According to the Federal Reserve’s Report on the Economic Well-Being of the U.S. Households, just 36 percent believe that they are on track for a financially comfortable retirement. Most people can benefit from building a cash cushion, especially older adults who are within a few years of retirement. Before putting money into a retirement account, it is important to fully understand the rules for plan distributions and how to maximize savings. A refreshed retirement plan can help aging adults retire with sufficient savings.
Types of Retirement Plans
There are several main types of retirement plans, each with its own set of benefits and restrictions. Take the time to compare each plan to determine which is the best option based on income and other factors.
Employers often offer 401(k) retirement plans as part of an employee benefits package. This type of retirement account allows employees to contribute a portion of their pre-tax paycheck to tax-deferred investments, thus reducing the amount of taxes paid on income for that year. Investment gains continue to grow tax-deferred until the money is withdrawn at retirement. There is a penalty for account holders who withdraw funds before the age of 59½. Many employers opt to match their employees’ contributions.
Individual Retirement Accounts (IRAs)
An IRA is a type of tax-favored account that can be used to invest in bonds, stocks, ETFs, mutual funds and other types of investments. If an employer does not offer a retirement plan or 401(k) contributions have been maxed out for the year, an IRA can be a great choice. In 2021, the contribution limit is $6,000 and increases to $7,000 for people who are 50 or older. No taxes are paid annually on investment gains which allow the money to grow more quickly.
Roth IRA contributions are made with post-tax dollars and any money that is generated in the account is never again taxed. Contributions made to a Roth IRA can be withdrawn before retirement without penalty if at least five years have passed since the date of the first contribution. Putting funds into a Roth IRA is an excellent option for people who are just starting and believe that their income will grow over time.
Roth 401(k) Plans
Roth 401(k) retirement plans have features of both 401(k)s and Roth IRAs. This type of account is usually offered through employers and involves contributions that come from after-tax paychecks. If the account holder remains in the plan for at least five years, no further tax is collected on contributions or earnings. Unlike a Roth IRA, there are no income limits.
A Savings Incentive Match for Employees (SIMPLE) IRA is a type of retirement plan typically offered by small employers with 100 employees or less. SIMPLE IRAs work similar to 401(k)s with contributions taken from pre-tax paycheck withdrawals. Distributions taken before age 59½ or within two years of opening the account may result in penalties. In addition, an account holder cannot borrow from a SIMPLE IRA.
Benefits of Retirement Planning
Nearly everyone can benefit from setting up a retirement account. It is also never too early or late to start saving. Saving for retirement is a wise choice regardless of wealth or income. Proper planning can provide security and reduce stress during retirement. It can also eliminate uncertainty and allow aging adults to reach their golden years with a sense of financial stability. .
There are also countless tax benefits associated with retirement planning. Depending on the plan chosen and the contributions made, some people may see a noticeable reduction in the amount of income taxes paid during retirement. Tax diversification is an important topic that many people overlook when saving for retirement. This process involves establishing various “pools” of money in tax-free, taxable and tax-deferred accounts. With these different accounts, income during retirement can be strategically withdrawn from several sources.
There are also other benefits of setting up a retirement plan. For employees interested in saving for retirement, contributions can be easily made through payroll deductions and any retirement assets can be carried from one employer to the next. Interest also accrues over time, allowing contributions to grow significantly over many years until the retirement age is reached.
Speak with an Experienced Wealth Advisor
The retirement planning process can be complex as there are many plans to choose from and each has its limitations and benefits. It is important to carefully consider how each plan is taxed and how any current income may rise or lower over time, impacting the amount of taxes paid. For more information about who benefits from a refreshed retirement plan or to speak with an experienced wealth advisor about retirement planning services, contact Campbell Wealth Management.
This is intended for informational purposes only and should not be construed as tax advice. Consult your tax advisor regarding your situation.