Which retirement plans suit your needs the most?
We’ll guide you through different types of retirement plans below.
Are you eligible for a retirement plan through your employer?
If you have a 401(k) or another retirement plan provided by your workplace, it’s a good idea to contribute enough to take advantage of any employer matching contributions. To learn more about the benefits and drawbacks of these plans, you can read our section on employer-sponsored retirement plans, which covers 401(k)s, 403(b)s, 457(b)s, defined benefit plans, and TSPs.
Interested in setting up an individual retirement account?
If you’ve maxed out your 401(k) or you don’t have access to a retirement plan through your job, you can skip ahead to our section that discusses the pros and cons of IRAs, including traditional and Roth options.
Are you self-employed or run a small business?
If you fall into this category, you can jump to our section that focuses on retirement accounts tailored to your needs. This includes information about the SEP IRA, solo 401(k), SIMPLE IRA, and profit-sharing plans.
Retirement plans offered by employers, including 401(k)s and similar options.
During your new employee orientation, your HR department will provide you with a lot of information. It’s important to pay attention because there could be valuable details about a retirement plan offered by your workplace buried within the stack of paperwork you’ll be asked to review and sign.
Employer-sponsored retirement plans typically come in two primary varieties:
- Defined Benefit Plans: You might have heard of pension plans in the past. Some companies used to promise employees a specific retirement benefit. The company would contribute money to a central retirement fund, and that fund would make investments. These types of plans are rare today. However, you may still find employers who make annual contributions to a retirement plan based on a similar formula, although there’s no guarantee of the retirement benefit amount.
- Defined Contribution Plans: These are the most common workplace retirement plans nowadays. Employers establish these plans, like 401(k)s and 403(b)s, to allow employees to contribute to their own individual accounts within the company’s plan. This typically happens through automatic payroll deductions. If you see the term ‘company match’ in your benefits information, it means you have an opportunity to receive some free money. Your employer will contribute to your account based on your personal contribution level (for example, matching your contribution dollar-for-dollar or at a percentage, often up to a certain limit)
The primary benefits of defined contribution plans are as follows:
- Easy Setup and Maintenance: These plans are straightforward to establish and keep up. Many employers provide an option for automatic payroll deductions, and a separate financial institution handles statements, disclosures, and updates.
- Employer Matching: Some employers will match a portion of your contributions. This essentially means you’re getting free money added to your retirement savings.
- Higher Contribution Limits: 401(k) plans typically allow you to contribute more money compared to IRAs, which can be advantageous for saving more for retirement.
- Tax Benefits: When you contribute to a 401(k) (excluding Roth 401(k)), your taxable income for the year decreases. This initial tax break is beneficial, although you will owe taxes on the withdrawals you make during retirement. Roth 401(k) contributions, on the other hand, don’t provide an immediate tax break since you use after-tax money for contributions. However, the withdrawals you make from the account during retirement are tax-free.
- No Income Restrictions for Roth 401(k): Unlike Roth IRAs, there are no income restrictions for contributing to a Roth 401(k). This means you can enjoy the benefits of a Roth account regardless of your income level.
Here are some key downsides to defined contribution plans:
- Limited Investment Options: When it comes to these employer-sponsored retirement plans, your choices for where to invest your money are often restricted to specific funds. This means you’ll have fewer investment options compared to an IRA. If you don’t have a lot of money to put into retirement, you’ll need to weigh whether it’s better to invest in an IRA or a 401(k).
- Fees Can Eat Into Your Returns: Keep in mind that there are management and administrative fees associated with these plans, and over time, these fees can chip away at your investment earnings.
- Waiting Period for New Employees: If you’re a new employee, there might be a waiting period before you can start contributing to the retirement plan, typically ranging from 30 to 90 days after starting your job.
- Vesting Schedules for Employer Matching: In some cases, employer contributions, especially matching ones, might be subject to a vesting schedule. This means that the money your employer contributes doesn’t become entirely yours until you’ve worked for the company for a specific period. It’s like a waiting period before you fully own those funds.
5 categories of retirement plans offered by employers
| Pros | Cons | Good to know | |
| 401(k)/Roth 401(k) | •The employer may decide to match contributions.
•If the employer provides both traditional and Roth 401(k) options, participants can contribute to both. The combined annual limit is $20,500 ($27,000 for those aged 50 and above) in 2022 and $22,500 ($30,000 for those aged 50 and above) in 2023. |
•There could be restrictions on investment choices.
