• American Financial Partner

Choosing the Best Retirement Plan for You

Updated: Sep 7, 2021

Choosing the right home for your retirement savings is as important as saving for retirement in the first place. Your retirement plan dictates how much you can contribute annually, how it's taxed, how withdrawals work, what you can invest in, and how much you pay in fees.

To help you decide which retirement plans work best for you, consider the following options:

  • 401(k)

  • 403(b)

  • 457

  • IRA

  • Roth IRA

  • Nondeductible IRA

  • Solo 401(k)

  • SEP IRA

  • SIMPLE IRA

  • Keogh plan

This article will cover employer-sponsored plans, individual retirement accounts, and plans for self-employed individuals and small business owners.


401(k)

A 401(k) is the most common type of employer-sponsored retirement plan. Your employer preselects a few investment choices and you defer a portion of each paycheck to the account. If you leave your job, you may take your 401(k) funds with you or leave them where they are.

In 2020 and 2021, you can contribute up to $19,500 to a 401(k), plus an additional $6,500 if you're 50 or older. Some employers also match a portion of employee contributions. With few exceptions, you cannot withdraw funds from your 401(k) before 59 1/2 without penalty.

401(k) pros:

  • High contribution limits

  • Tax savings

  • Employer matching

  • Loans available with some plans

401(k) cons:

  • Limited investment options

  • Fees can be high

  • Early withdrawal penalties before 59 1/2

  • Loans are taxed as early distribution if they aren’t paid back on time.

If you hope to get the most out of your 401(k), contribute as much as you are able to and choose your investments carefully to minimize fees. You should also claim any employer match that's available and watch out for your company's vesting schedule, which determines when you get to keep employer-matched funds.

  • Tax benefits: Most 401(k)s are tax-deferred, which means your contributions reduce your taxable income this year but you pay taxes on your distributions. This is usually smart if you believe you'll be in a lower tax bracket in retirement than you are today. But Roth 401(k)s are also growing in popularity. Contributions to these accounts don't reduce your taxable income for the year, but distributions are tax-free. You'll save more in taxes with a Roth 401(k) if you're in the same or a lower tax bracket today than you'll be in once you retire. Employer-matched funds are still tax-deferred with these plans.

  • 401(k) loans: Some plans allow 401(k) loans. This enables you to borrow against your retirement savings and pay back that money with interest over time. But if you fail to pay back everything by the end of the loan term, the government taxes the outstanding balance as a distribution.

Other employer-sponsored retirement plans

403(b) and 457 plans are other types of employer-sponsored retirement plans you may come across.

403(b)

A 403(b) is similar to a 401(k), but it's only available to certain ministers, public school employees, and employees of tax-exempt organizations such as nonprofits. The key difference, apart from who can use a 403(b), is that employees who have worked for their employer for at least 15 years are eligible to contribute up to $3,000 extra per year to a 403(b).

457

457 plans are available to state and local government workers and some nonprofit employees. They have the same contribution limits as 401(k)s and 403(b)s, but they allow for catch-up contributions of up to $39,000 in the final three years before retirement. Employer matching is less common with these accounts.

IRA

An IRA is a retirement account anyone may open and contribute to, as long as they are earning income during the year or are married to someone who is. IRAs offer a greater variety of investment options than most employer-sponsored plans.

DID YOU KNOW?

IRAs offer a much greater variety of investment options than most employer-sponsored retirement plans.

That, coupled with the fact that you can open an IRA with any broker, means you may be able to keep your fees lower with an IRA than you could with the plans listed above.

IRA pros:

  • Wide variety of investment options

  • Fees can be lower than with employer-sponsored plans

  • Tax Savings

  • Almost anyone can contribute

IRA cons:

  • High-income earners cannot contribute to Roth IRAs

  • Early withdrawal penalties before 59 1/2

  • No employer matching

  • Low contribution limits

Getting the most out of your IRA involves choosing your broker and investments carefully to minimize fees, while keeping your investments diverse and well-matched to your risk tolerance. You should also choose the right type of IRA -- traditional or Roth -- based on which you think will give you the greatest tax advantages, and contribute as much as you can each year.

