If you are a salaried employee, chances are you will receive a salary and be taxed on it. Self-employed people can also have their earnings taxed at their regular personal income tax rate. In other words, if you have set up your business as a self-employed person, chances are you will receive dividends from that business and pay taxes on those dividends.
The question is – how much should you save for retirement? And which savings vehicle should you choose to do so? That’s where the confusion arises! What kind of retirement savings plan is right for you? Let’s take a look at the pros and cons of each type of retirement savings plan to help you make an informed decision.
Table of Contents
Traditional 401(k) Plans
A traditional 401(k) plan is a retirement savings plan that you can contribute money to with pre-tax dollars, meaning you don’t have to pay taxes on the money before it goes into your account.
With traditional 401(k) plans, you may or may not be able to contribute a certain percentage of your income depending on your employer’s contribution and the maximum contribution limit. If you are contributing a certain percentage of what you earn, this means that some of your earnings may be taxed at the end of the year if you do not make enough money in that year. If your employer doesn’t offer a traditional 401(k), this means that you will have to choose another type of retirement savings plan or plan out how much you want to save yourself.
Pros: The pros for using a traditional 401(k) plan are pretty straight forward – there are no fees and it is easy for employers to administer, making it an easy way for employees to save for their retirement. However, their downside is that there might be restrictions on the amount of contributions an employee can make each year and there might be additional taxes due at the time of withdrawal if those contributions were made with pre-tax dollars.
Cons: A con for using a traditional 401(k) is that when an employee leaves the company he/she has contributed money into over his/her career, he/she will likely owe taxes and other penalties. Additionally, when investing with pre-tax dollars
Roth IRA Vs. 401K
The Roth IRA is a great option for anyone who wants to save for retirement. You can contribute up to $5,500 per year, as well as make withdrawals without any taxation of earnings (i.e. you won’t owe taxes on the withdrawals). There are no restrictions on contribution amounts or types of retirement savings plans to which you can contribute in order to be eligible.
There are two disadvantages of the Roth IRA: firstly, it will be harder than a 401k to fund your retirement if you aren’t very successful financially and secondly, the account must stay open until age 59-1/2 in order to avoid paying taxes on earnings withdrawn before then
403(b) Plan Vs. 401 (k) Plan
A 403(b) plan is a tax-sheltered retirement savings plan that allows your contributions to be made with pretax dollars, meaning they are not taxed until you withdraw them from the account. If you contribute to a 403(b) plan, the money will grow from your earnings on a tax-deferred account. This may be beneficial to you if you anticipate being in a lower tax bracket when you retire and want to offset some of the taxes you would otherwise pay during retirement.
A 401(k) plan doesn’t have such restrictions and can be accessed at any time without having to pay taxes or penalties for early withdrawal. If your company matches contributions into this type of account, it’s likely a good deal for you and worth considering over a more restrictive investment vehicle like a 403(b) plan.
The main drawback of 401(k) plans is the potential for higher costs due to certain limitations of how an individual can invest in them. The IRS places limits on how much an individual can invest in stocks or bonds – typically 3% to 4% – which may put off investors with larger portfolios who want more flexibility in their investments. Additionally, these types of accounts also require additional administrative fees that can increase costs significantly over time as well as take up valuable resources within your company’s budget
457 Plan Vs. 401K
A 457 plan is a supplemental retirement savings plan for federal employees. It’s an employer sponsored plan that allows you to contribute money to your own retirement account on top of what the government matches. This means you can save up to $18,000 per year into your retirement account.
401k plans are a type of retirement savings plan that offers tax matching benefits and are available through employers, typically in conjunction with a pension program. 401ks offer tax-deferred growth and are generally available for small businesses with fewer than 100 employees and solo members.
Another difference between the two plans is that both 457 plans and 401ks allow you to defer taxes on withdrawals until age 59½ or later–which means you don’t pay taxes on those earnings until your retirement years, rather than during the years they were earned. The biggest difference between the two types of plans is how much money each offers–457s allow more savings while 401ks allow less savings but come with tax-deferred growth instead of tax-free growth
Other Retirement Savings Options
401k: 401ks are an excellent retirement savings plan. They allow employees to contribute a portion of their salary before taxes, so they take home more money each month. Plus, companies can match a certain percentage of the employees’ contribution.
Rrsp: RRSP stands for Registered Retirement Savings Plan. You can contribute up to $24,000 a year into this plan without paying any tax on it. The catch is that if you don’t use all your RRSP contributions in one year, you’ll pay tax on the remaining amount when you’re ready to withdraw it.
A combination of both: A combination of both a 401k and rrsp would be ideal for some people as these plans are versatile and offer many benefits to those who use them responsibly while also offering the benefit of tax deferral. This combo solution makes it easier for you to save in the long-term and get back some money now!
Before You Invest In 401K
The 401k is an employer-sponsored retirement savings plan that allows you to save up to a certain percentage of your income for the future. When you set up a 401k, you will be limited to how much you can contribute. However, if your employer matches contributions made by employees, then the limit drops significantly.