•The expenses associated with the plan can be substantial. |
Roth 401(k) mandates that you commence minimum distributions at age 73, which is different from Roth IRAs where there are no mandatory distributions. |
| 403(b) (aka TSA or Tax-Sheltered Annuity) | •Boasts more generous matching limits compared to a 401(k)
•Allows for optional catch-up contributions under the 15-year rule, with a maximum lifetime cap of $15,000. |
•Investment choices may be restricted to mutual funds with high fees and/or multiyear contracts for variable annuities. |
Workers who have completed 15 years of service may be eligible for catch-up contributions of $3,000 annually for a period of 5 years. |
| 457(b) | •If the employer provides a 403(b) or 401(k) alongside the 457 plan, employees may have the opportunity to contribute to both.
•There is no early withdrawal penalty if you decide to leave your job. •Contractors are eligible to participate. |
•Qualified early withdrawals are not permitted. |
Participants may be eligible for the Retirement Saver’s Credit. |
| Defined Benefit Plan |
•A consistent retirement benefit can be expected. •Employers receive a more substantial deduction for providing this plan. |
•Challenging and expensive to set up. |
Participants have limited influence over the amounts they contribute and the investments they choose. |
| TSP (Thrift Savings Plan) | •Matching funds are provided to employees irrespective of their contributions.
•Provides investment choices with minimal costs. |
•Certain agency contributions and earnings adhere to a vesting schedule spanning three years.
•Investment choices are constrained or limited. |
Federal employees are also enrolled in a defined benefit plan. |
Sources: IRS
IRAs
An IRA is a widely used retirement plan. It’s something you can open at a bank or brokerage firm to save and invest for your retirement. Inside your IRA, you can hold various types of investments like stocks, mutual funds, bonds, and cash, all meant for your retirement years.
The IRS has rules in place that limit how much money you can put into your IRA each year. The way your contributions and withdrawals are taxed, or if they’re even taxed at all, depends on the type of IRA you choose (there are several types to consider).
Here are the key benefits of IRAs:
- You’re in Control: With an IRA, you’re the one in charge. You get to pick the bank or brokerage where you open your account, and you make all the decisions about how to invest your money. If you prefer, you can also hire a professional to make investment choices for you.
- Tax Break Flexibility: The type of IRA you choose, whether it’s Roth or traditional, allows you to decide how and when you receive tax benefits, depending on your eligibility and circumstances.
- More Investment Options: IRAs offer a broader range of investment choices compared to workplace retirement plans. This means you have more flexibility to tailor your investments to your preferences and goals.
- Contribute to Both Roth and Traditional: If you qualify for both a Roth and a traditional IRA in the same year, you have the option to contribute to both. However, your total contributions must stay within the combined IRA contribution limit. This “two-fer” approach can provide tax diversification in your retirement savings.
- Watch Out for Low Fees: If you’re considering opening an IRA, it’s a good idea to choose a provider with minimal fees. Low fees can help you keep more of your money working for you in the long run.
Here are the main drawbacks of IRAs:
- Lower Contribution Limits: IRAs come with annual contribution limits that are typically lower than those of most workplace retirement accounts. In 2022, you can put a maximum of $6,000 into an IRA (or $7,000 if you’re 50 or older). In 2023, the limit is $6,500, with an additional $1,000 allowed for catch-up contributions. In contrast, the annual maximum for 401(k)s in 2023 is $22,500 ($30,000 for those aged 50 and older). This is a key factor to consider when deciding between an IRA and a 401(k).
- Income Limits for Roth IRAs: Roth IRA contribution limits are determined by your modified adjusted gross income. Your allowable contributions begin to decrease once your income reaches $129,000 (for single taxpayers) or $204,000 (for married couples filing jointly) in 2022. These thresholds increase to $138,000 and $218,000, respectively, in 2023.
- Deductibility Limits for Traditional IRAs: While anyone can contribute to a traditional IRA, your ability to deduct those contributions may be limited if you or your spouse has a retirement plan through work. If this applies to you, it’s important to check the IRA contribution limits to understand how this might affect your tax deductions.
- Tax Guesswork: Choosing between a Roth and a traditional IRA requires you to make an educated guess about your future tax situation when you start withdrawing from the account. Some may find the immediate tax break of a traditional IRA more appealing, while others prefer the potential for tax-free income in retirement offered by a Roth IRA. In our Roth vs. traditional IRA comparison, we argue that the Roth is a better choice for most eligible retirement savers.
