Only 31 percent of non-retirees think their retirement saving is on track, according to the Federal Reserve's Report on the Economic Well-Being of U.S. Households in 2022.
Planning for retirement is complex, and even people who save consistently aren't always confident in their ability to manage their investments in a way that aligns with their retirement goals.
In this article, you'll learn about many of the different types of retirement accounts available, the pros and cons of each and how to choose the plan that's right for you.
Retirement Planning Basics
You may not be able to predict the future, but you can prepare for it. Saving early and often is one of the best ways to ensure you have the financial resources to live the life you want in retirement.
That looks different for everyone, but knowing what you want is the first step in creating a strategy to help you achieve your goals.
The fastest and easiest way to save for retirement is typically through a corporate-sponsored plan. But if you don't have access to one, there are other options. Here's what you need to know.
What Are the Different Types of Retirement Plans?
There are many ways to save for retirement. Here's a brief overview of common employer- and non-employer-sponsored plans you may be able to choose from.
Traditional 401(k)
A traditional 401(k) is an employer-sponsored plan that lets employees contribute pre-tax dollars to a retirement account through payroll deductions.
To encourage participation, some plans have automatic enrollment features that require employees to opt out of participating while others require employees to opt in.
The maximum contribution limit for 2023 is $22,500 for employees under 50. Employees 50 and over can contribute an additional $7,500 in catch-up contributions for a total of $30,000. Both for-profit businesses and non-profit organizations may offer 401(k) plans.
Pros
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It's easy to contribute.
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Contributions reduce taxable income.
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Annual contribution limits are high.
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Some employers match employee contributions.
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Contributions grow tax deferred.
Cons
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There may be limited investment options.
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Withdrawals are taxable.
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Employer contributions may not vest immediately.
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There may be a waiting period before employees can contribute.
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Withdrawals made before age 59½ may be subject to penalties.
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Account funds are subject to required minimum distribution (RMD) requirements.
Simple 401(k)
Simple 401(k) plans are available through small businesses with 100 or fewer employees.
As with a traditional 401(k), employees can contribute pre-tax dollars (up to $15,500 in 2023) to their account through payroll deduction. Unlike a traditional 401(k), employers must contribute either a matching contribution of up to 3% of each employee's salary or a non-elective contribution of 2% of their salary.
However, simple 401(k)s are rare. Most small business owners opt for simple IRAs instead because major providers offer more support for them.
Pros:
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Contribution limits are high.
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Employees are immediately vested in all funds.
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Employer contributions are required.
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Employee contributions reduce their taxable income.
Cons:
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The employer chooses the investment options.
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Withdrawals are taxed.
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Employees must wait until age 59½ to make penalty-free withdrawals.
Roth 401(k)
Some employers offer Roth accounts in their 401(k) plan that allow employees to contribute after-tax dollars. In 2023, the limit for all 401(k) contributions, whether deposited into a Roth or tax-deferred account is $22,500 for employees under 50 and $30,000 for employees 50 and older.
Pros:
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Annual contribution limits are high.
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Unlike a Roth IRA, there are no income limits for contributing to a Roth 401(k).
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Withdrawals are not taxed as long as they're a qualified distribution.
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Effective 2024, Roth accounts within a 401(k) aren't subject to RMD requirements.
Cons:
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Contributions don't reduce your current taxable income.
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There may be limited investment options.
403(b)
A 403(b) is a tax-advantaged, employer-sponsored retirement plan similar to a 401(k), but it's only available in schools and 501(c)(3) tax-exempt organizations. For 2023, the maximum contribution limit is $22,500 for employees under 50 and $30,000 for employees 50 and over. Employees with 15+ years of service may be eligible for additional "catch-up" contributions.
Pros
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Payroll deductions make contributing easy and convenient.
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Contributions grow tax deferred.
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Annual contribution limits are high.
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Some employers offer matching contributions.
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Employees may begin contributing immediately.
Cons
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Investment options may be limited.
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Funds are taxed in the year you withdraw them.
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Accounts are subject to RMD requirements.
Traditional IRA
A traditional IRA is an account that allows individuals to save for retirement while providing significant tax benefits. Individual retirement accounts are not employer-sponsored. If you want to open one, you can work with a financial institution or have a financial advisor open one for you. In 2023, IRA contributions are capped at $6,500 for people under 50. Individuals 50 and over may contribute $7,500.
Pros:
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Contributions may be tax-deductible.
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Your money grows tax deferred.
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You may have more investment options than with an employer-sponsored plan.
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Anyone with taxable compensation can contribute. (If you don't earn taxable income, you may be able to set up a spousal IRA that allows you to save for retirement.)
Cons:
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Traditional IRAs have low contribution limits compared to employer-sponsored plans.
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You pay income tax on the money when you withdraw it.
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Early withdrawals may be subject to penalties.
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Account funds are subject to RMD requirements.
Roth IRA
A Roth is a type of IRA that allows people to save after-tax dollars for retirement. You can open one on your own or work with a professional to set up an account for you. In 2023, combined contributions to all IRA plans can't exceed $6,500 for people under 50 and $7,500 for people 50 and over. Not everyone can contribute to a Roth IRA — your income determines eligibility.
