When you retire, do you plan on doing one or more of the following?
- Travel the world and explore exotic locales.
- Spoil your grandchildren.
- Relax in your beach house or mountain cabin.
- Live comfortably until you pass away.
Internally, we all have big dreams for that day when we finally step down from our job and step into a life of leisure in our golden years.
But those dreams will require money. Lots of money.
Unfortunately, 22% of Americans have less than $5,000 saved for retirement, according to Northwestern Mutual’s Planning and Progress Study 2019, with 15% having no retirement savings at all. Many simply don’t understand how best to use the types of retirement plans offered by employers and financial services.
Below are overviews of some of the best retirement plans, along with the many types of plans offered by employers and the best options for the self-employed. Each overview has a link to additional information.
Once you develop a working knowledge of the best retirement plans, you will have the tools to get started today on saving for a comfortable retirement in the future.
401(a) vs. 401(k)
401(k) plans are among the most common (and popular) types of retirement plans offered by employers: Americans have an estimated $5.7 trillion in 401(k) plans. That’s over 19 percent of the nation’s $29.1 trillion in retirement assets.
401(k)s aren’t the only employer-sponsored retirement plans, however. The 401(a) is another type of employer-sponsored plan offered by government and nonprofit organizations.
Individual retirement accounts are not typically sponsored by employers. Instead, you purchase an IRA through financial institutions such as banks and brokerages. Understanding how IRAs work helps you decide which type of IRA best suits your retirement needs.
Traditional IRA vs. Roth IRA
A traditional IRA allows you to claim contributions as income tax deductions in the year you make them. Roth IRA contributions are taxed the year they’re added to the IRA fund.
SIMPLE IRAs vs. SIMPLE 401(k)s
Small businesses can struggle to provide retirement plans for their employees. SIMPLE IRAs and SIMPLE 401(k)s are designed so companies with fewer than 100 employees can help their workforce save for retirement. There are limitations on which type of retirement plan employers can offer, however, and some significant differences between SIMPLE IRAs and 401(k)s.
Pro tip! What if you’re self-employed? SIMPLE IRAs and SIMPLE 401(k) plans are among the best retirement plans. Other retirement plans include solo 401(k) plans and SEP IRAs.
401(k) vs. IRA
There’s a common misconception that if you have a 401(k), you cannot contribute to an IRA, and vice versa. While a 401(k) has a higher contribution level than an IRA, you can contribute to both — and get the corresponding tax benefits — until your income exceeds $74,000 (or $123,000 if you file jointly). You can contribute to both a 401(k) and an IRA.
401(k) vs. 403(b)
401(k) plans are hardly the only employer-sponsored options. If you work for a nonprofit, religious group, school district, or certain government organizations, you may be offered a 403(b) instead of a 401(k). 403(b) plans are exempt from many 401(k) administrative costs, making them cheaper for the employer to offer. Exemption from these administrative processes, however, affects the security of your retirement savings to some degree.
401(k) vs. 457 plan
The 457 is another variety of the 401(k) normally available only to government employers. Unlike with most 401(k) plans, contributions to a 457 can be taxed either before they enter the fund or when funds are withdrawn. Some nonprofit companies also offer 457 plans, usually designated as 457(b) plans.
Understanding mutual funds
Investing in a mutual fund allows you to pool your money with those of other investors, increasing the buying power of the fund and allowing you to invest in stocks and bonds normally too expensive for individual investors. Mutual funds are often part of a company’s 401(k) plan, so it’s important to understand the pros and cons of mutual funds and how they work.
Mutual fund vs. 401(k)
Should you opt for a mutual fund instead of investing in a 401(k)? Since many 401(k)s include mutual funds, it’s usually best to take advantage of the tax benefits of the 401(k). This is especially true if your employer matches 401(k) contributions. Of course, you can always contribute to a 401(k) and your own mutual fund, which can diversify your retirement assets.
An annuity is a special type of life insurance. Upon retirement, the plan sends you a monthly check for a set amount for the rest of your life. While an excellent option for retirees who value stability, annuities do come with high fees and complex policy agreements, making it important to understand annuities before signing up for one.
Annuity vs. 401(k)
While 401(k)s are great, they may not allow you to save enough money for your entire retirement, especially if you live to a ripe old age. If you’re concerned about outliving your retirement savings, it’s possible to use your 401(k) plan to purchase an annuity. Carefully review the pros and cons of annuities and 401(k) plans before making a decision.
Annuity vs. IRA
An IRA is an investment product purchased from a bank, brokerage, or financial advisor. In contrast, an annuity is an insurance plan that pays a set amount per month upon retirement. When considering annuities vs. IRAs, remember that IRAs have annual contribution limits. Annuities have no contribution limits but are associated with high fees and expenses.
Pensions were once the most common types of retirement plans offered by employers, but they have largely been replaced by 401(k) plans. A pension is a retirement plan where the employer — not the employee — contributes to a large pool of funds set aside for employee retirement. The employer invests these funds on the employee’s behalf, and the income from those investments fund retirement income.
Pension vs. 401(k)
The biggest difference between a pension plan and a 401(k) is the contributor. If you have a pension plan, your employer contributes to the fund. If you have a 401(k) plan, you make pretax contributions, and your employer has the option of matching your contributions.
Life insurance vs. 401(k)
Life insurance is usually thought of in terms of financial protection as it provides financial stability to your family in the event of your death. Life insurance can also be used as a retirement tool: Your insurance payments are saved or invested and distributed to you at the end of the policy’s term. Like a 401(k), life insurance is a long-term investment. It can take up to 20 years for a policy to yield significant cash value.
Pro tip: Consider health savings accounts. Health problems become more common as people age, and a serious health emergency can decimate your retirement savings. Establishing an HSA allows you to save money on a pretax basis to pay for medical expenses.
The bottom line
Whatever your goal, you need to understand the pros and cons of the many different types of retirement plans. The better informed you are, the better prepared you are to get the most out of your retirement portfolio so that you can make your retirement dreams a reality.