4 types of Individual Retirement Accounts (IRAs)
| Pros | Cons | Good to know | |
| Roth IRA | •Withdrawals during retirement are tax-free.
•Contributions (excluding investment earnings) can be withdrawn at any time without incurring penalties. |
•The opportunity to make contributions decreases as income levels increase.
•Tax benefits are only realized if your tax rate is elevated during retirement. |
You need to possess earned income to be eligible for contributions. |
| Spousal IRA (traditional or Roth) |
Permits a nonworking spouse to accumulate retirement savings with tax advantages. |
A nonworking spouse is held to the same contribution and deductibility limits as a working spouse |
Eligibility requires the filing of a joint tax return. |
| Traditional IRA |
Contributions that are deductible reduce your tax liability for the year in which they are made. |
•If you or your spouse is enrolled in a workplace retirement plan, you might not be eligible to claim deductions for your contributions if your income surpasses IRS thresholds.
•Mandatory minimum withdrawals commence at age 73. |
In order to make contributions, it is necessary to have earned income. |
| Rollover IRA (aka conduit IRA) |
When transferring funds from a previous employer’s 401(k), you gain increased control. |
Transferring funds into an account with a distinct tax treatment, such as moving from a 401(k) to a Roth IRA, qualifies as a conversion and initiates income taxes on the initial contributions. |
•Opt for a direct rollover for a straightforward process
•If you opt not to perform a direct rollover, make sure to adhere to the 60-day rule to prevent penalties and taxes. |
Sources: IRS
Retirement savings options for entrepreneurs running small businesses and individuals who are self-employed.
Based on a report from the Bureau of Labor Statistics in 2022, nearly 28% of workers don’t have the option of participating in a retirement plan offered by their employer. In smaller companies with less than 100 employees, about half of the workforce is provided with a retirement savings plan.
If you happen to work for or operate a small business or are self-employed, you might find a variety of retirement plans available to you. Some are based on Individual Retirement Accounts (IRAs), while others are similar to compact 401(k) plans designed for single individuals. Additionally, there are profit-sharing plans, which fall under the category of defined contribution plans.
Here are the key benefits of retirement plans for self-employed individuals, contractors, and small-business owners:
- Higher Contribution Limits: These plans come with more generous contribution limits compared to most employer-sponsored plans and IRAs. This means you can save more for your retirement.
- Greater Investment Choices: Typically, these plans offer a wider range of investment options than employer-sponsored plans like 401(k)s. This flexibility allows you to tailor your investments to your preferences.
- Easy Setup: Many of these plans are straightforward to establish, and they don’t create a significant administrative burden for the employer – which could be you if you’re a small-business owner.
- Convenient Account Placement: You may have the option to set up your retirement account at a financial institution you already use, making it more convenient for you to manage your finances.
- Generous Contributions: If you’re self-employed, you have the opportunity to make substantial contributions, both as an employer (through profit-sharing) and as an employee (via elective deferrals, including catch-up contributions). This allows you to supercharge your retirement savings.
Here are the key drawbacks of retirement plans for self-employed individuals:
- Limited Employer Contributions: In some cases, employer contributions to these plans are entirely optional. This means that more of the responsibility for saving falls on the employees or plan participants.
- Setup and Administrative Responsibilities: With more complex plans, the employer – which could be you if you’re self-employed – may have to handle setup and administrative tasks. This can be time-consuming and potentially challenging.
- Restricted Early Withdrawals: Some of these plans have stricter rules when it comes to allowing early withdrawals compared to traditional IRAs and employer-sponsored retirement plans. This can limit your access to your savings.
- Requirements for Loans: If you need to take out a loan from your retirement plan, there may be specific requirements and an application process that you must follow.
- Profit-Sharing Cap: For self-employed individuals, there is a limit on the amount you can contribute to a profit-sharing plan, which typically amounts to around 20% of your net profits. This limitation is due to Federal Insurance Contribution Act (FICA) taxes that apply to net profits.