Pros:
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Withdrawals aren't taxable.
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Your money grows tax-free.
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You may be able to use Roth IRA funds for a down payment on your first home.
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There are no required minimum distributions.
Cons:
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High earners aren't eligible to contribute.
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Contributions aren't tax deductible.
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Annual contribution limits are low.
SEP IRA
A simplified employee pension plan, also known as a SEP IRA, is a traditional IRA account an employer sets up for its employees. Employers may contribute up to 25% of an employee's pay or $66,000, whichever is less, to the account. However, employers aren't required to contribute a set amount, and employer contributions may vary from year to year.
Pros:
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Annual contribution limits are high.
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Employees are 100% vested in all contributions.
Cons:
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There are no catch-up contributions.
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Employer contributions may fluctuate.
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Employees aren't eligible to contribute.
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Account funds are subject to RMD requirements.
Simple IRA
A simple IRA is an employer-sponsored retirement plan available for small business owners and their employees. It allows the employer and its employees to contribute to a traditional IRA for the employee. Employers that offer simple IRAs must make a matching contribution of up to 3% of each employee's compensation or a 2% non-elective contribution to each employee's account.
The IRS set the 2023 maximum contribution limit at $15,500 for employees under 50. Employees 50 and over may contribute an additional $3,500 in catch-up contributions.
Pros:
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Contribution limits are higher than a traditional IRA.
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Employees are immediately vested in all contributions, including employer contributions.
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Employees may contribute to their account.
Cons:
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Contribution limits are lower than a traditional 401(k) or 403(b).
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Investment choices may be limited.
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Catch-up contributions are lower than other plan types.
Solo 401(k)
A solo 401(k) has the same rules as a traditional 401(k), but it's only available to business owners without employees. Business owners who set up a solo 401(k) plan can contribute to their account as both the "employer" and "employee."
As an "employee," you can contribute up to 100% of your earned income up to the maximum allowable contribution — $22,500 in 2023, plus catch-up contributions for business owners 50 and over. As the "employer," you can contribute up to 25% of your compensation or net earnings, depending on how your business is structured.
Your total contributions can't exceed $66,000 for 2023 (not including catch-up contributions for participants 50 and over).
Pros:
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Contribution limits are high.
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Contributions reduce your taxable income.
Cons:
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Withdrawals are taxable.
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There may be penalties for early withdrawals.
Defined Benefit Plans
Defined Benefit plans are a type of pension plan. They are generally funded by employers, although some employees may be required to contribute or allowed to make voluntary contributions. Contributions may vest immediately or over time. Employers that offer pensions may distribute retirement benefits as lifetime monthly payments or a lump sum — depending on how the plan is set up.
Pros:
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A pension may provide retirement income for life.
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Employers contribute to the account on behalf of employees.
Cons:
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You may not withdraw funds before age 59½.
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Funds may not vest right away.
Federal Employee Thrift Savings Plan
The Thrift Savings Plan is a tax deferred retirement plan available to federal employees. Like a 401(k) plan, employees can make tax deferred contributions to their accounts. Investment options include five individual funds and 10 target-date funds.
Pros:
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Employees can receive up to a 5% employer matching contribution.
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The plan is portable.
Cons:
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Matching contributions may not be fully vested right away.
Retirement Plan Considerations for Self-Employed Individuals
It's not uncommon for business owners to have their entire personal net worth tied up in their business. But as you approach retirement age, that gets increasingly risky. Investing in something other than your business becomes more important with fewer working years ahead of you. Diversifying your net worth gives you flexibility to manage factors beyond your control. When you have assets outside of your business, you're unlikely to feel pressure to accept a lower price because it's not a good time to sell or be forced into selling because you need cash.
What Type of Retirement Plan is Right for You?
The type of retirement plan that's best for you depends on your unique circumstances, including how much you have to invest, whether you're self-employed, what plans are available through your employer and more.
In general, there are three buckets you can put your money into: tax-deferred accounts, Roth accounts and taxable accounts. Having a mix gives you flexibility in retirement to withdraw funds in the most tax-efficient way. But the right mix depends on when you plan to retire and your retirement goals.
The simplest and most convenient way to save is to take advantage of employer-sponsored plans. They might be your best bet if the fees are low, and your investment options are easy to understand. But if you plan to retire early, Roth and taxable accounts may play a larger role in your strategy because there are fewer restrictions on withdrawals.
Another factor to consider is the cost of healthcare, which is likely to increase as you age. If you have access to an HSA, you can make contributions to it while you're working, let your account grow and use the money to pay for healthcare in retirement.
There's a lot to consider when planning for retirement, and it's not something you do once and forget about. When working with a financial advisor, you continually revisit your investment strategy to make sure it still aligns with your goals. An advisor can help you fine-tune your plan as your goals change, so you can be confident that you'll be able to handle whatever life throws at you.
Take our two-minute analysis to find out if you're making the right decisions with your money, and get personalized suggestions based on your responses.