The tax-deferred nature of the 401k means that it doesn’t take any money away from your paycheck in your present day as taxes are deferred until when you withdraw money from your account later on. This has a number of advantages; it gives people more time to accumulate funds and not have to worry about short-term fluctuations. It also helps people who have fluctuations in their income throughout the year or don’t know exactly how much they are going to be making throughout the year.
This is where the disadvantages come into play! You won’t be able to touch this money before retirement and as such all investments within this type of retirement account are locked until retirement age has been reached (or sooner, depending on what state laws allow). If you need access to these funds early on, then this type of account may not be right for you.
Conclusion
As an employee, you have the opportunity to invest in a 401(k) plan, though it’s not a one-size-fits-all option. There are many factors to consider when deciding how to invest your retirement savings, including how much you are able to contribute, what type of plan best fits your financial situation and whether you want to contribute pre-tax or after-tax.
FAQ’s
What are the different types of retirement savings plans?
There are several different types of retirement savings plans. The type that is best for you depends on your financial situation and your goals for saving for retirement.
If you are a salaried employee, the most common type of retirement plan is a 401(k) plan offered by your employer. The money that you save in this plan will grow tax-deferred and can be used tax-free when you take it out of the plan in the later years of your working life. The contribution limits to these plans are generally between $18,000 and $23,000 in 2017 (or $18,500 if 50 or older), depending on your income. You can contribute more if you can do so without hurting your income (there is a phase-out range – see IRS instructions below).
Another type of employer-sponsored retirement savings plan is a traditional IRA. Unlike a 401(k), contributions to a traditional IRA are tax-deductible, regardless of your income level. Contributions to a traditional IRA are also not limited as to how much you can put in each year; however, the amount you can contribute is reduced if your modified income is above certain levels. You can make additional contributions to a traditional IRA after age 50 without any additional taxes or penalties, but these later contributions are characterized as Roth contributions and never subject global income as standard IRA contributions are (see IRS instructions below).
A third type of employer-sponsored retirement savings plan is an457(b) plan. Contributions to an457(b) plans may be tax-deductible or tax-exempt depending on the plans’ terms and rules. Some 457(b) plans may have contribution limits or minimum investment requirements that are higher than those found in a 401(k) or traditional IRA account; others may have such limits or requirements that are lower than those in a 401(k).
In addition to these types of plans, if you have access to your company’s Thrift Savings Plan (TSP) account, you may be able to contribute pre-tax funds up to your contribution limit (employees who earn less than 100% FPL also get an up-front match – see TSP qualifications below). In addition, with an EET Marcos Taxable Thrift Savings Plan account, you can contribute aftertax funds with limited payout options – again with the ability to contribute up to your annual contribution limit.
What are the benefits of each type of retirement savings plan?
There are several different retirement savings plans available to you, each offering different tax advantages and other protections, as well as varying features and benefits.
One of the most common types of retirement savings plan is a 401(k) plan. A 401(k) is a type of tax-deferred retirement plan that allows employees to save pre-tax money for their future retirement.
Another popular option is an IRA, which is also a type of tax-deferred retirement savings account. Unlike a 401(k), money contributed to an IRA is not taxed until it is withdrawn.
Finally, there are also Roth and traditional Individual Retirement Accounts (IRA’s), which do not require taxes be paid on contributions or withdrawals at all. These accounts allow you to use your income tax liability throughout your working life to directly contribute to your retirement savings account.
What are the cons of each type of retirement savings plan?
The good news is that there are a plethora of retirement savings plans to choose from, depending on your individual needs and preferences. Whether you’re looking to prepare for a single lifetime, or for multiple generations of your family, there’s a plan out there that’s right for you. So, which one is right for you? That all depends on your specific situation and needs. Here are some of the most common types of retirement savings plans and the benefits and drawbacks associated with each.
1. Individual Retirement Accounts (IRAs)
Pros: IRAs can be a great way to save toward your financial goal of retirement. With an IRA, you can invest money from your paycheck that you can use tax-free when you retire. Plus, there are no penalties for investing early or withdrawing funds before age 59½.
Cons: Depending on the account you use, an IRA can have some hidden fees and taxes that can eat into your earnings. Additionally, because these accounts are distributed from the government in the form of a check or direct deposit, there can be delays on withdrawals (up to 6-8 weeks at times).
2. 401(k)s
Pros: 401(k) accounts are great vehicles for investing pretax money that you can use tax-deferred when you retire. There are typically no fees associated with investing in a 401(k), plus withdrawals may be tax-free if taken before age 59½. The account holder is also able to select the plan’s investment options and company matching fund contributions up to a certain amount per year may be available as well (depending on plan type).
Cons: Depending on the account you use and plan options selected, 401(k) plans can have hidden fees when it comes to investment management as well as plan administration costs (fund management firms charge regular operating fees as well as additional advisory fees). Additionally, withdrawal penalties may apply if taking funds before age 59½ is required.
3. 403(b)s
Pros: A 403(b) account allows nonresidents working in the US to contribute pretax money toward their retirement saving goals without paying taxes on earnings (with some exceptions). Additionally, those who contribute up to set annual limits on pretax earnings may receive education-based matching funds from their employer’s matching program up to certain limits per year (depending on plan type). Contributions made by way of salary reduction programs may also
