxed as ordinary income. Employers may make matching contributions to a DC account.

Individual Retirement Accounts (Traditional and Roth IRAs)

Individual retirement accounts (IRAs) are like DC plans. These accounts are available if you do not have employer-based retirement plans or as an additional plan to expand your retirement savings.

  • Traditional IRAs allow tax-deferred contributions and earnings until the money is withdrawn; withdrawals are taxed as ordinary income.
  • Roth IRAs are funded with after-tax dollars. Earnings on contributions are not subject to income tax, even when they are withdrawn.

Self-employed or Small Business Owner Plans

To encourage retirement savings if you are self-employed or own a small business, the IRS allows the following plans:

  • Simplified Employee Pension (SEP) plans which are like traditional IRAs. Though encouraged for small business owners, a business of any size can set these up as well as employees with freelance income.
  • Solo 401(k) plans that operate like a traditional 401(k). Contributions can be made to this plan as both the employer and the employee.

The Fine Print: Retirement Plan Rules and Taxes

Contribution limitations are adjusted for retirement savings accounts each year, and each has its own rules and income tax implications. Use this information below to help identify the retirement plans that pertain to your situation. (2017 figures are used.)

  • Tax Implications
    • Employers contribute on behalf of employee, so payments to retirees are taxed.
  • Contribution Limitations
    • Annual benefit cannot exceed the lesser of:
      • 100 percent of the participant's average compensation for his or her highest three consecutive calendar years, or
      • $215,000
  • Penalties or Special Rules
    • Mandatory distributions are usually required after age 701/2.
  • Special Notations
    • Each employer may have special rules for participation, vesting and payments.
  • Tax Implications
    • Contributions are tax-deferred, so taxes must be paid when withdrawals are made.
  • Contribution Limitations
    • $18,000 for workers under age 50
    • $24,000 for 50 or older
  • Penalties or Special Rules
    • Withdrawals prior to 59½ are subject to a 10 percent tax penalty, with some exceptions.
    • Mandatory distributions required after age 70½.
  • Special Notations
    • Catch-up contributions for employees 50 or older is $6,000
    • Administration, investment, or individual service fees may apply.
  • Tax Implications
    • Contributions are made after taxes have already been paid so no additional taxes need to be paid at withdrawal.
  • Contribution Limitations
    • $5,500 for persons under 50
    • $6,500 for 50 or older
  • Penalties or Special Rules
    • Withdrawals prior to 59½ are subject to a 10 percent tax penalty, with some exceptions.
    • If you are over 59½ and have owned a Roth IRA for at least five years, you can take any amount of money out of your Roth IRA without having to pay any income taxes or penalties.
    • No mandatory distributions are required until after the death of the owner.
  • Special Notations
    • Catch-up contributions for employees 50 or older is $1,000
    • Total contributions to all traditional and Roth IRAs cannot be more than $5,500 (or $6,500 if age 50 or older).
    • Administration fees may apply.
  • Tax Implications
    • Contributions are tax-deferred, so taxes must be paid when withdrawals are made.
  • Contribution Limitations
    • $5,500 for persons under 50
    • $6,500 for 50 or older
  • Penalties or Special Rules
    • Withdrawals prior to 59½ are subject to a 10 percent tax penalty, with some exceptions.
    • Mandatory distributions are required after age 70½.
    • Your tax deduction may be limited if you are covered by a retirement plan at work, and considering your filing status and adjusted gross income level.
  • Special Notations
    • Catch-up contributions for employees 50 or older is $1,000
    • Total contributions to all traditional and Roth IRAs cannot be more than $5,500 (or $6,500 if age 50 or older).
    • Administration fees may apply.

Understanding All Retirement Plan Options

The IRS is the best source for identifying all retirement plan options available to you.

Employer Contributions and Free Money

You are lucky if you work for a company that offers a defined benefit retirement plan (pension). The number of employers offering these plans is shrinking due to the cost of maintaining these benefits. Be sure you understand your options for these plans if you are leaving your job, taking early retirement or if you are offered a severance package/buyout.

In the case of an employer offering a defined contribution plan such as a 401(k), 403(b) or similar plans, some employers match a portion of your contributions to up to a certain level. Try to contribute up to the maximum that the employer will match — this essentially is free money. So, if your employer will match up to 3 percent, then you should plan to contribute at least 3 percent to get the full benefit of the matching contribution.

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Check Your Knowledge

What do you know about the different types of retirement savings accounts? Drag the plan type to the description it matches.

Pension

401(k)

Roth IRA

Traditional IRA
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Tax-deferred contributions and earnings are subject to a 10 percent penalty if withdrawn before age 59½.
Traditional IRA
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Correct
Contributions are made after taxes have been paid.
Roth IRA
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A defined contribution plan in which matching contributions may be made by your employer.
401(k)
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Correct
Contributions and administration of the plan are usually the responsibility of an employer.
Pension
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