5 Retirement Plans available to individuals who are self-employed or small-business owners
| SEP IRA | Solo 401(k)/Solo Roth 401(k) | SIMPLE IRA | Payroll deduction IRA | Profit Sharing | |
| Best for |
Individuals who work for themselves and employers with one or more workers. |
Self-employed individuals with no employees except for a spouse. |
Individuals who are self-employed and businesses with a workforce of up to 100 employees. |
Individuals who work for themselves and employers with at least one employee. |
Self-employed individuals and employers with any number of employees. |
| Funded by | Employer; individual, if self-employed | Self or qualified spouse | Employee deferrals; employer contributions | Employee, via payroll deduction |
Employers, as they see fit, can choose to link this with their workplace retirement plan. |
| 2022-2023 employee contribution limits |
Contributions for employees are exclusively made by the employer (or sole proprietor) and are capped at 25% of net self-employment income, with a maximum limit of $61,000 in 2022 and $66,000 in 2023. |
The lower of $20,500 in 2022, $22,500 in 2023 ($27,000 and $30,000 for individuals aged 50 and above) or 100% of earned income. |
For individuals below the age of 50, the limit is $14,000 in 2022 and $15,500 in 2023. Those who are 50 years or older can make an extra catch-up contribution of $3,000 in 2022 and $3,500 in 2023. |
Based on employee’s IRA eligibility; maximum of $6,000; $7,000 for those age 50 and older in 2022 and $6,500; $7,500 in 2023. | N/A |
| 2022-2023 employer contribution limits |
The lower of either 25% of compensation or $61,000 in 2022 and $66,000 in 2023. |
In the dual role of both an employee (working for yourself) and an employer, you can contribute a maximum of $61,000 in 2022 and $66,000 in 2023. For individuals aged 50 and above, there is an option to contribute an additional $6,500 in 2022 and $7,000 in 2023. |
A compulsory match of up to 3% of an employee’s compensation or a fixed contribution of 2%. |
N/A |
The lower of either 25% of employee compensation or $66,000 (including catch-up contributions of $73,500) for 2023; $61,000 (including catch-up contributions of $67,500) for 2022. |
| Taxes on contributions and earnings |
Contributions and investment gains receive tax deferral, allowing earnings to grow tax-deferred. |
In a traditional Solo 401(k), both contributions and investment income enjoy tax deferral, while contributions to a Solo Roth 401(k) are taxable, but the earnings grow tax-free. |
Contributions and investment returns are deferred from taxation, and earnings also experience tax-deferred growth. |
Contributions to a traditional IRA could be eligible for deductions, whereas contributions to a Roth IRA are subject to taxation. In both cases, earnings enjoy tax-deferred growth. |
Contributions are tax-free, and earnings experience tax-deferred growth. |
| Taxes on withdrawals after age 59 1/2 |
Taxed at ordinary rates |
Withdrawals from a Traditional Solo 401(k) are subject to taxation at regular (ordinary) rates, while withdrawals from a Solo Roth 401(k) are tax-free. |
Taxed at ordinary rates |
Distributions from traditional accounts are subject to taxation at regular (ordinary) rates, whereas Roth withdrawals are tax-free. |
Taxed at ordinary rates |
| Pros |
Easier for employers to establish compared to Solo 401(k)s, and employers receive tax deductions on their contributions. |
Enables small-business proprietors to contribute both as employees and employers, featuring higher contribution limits compared to certain other plans. |
Employees have the option to contribute up to 100% of their compensation, up to the specified limit. |
Straightforward to establish and manage, with no mandatory employee coverage requirements. |
Employees may have the opportunity to borrow from their vested balance without incurring penalties before reaching retirement age, although the borrowed amounts are subject to income tax. |
| Cons |
Sole proprietors have lower contribution limits compared to Solo 401(k)s, and catch-up contributions are not permitted. Additionally, employer contributions are at the discretion of the employer. |
Setting up this plan is more intricate than a SEP IRA, and withdrawals before reaching the age of 59 ½ are only permitted in cases of disability or plan termination. |
A 25% penalty is imposed on distributions taken before reaching the age of 59 ½ within the initial two years of the plan, and loans are not permitted. |
Employees are subject to eligibility criteria for both Roth and traditional IRAs. |
A vesting period is typically mandatory, and there is no diversification; the plan is linked to employer earnings. |
| Good to know |
When you function as both the employer and employee, a distinct calculation is employed to determine permissible SEP contributions. (See the IRS SEP IRA worksheet.) |
Employer contributions could potentially be governed by vesting conditions. |
The distribution rules impose penalties for transferring funds to another account within the initial two years of plan ownership. For self-employed individuals, a SEP IRA or Solo 401(k) may present more favorable options. |
The employer chooses the provider |
Employer contributions are determined at the employer’s discretion and may fluctuate from year to year. The employee’s share is contingent on their salary and job level. |
Sources: IRS
