Whether you work for a large company, a small business or are self-employed, there are many types of retirement plans available, and each has its own advantages and disadvantages. Understanding how they work can often seem complicated, but when it comes to planning your future, you can't afford not to be prepared.
Types
There are several types of retirement plans, and which one you invest in may depend on your employment status and income. Your employer may offer a 401(k) or 403(b) plan, depending on the type and size of the organization. If you're self-employed, you may participate in a self-employed pension (SEP IRA), a SIMPLE IRA or a Keough pension plan. An individual retirement account (IRA) is a third option for retirement savings.
Function
The purpose of any retirement plan is to allow you to save either pre-tax or after-tax dollars in an investment fund that typically will earn a higher rate of return than a regular savings account. Retirement plans are structured in such a way that the money generally cannot be made available to you without incurring a tax penalty until you reach a certain age.
Contributions
Contributions to a retirement plan are regulated by the Internal Revenue Service and vary with the type of plan. Contribution limits are higher for 401(k), 403(b), SIMPLE IRA, SEP IRA and Keough plans; traditional and Roth IRAs have the lowest contribution limits. Contribution limits are also higher for individuals age 50 and over, and the IRS increases the limits periodically.
Withdrawals
Just as the IRS regulates contributions to retirement plans, it also regulates when you can take withdrawals without incurring a significant tax penalty. Generally, you must be age 59 1/2 to withdraw from your retirement plan, regardless of its type. The IRS allows early withdrawals under certain circumstances, such as extreme financial hardship, buying a first home or to pay for qualified education expenses. Certain types of retirement plans may also require that you begin taking distributions by age 70 1/2 to avoid additional tax penalties.
Benefits
The benefits of investing in a retirement plan vary with the type of plan you choose. If you're eligible to participate in your employer's retirement plan, the employer may choose to match a certain percentage of your contributions. If you're investing in a traditional IRA, you may be able to deduct your contributions, while a Roth IRA allows your contributions to grow tax-free.
Considerations
When choosing a retirement plan, you should consider what your estimated retirement needs are as well as how much you will need to contribute to meet your goals. You should also consider the potential impact on your tax liability that contributing to or withdrawing from a retirement plan may have.
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