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What are the Different Types of Retirement Accounts?

April 4, 2021172 Comments

Which type of retirement savings account is best for me? Which retirement account gives me the best value for my money?

We understand – merely searching for these questions on Google may make this task more complex than when you first started.

This is what we’ll be tackling today. After reading this blog, you would have a better idea about the different types of retirement accounts available. So, let’s get started.

401(k)s

This is a retirement fund that your employer sets up for you. It may or may not contain a type of investment, but you’ll be given the choice of choosing from different mutual funds that your company’s plan covers.

401(k)s are further classified into traditional and Roth accounts. The main difference boils down to how they are taxed.

Traditional 401(k)s give you a tax break upfront because you make contributions with pre-tax dollars, effectively reducing your current income tax bill. A Roth 401(k) is the opposite, in that, your contributions are after-tax dollars, which means you don’t get any upfront tax deductions. However, withdrawals for both types are tax-free once you turn 60 (if you’ve held them for 5 years at least).

Choosing between the two depends a lot on whether it’s better for you to pay the taxes now or later. And that depends on your current time frame as well as the future. Most people play it safe by investing a portion in a traditional plan and a portion in a Roth plan.

403(b)

403(b) plans are offered to employees of non-profit organizations, teachers, doctors, and government employees. 403(b) accounts share many of the same features as 401(k)s, including the same tax treatments, early withdrawal penalties, and contribution limits. The big difference is that 403(b)s only offer mutual funds and annuities (that often have low returns, surrender charges, and expensive fees).

If you were to ask us, we’d go with a different plan and stick with the tried and tested strategy of mutual funds.

Individual Retirement Arrangement (IRA)

IRAs are savings accounts that are only available to individuals with earned income. Your investment options are diverse and include annuities, mutual funds, as well as real estate. At the time of writing, the contribution limit for an IRA is $6,000 or $7,000 if you are above the age of 50.

IRAs are further categorized into two options: traditional RIAs and Roth IRAs. It’s important to understand the differences between the two.

A Traditional IRA lets you contribute pre-tax dollars, which means your money will grow tax-deferred, but you’ll have to pay taxes when you withdraw in retirement. With a Roth IRA, you contribute after-tax dollars and your money grows tax-free, and you won’t owe any taxes when you withdraw in retirement.

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Health Savings Account

A Health Savings Account lets you build funds to cover healthcare expenditures in retirement. To qualify for an HSA, you’ll need a high-deductible health insurance plan. You can contribute as much as $3,600 to an HSA in 2021 (or $7,200 if you have family coverage). People over the age of 55 can contribute an additional $1,000. This amount is tax-deductible so your money grows tax-free and can be withdrawn tax-free to pay for healthcare.

HSAs may not be a good idea if you know you’ll need expensive medical care in the near future. So it doesn’t make sense if you have a big medical bill coming.

Solo 401(k)

Solo 401(k) is a retirement account designed for entrepreneurs who don’t have full-time employees. Also known as an individual 401(k) plan, a solo 401(k) account offers the same benefits as a traditional 401(k).

You can contribute as much as $19,500 per year (or $26,000 if you’re above the age of 50) – tax-deductible. You can contribute an additional ‘employer match’ – a maximum of 25% of your income – as long as your total contribution isn’t higher than $57,000 per year.

SIMPLE IRA

This is a retirement savings plan suitable for small employers and startups. A SIMPLE IRA allows employers and employees to contribute to traditional IRAs set up for employees.

It makes it easy for entrepreneurs to contribute to their own retirement and their employees’ retirement accounts as well. These funds will grow tax-deferred until it is withdrawn at retirement. You won’t have to pay a tax on your investment gains, but you’ll have to pay applicable taxes once you withdraw the money.

Simplified Employee Pension (SEP) IRA

A SEP IRA lets you contribute a portion of your income into your own retirement account. This account applies to self-employed individuals who do not have full-time employees. This contribution can be deducted from your taxable income.

The limits for maximum annual contribution are higher than most retirement accounts: 25% of income or $58,000 – whichever is less – at the time of writing.

Profit-Sharing Plans

Some businesses offer a profit-sharing plan to their employees as an added incentive for them to work harder. The only catch is that employers get to decide whether to contribute from year to year. It is worth noting that profit-sharing plans aren’t a fail-safe way to ensure financial security but they are a good way to supplement a well-rounded retirement plan. As the old saying goes, the more the merrier.

Wrapping Up: Which Retirement Account is Best for You?

In some cases, you probably won’t get a choice of retirement plans. You’ll have to take what your employer offers, whether that’s a 401(k), a 403(b), or anything else. But you can supplement this with an IRA, which is available to everyone.

As always, we do recommend working with an investment expert because retirement is a big decision in your life. It’s not advisable to make these critical decisions on your own, especially if you’re not well versed with financing. The earlier you start investing in your future, the more money you will be able to withdraw come retirement.

So those are some of the major types of retirement accounts. What is your preferred retirement strategy? Let us know your thoughts in the comments.  

“As a Blogger, my content may include affiliate links from advertisers such as amazon and google, I may earn money from actions readers take on these links, such as a click, purchase, or subscribe at no cost to you. However, These are tools and products that I recommend fully and have helped my blog tremendously.”

Did you find this article helpful? Follow Rykerblogs to learn more about personal finance and investments and stay on top of your finances!

Last updated on April 4, 2021

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