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Are You Ready For Retirement?

As of 2020, more than 47.8 million U.S. Citizens (about 15% of the population) are 65-years-old or older. However, by the time Americans reach this crucial stage in their life, they have only saved on average 12% of what they will need to fund their retirement. The average retiree spends annually about $46,000 on living expenses and $4,300 on healthcare. The thought of retirement and its financial burden doesn’t just haunt those about to make the transition. Over 43% of millennials say they are afraid of outliving their investments and savings and will be unable to meet their basic economic needs once they retire. That’s why it is crucial to understand what retirement plans are available right now and how to make the best use of them.

 

Types of Retirement Plans

There are several types of retirement accounts available in the United States; some you’re familiar with, while others may seem new to you.

 

Retirement Plans Offered by Employers

 

Pre-Tax or Roth 401(k) Plans

401k plans are the long-established and most popular type of workplace retirement plan available right now. In essence, the classic 401(k) allows employees to contribute pre-tax or possibly, post-tax (Roth) dollars to their retirement fund.

If you make a pre-tax contribution, that amount will be reduced from your taxable income. The money will grow in a tax-deferred account, and you will pay the income taxes upon withdrawal at a later date, hopefully when you are in a lower tax bracket.

If you make a post-tax contribution, or more popularly known as the Roth 401(k), you do not receive a tax break today. However, the money grows tax-deferred, and withdrawals are tax-free during retirement.

Here are a few more things to keep in mind about 401(k) plans:

    • The employee contribution limit for 2021 is $19,500.
    • People over the age of 50 can contribute an extra $6,500 annually.
    • Money is usually deducted from your regular paycheck.
    • There are penalties for early withdrawal (before the age of 59½ ).
    • You are limited to the investment options offered by the employer.
    • An employer may match your contributions to the plan.

SIMPLE (Savings Incentive Match Plans for Employees) IRA

A SIMPLE IRA is a plan that has features of 401(k)s and IRAs. Like a 401(k), it is sponsored by a company. It differs in that the employer is required to contribute to its employees’ plans. Employers have one of two options:

    1. To contribute 2% of your salary to the plan, or
    2. Match your contributions to the plan up to 3% of your salary.

Here are a few more things to keep in mind about SIMPLE IRAs:

    • SIMPLE IRAs are pre-tax only, and there is no post-tax (Roth) option.
    • You will pay taxes on withdrawals upon retirement.
    • Contribution limits for 2021 is $13,500.
    • People over the age of 50 can contribute an extra $3,000 annually.
    • Only employers with less than 100 workers can offer this plan.
    • Contribution limits are lower than traditional 401(k)s.
    • There are penalties for early withdrawal (before the age of 59½ ).
    • Compared to a 401(k), the employee has more flexibility with investment options and providers they want to use.

 

SEP (Simplified Employee Pension) IRA

A SEP IRA is another type of retirement plan established by a small business owner or a self-employed person. A SEP IRA is also a pre-tax plan, and, unfortunately, it does not offer a post-tax (Roth) option. A critical aspect of this plan is that it is 100% funded by the employer, and worker contributions are not allowed.

Here are some points to consider about these plans:

    • Contributions for 2021 are limited to either $58,000 or 25% of earned income — whichever is lower.
    • Contributions are tax-deductible by the business.
    • The employee has control over the investment selections and providers they want to use.
    • There are penalties for early withdrawal (before the age of 59½ ).
    • They are more common for small businesses, solopreneurs, or self-employed individuals.

 

Profit-Sharing Plans (PSPs)

Similar to SEP IRAs, a Profit-Sharing Plan is funded 100% by the employer. Companies using this type of plan can usually have various formulas they can use to determine how much each employee will receive. Companies can vary the contributions into the plan depending on what they are trying to accomplish or how the business is performing. These plans are great for firms that want to reward and motivate employees to perform better and help grow the company’s general profitability. However, there could be some years where the company may decide not to fund the plan.

Here are some other things to consider:

    • Contributions for 2021 are limited to either $58,000 or 25% of earned income — whichever is lower. However, these plans offer a lot of flexibility on how much is contributed for each employee.
    • Companies can set these types of plans in addition to other traditional retirement accounts. It is common to see these plans combined with a 401(k) plan.
    • There are penalties for early withdrawal (before the age of 59½ ).
    • These plans generally have a vesting schedule, so the longer you stay with the company, the larger the percentage you can take with you when you leave or retire from the company.

 

Other Employer-Sponsored Plans:

Here are a few more plans that we see offered by employers:

    1. Employee Stock Ownership Plans (ESOPs) – These plans allow employees to invest in the employer’s stock.
    2. 457 Plans – These plans are generally offered by government agencies, state-based agencies, or non-profits. These plans are similar to 401(k) plans where they can accept employee and employer contributions. However, they do have a few rules that are different from 401(k) plans.
    3. Thrift Savings Plan (TSP) -The TSP is similar to a 401(k) plan and is only available to federal employees and uniformed services members.
    4. Defined Benefit Plans (or Pension Plans) – These are 100% employer-funded plans and pay out a lump-sum or monthly income during retirement.

 

Retirement Plans Available to Individuals

 

Traditional Individual Retirement Accounts (IRAs)

IRAs are the classic retirement account that you open and fund yourself and are not linked with your employer. Contributions are generally tax-deductible, but the deduction can be restricted or eliminated if you have access to other retirement plans at work. The funds grow tax-deferred and will be taxable upon withdrawal.

    • The contribution limit is $6,000 for 2021 or $7,000 for individuals over the age of 50.
    • A 10% early withdrawal penalty is applied for withdrawing funds before age 59½.
    • The IRS requires you to start taking withdrawals at age 72, called Required Minimum Distributions.

 

Roth IRAs

Roth IRAs are becoming more popular in recent years as individuals become concerned about increased taxes during retirement. Roth IRAs are funded with post-tax money, which means that you do not receive a tax deduction today. The funds grow tax-deferred, and withdrawals can be tax-free at retirement, subject to specific IRS rules we will go over in another article.

    • Like the Traditional IRA, the contribution limit is $6,000 for 2021, or $7,000 for individuals over the age of 50.
    • There is a penalty for early withdrawal.
    • The contributions are restricted if your income is over a certain threshold.

 

What Plan Works for You?

As you can see, there are a multitude of options available to Americans to save for their retirement. Congress and several states are also implementing new plans or changing rules around how these plans function. It is crucial to have a Financial Advisor on your team to help navigate these options and determine which ones fit best in your situation. Many of our clients use multiple options for their retirement savings, and our future articles will cover each of these plans in detail.

If you have additional questions about the different retirement plans and how you can best save for retirement, please feel welcome to contact us.

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Strategic Wealth Design