WHAT TYPE OF RETIREMENT ACCOUNT SHOULD I OPEN IN 2022?

30 July 5 MINS READ
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Retirement planning is important, well except you plan to work until you die. There are several ways to prepare for retirement, but in general, you'll need to open a retirement account. That way, instead of being stuck behind a desk or starting a second career as a retail greeter, you can spend your golden years traveling, relaxing, and enjoying your family.

In this article, we let you in on some of the retirement account options you could consider.

EMPLOYER-SPONSORED RETIREMENT PLANS

1. 401(k)

Employers provide 401(k) accounts, so you should check to see if this plan is available at your workplace. A portion of your contributions may be matched by your employer and contributions to a 401(k) are deducted from your taxable income. Starting from the age of 72, you must begin taking the required minimum distributions from the account. Taxes are levied when funds are withdrawn. You may also face penalties if you withdraw funds from the account before reaching the age of 59 1/2.

With a Roth 401(k), however, an employee contributes after-tax dollars, and gains are not taxed if withdrawn after the age of 59 1/2.

2. 403(b)

A 403(b) plan is similar to a 401(k), but it is available through public schools, charities, and some churches. Because the employee makes pre-tax contributions to the plan, the contributions are not considered taxable income, and the funds can grow tax-free until retirement. Withdrawals are treated as ordinary income in retirement, and distributions made before the age of 59 1/2 may result in additional taxes and penalties.

A Roth 403(b), like a Roth 401(k), allows you to save after-tax dollars and withdraw them tax-free in retirement.

3. 457(b)

If you work for a state or local government, you may be able to save for retirement through a 457(b) plan, which allows you to invest pre-tax money from your paycheck in your retirement account. Because the account is tax-deferred, you don't have to pay taxes on your contributions or earnings until you start withdrawing in retirement. Some 457(b) plans allow Roth accounts, which function similarly to Roth 401(k)s.

4. Defined Benefit Plans

Defined Benefit Plans, also known as "pension plans," calculate a guaranteed payout in retirement using a formula based on your salary history and length of employment. The risk in these plans is on the employer to save and invest the contributions. All you have to do is do your job and stay loyal to the company, and you'll get a gold watch and a monthly pension check when you retire.

That was back in the day, though. In most workplaces, pensions have been replaced by "defined contribution plans" such as 401(k) and 403(b). The majority of pensioners today are baby boomers, union members, and public sector workers. However, pensions aren't always reliable because some companies and governments reduce pension benefits if they are in financial trouble or have mismanaged their investments. So, if you have a pension plan, be cautious—they aren't always a sure thing. You should consult with an investment professional on a regular basis to determine whether your pension will be sufficient for your retirement needs.

INDIVIDUAL RETIREMENT PLANS

5. IRA

An IRA is a type of tax-advantaged investment account. After you deposit money into the account, you can use it to invest in stocks, bonds, mutual funds, ETFs, and other types of investments. You make the investment decisions yourself unless you want to hire someone to do so for you. If your employer does not provide a retirement plan or if you have exhausted your 401(k) contributions for the year, you may want to consider investing in a traditional IRA.

Many taxpayers can deduct IRA contributions on their income tax returns if they do not also have a 401(k) retirement account, lowering their taxable income for the year. There are some income-based restrictions. Income taxes are levied on contributions as well as gains when the money is withdrawn in retirement.

You can buy and sell investments within the IRA, but taking money out before the age of 59 1/2 is known as an "early distribution," and you'll almost certainly have to pay a 10% penalty fee, just like with a 401(k). The withdrawal will also be subject to federal, state, and income taxes.

6. Roth IRA

The primary distinction between a Roth IRA and a traditional IRA is when you receive tax benefits. You don't pay income tax on your contributions to a traditional IRA, but you do when you withdraw the money. With a Roth IRA, you pay taxes on the money you contribute, but you can withdraw it tax-free when you retire, so every dollar in your account goes directly into your pocket.

Should you invest in a traditional or a Roth IRA? Experts say one important factor to consider is whether you expect to be taxed at a higher or lower rate when you retire. Because their income is lower after retirement, many people anticipate a lower tax rate. If you are one of them, you may be better off with a traditional IRA. If not, a Roth IRA may allow you to pay less income tax overall.

Other distinctions exist between a Roth IRA and a traditional IRA. For example, unlike a traditional IRA, you can only contribute to a Roth IRA if your income is below a certain level. Roth IRAs are similar to traditional IRAs in contribution limits though.

7. Fixed Annuities

A type of insurance contract that can supplement your retirement savings is an annuity. There are many different types of annuities to choose from, but fixed annuities are simpler to understand compared to indexed or variable annuities. Fixed annuities typically provide predictable benefits, tax-deferred growth, and, in some cases, a death benefit payable to a beneficiary if you die.

In addition, unlike other retirement plans, annuities are not subject to IRS contribution limits, so you can put as much money into your future as you want.

8. Spousal IRA

Nonworking people are typically ineligible to open an IRA because they do not earn an income. However, married nonworking people whose spouses work can open a spousal IRA if they meet certain requirements. In this manner, the working spouse can contribute to an IRA on behalf of the nonworking spouse. It's important to note that each spouse has their own IRA. IRAs cannot be held in a joint account.

SMALL BUSINESSES & SELF-EMPLOYED

9. Solo 401(k)

A Solo 401(k) is for self-employed people and provides the same benefits as a regular 401(k), but it is only for businesses where the owner (and their spouse) are employees. You can choose to make after-tax salary deferrals (adding a Roth component), with the tax benefits of tax-free withdrawals when the time comes.

10. Simple IRA

If you own a small business and don't have another retirement plan for your employees, consider contributing to a SIMPLE IRA for each of your employees. Your contributions must either match your employees' contributions, up to 3% of their total pay, or you contribute 2% of your employees' salaries, even if they do not contribute themselves.

Employees are immediately vested with a SIMPLE IRA, which means they have full ownership of all funds in their accounts. Your company's contributions can be deducted from its taxes.

11. SEP IRAs

SEP IRAs are retirement vehicles that are managed by small businesses or self-employed individuals. Employees (including self-employed individuals) are eligible if they have reached the age of 21 and have worked for the company for at least three of the previous five years.

SEP IRAs also require that all plan contributions be fully vested. This means that each employee has immediate and complete ownership of all contributions made to their account, including any employer match. Employees are protected from financial loss by vesting. According to the IRS, an employer can forfeit amounts of an employee's account balance that aren't fully vested if the employee hasn't worked more than 500 hours in a year for five years.

BOTTOM LINE

Whatever you decide, keep an eye on the various IRS rules and restrictions for retirement accounts. All of them currently have a contribution limit that can change from year to year, which means that if you want to contribute more than the maximum allowed, you may need to invest in more than one type of account.

Plan for life after retirement with these retirement options.