  • Tax savings: Traditional IRAs are tax-deferred -- that is, your contributions are pre-tax, so they lower your taxable income for the year and you pay taxes on distributions. Roth IRAs use after-tax dollars, so your contributions have no effect on your taxes this year, but you can then withdraw your savings tax-free in retirement.

  • Contribution limits: In 2020 and 2021, you can only contribute up to $6,000 to an IRA, plus an additional $1,000 if you're 50 or older. You may contribute to an employer-sponsored retirement plan and an IRA in the same year, and you may contribute to tax-deferred and Roth accounts at the same time, but you may not make more than $6,000 (or $7,000 if 50+) in combined traditional and Roth IRA contributions in 2020 or 2021.

Types of IRAs

In addition to traditional IRAs, there are several types of IRAs to consider. Here are a few key alternatives.

Roth IRAs

As mentioned above, Roth IRAs are funded with after-tax dollars, so you pay taxes on your contributions now to avoid taxes on your distributions. Contribution limits are the same, but individuals with modified adjusted gross incomes (MAGIs) of $139,000 and married couples with MAGIs of $206,000 or more in 2020 cannot contribute to a Roth IRA directly. These limits rise by $1,000 and $2,000, respectively, for 2021.

Nondeductible IRAs

High-income earners -- individuals with MAGIs of $75,000 or more and married couples with MAGIs of $124,000 or more -- who also have an employer-sponsored retirement plan may not deduct their traditional IRA contributions from their taxes, so they end up with a nondeductible IRA. These income restrictions rise by $1,000 and $2,000, respectively, for 2021. Contributions use after-tax dollars, so you pay taxes now and not in retirement. But your earnings are tax-deferred and you pay taxes on them once you withdraw the funds in retirement unless you use a backdoor Roth IRA strategy.

Retirement plans for the self-employed and small business owners

Self-employed individuals and small business owners may contribute to an IRA, but there are also several special retirement plans available just for them that enable them to contribute more money per year, since they don't receive the benefit of an employer-sponsored retirement plan. Here's a look at some of the most common retirement plans for small business owners and the self-employed.

Solo 401(k)

A solo 401(k) is a type of 401(k) that's only available to self-employed individuals without full-time employees. Contribution limits are higher -- up to $57,000 in 2020, or $63,500 if you're 50 or older -- because you can make contributions as both employee and employer. Both limits rise by $1,000 for 2021. There are no income restrictions on who can open a solo 401(k), and the account may be traditional or Roth.

SEP IRA

A SEP IRA is a type of IRA available to self-employed individuals and small business owners. In 2020, you may contribute up to the lesser of 25% of your compensation (only the first $285,000 you earn in compensation counts) or $57,000. In 2021, you may contribute up to the lesser of 25% of compensation (only counting the first $290,000 you earn) or $58,000. If you have employees, you must contribute the same percentage of your employees' income to their SEP IRAs as you do to your own.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is designed for small businesses with fewer than 100 employees. You may contribute up to $13,500 to a SIMPLE IRA in 2020 or $16,500 if you're 50 or older. Employers are required to contribute some money to employees' SIMPLE IRAs, though they can choose between a 3% matching contribution or a 2% non-elective contribution.

Keogh plan

A Keogh plan is a type of retirement plan available to self-employed individuals and unincorporated businesses, though not to independent contractors. They are tax-deferred and can be either defined-benefit, like a pension where the employer does the funding, or defined-contribution, where employees do the funding. In 2020, you may contribute up to the lesser of $57,000 or 100% of your compensation. In 2021, the maximum contribution rises to $58,000. These plans have more administrative requirements and higher upkeep costs than the other types of plans listed here.

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