Retirement Plans 101

Here are 5 basic retirement plans and a brief explanation:

  1. Individual Retirement Account (IRA). The annual contribution limit for both IRAs is $6,000 as of 2019. There are two kinds of IRAs:
    1. Traditional IRA. You contribute money and will be taxed when withdrawn upon retirement. If you withdraw before you’re 59½, you will pay a 10% penalty and be taxed at your ordinary income rate.
    2. Roth IRA. You contribute money and will be taxed now rather than at the time of retirement. You can withdraw your contributions at any age without a penalty. Eligibility depends on your income and single or married status. If you are ineligible, you can get a “backdoor” Roth IRA which converts a traditional IRA into a Roth IRA.
  2. 401(k). A tax-deferred employer-sponsored account meaning you will pay taxes on the money only when you withdraw it and the employer chooses where the money is invested. Important to note, these accounts are only available with companies that sponsor a plan. You can contribute up to $19,000 per year as of 2019. Contributions are taken out of your paycheck pre-taxed.
    1. Be aware of fees. There are three main fees and each depend on the size of your company (larger the company, less fees and vice versa):
      1. Investment management fee – the bulk of your total cost.
      2. Administrative fee – for day-to-day operations such as record keeping.
      3. Service fee – for additional services like a brokerage window or loans.  
  3. Roth 401(k). Just like Roth IRAs, you pay taxes for contributions upfront. Funds can be withdrawn income tax-free as long as you’ve reached 59½ and held the account for five years or longer.
  4. SIMPLE IRAs and SEP-IRAs. A Savings Incentive Match Plan for Employees (SIMPLE) IRA is geared towards small businesses with 100 or less employees and self-employed individuals. You and your employer can contribute money to a traditional IRA established on your behalf. Max contribution is $13,000 per year as of 2019. If you are self-employed, you can use a Simplified Employee Pension (SEP-IRA), contributing up to $56,000 or 25% of your gross earnings per year, whichever is less, as of 2019. Contributions are taxed upon withdrawal and are also tax-deductible.
  5. 403(b) and 457 plans. These operate like 401(k) plans designed for employees of non-profit organizations churches, government entities, and public schools.

When switching employers, it’s recommended not to cash out, but have contributions rolled over to your new account. Cashing out will trigger the 10% penalty.

You can’t leave money in there forever, you must withdraw a minimum amount by 70½.

Image Source: Forbes

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Retirement Plans 101

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