I often get questions about the best retirement platform to utilize for retirement savings. All of the available types of plans have options and limitations which can be confusing. I’ll try to lay out, in understandable terms, the differences between each.
To start, there are two types of plans: Employer Provided Plans and Individual Plans. All plans fall under one of these designations. Plans may have certain unique characteristics and allowances so this is meant to explain options in a very general way.
Employer Provided Plans
As the name implies, these are plans that are sponsored and maintained by employers. They typically come in several different flavors. These are the most common:
- 401(k) A 401(k) allows employees to defer part of their compensation into a specific investment vehicle (typically mutual funds). In many cases, the employer will match some or all of the employee’s deferral amount. These funds are almost always fully vested to the employee. Thus, if an employee leaves an employer, their 401(k) is portable and can be rolled over into a new employer’s 401(K) or an IRA Rollover.
- 403(b) A 403(b) is essentially a 401(k) but for nonprofit or governmental entities. There are some differences in how the plans are administered and the types of investment platforms offered. But from the employee’s perspective they accomplish the same goal.
- Simplified Employee Pension (SEP) A SEP is most often used by very small companies. It allows the employer to fund retirement dollars on behalf of employees. The amounts that are put away typically vest to the employee over time. But once the vesting period is over, the funds are available to the employee should they separate from employment.
- SIMPLE Plans SIMPLEs are used by very small companies. The reason these are used is the simplicity of setup and administration. Employees defer compensation into the plan similar to 401(k) plans. SIMPLE plans allow lower contribution maximums than 401(k) plans but the employer is required to make some sort of matching contributions. All funds are fully vested immediately and fully portable by the employee.
All of the above plans are also available for self employed individuals.
- IRA IRAs have been around forever and are often referred to as Traditional IRAs. It is important to understand that IRA contributions are always, always, always allowed for taxpayers with earned income. However, not all IRA contributions are deductible.
- ROTH IRA A type of IRA where the contributions are not deducted but the qualifying withdrawals (including growth) are not taxed. They also have some benefits related to early withdrawals and estate planning as compared to traditional IRAs. Like traditional IRAs a taxpayer must have earned income to make ROTH contributions. In addition, there are income limits related to who can make contributions.
These are the only retirement plans that are available to an individual taxpayer. Any other plan pitched or sold to you is not an “official” retirement plan. It may have some tax advantaged components to it but it is not a qualified retirement vehicle. The most common of these alternative plans are annuities. They are not qualified retirement vehicles in and of themselves. They can be wrapped in an IRA or other qualified plan wrapper but on their own they are not retirement vehicles.
I hope this helps. These plan types are often thrown around by me and others without sufficient explanation. Obviously every plan has unique characteristics so please let us know if you need help understanding your options. Oftentimes, decisions made surrounding contributions to and distributions from retirement vehicles can have MATERIAL tax implications. Don’t get surprised by an unexpected tax bill. Call us first.