NEWS & RESOURCES

Authored by: Adelae Winters

Retirement Plan Types

Most people have at least heard of two prevalent types of retirement plans: the 401(k) and the IRA. Deciding which is appropriate for you, however, is another story. Having a basic understanding of these two types of retirement accounts, along with their potential advantages and drawbacks, can equip you to make more informed decisions about saving and investing for retirement. However, not everyone finds themselves in a situation where they are an employee with an employer who offers the benefits of a 401(k) plan. For small business owners, self-employed and contract or freelance workers, there are a few options to explore outside of these common 401(k) and IRA.

401(k) Retirement Plans

A 401(k) is a retirement plan provided by employers for eligible employees. Under a 401(k) plan, an employee makes pre-tax or after-tax contributions to their account directly out of their paycheck each pay period. The funds in this account are allocated to investments, usually mutual funds, but can have other choices. Employees don’t receive the benefit until retirement age, which is why the 401(k) is classed as a “deferred compensation” plan. If contributions are made pre-tax, the money is taxed upon withdrawal, if the participant had Roth 401k, the distribution will be tax-free.

• 401(k) makes saving for retirement simple. Once set up, contributions will be automatically deducted from your paycheck.
• It provides a way to put money aside in a consistent, long-term strategy.
• Money contributed could be deducted from your taxable income, which means you’ll pay less in income taxes for that tax year.
• Your money grows tax-deferred in your account. And, although you’ll pay taxes when you begin to withdraw the funds in retirement (if you made pre-tax contributions), you might be in a lower tax bracket when that time comes.
• If your employer offers it, you can make Roth contributions to your 401k. That way the moneys grow tax-deferred and are tax-free when withdrawn as qualified distribution such as retirement or attaining age 59 ½.
• Your employer can contribute to your 401(k) and might offer matching contributions, up to a certain limit. If you take advantage of the offer, that’s essentially a 100% return on your investment. (Although your investments are subject to market fluctuations and potential loss.) Employer contributions can be considered part of your overall benefits package.
• Loans from the account may be possible in the event of an emergency or financial crisis.
• Although short-term fluctuations may occur, 401(k) plans usually offer conservative long-term returns.
• If you leave your job, you have the option to roll your money over to another 401(k) or to an IRA.
• You can’t distribute funds from a 401(k) prior to the age of 59 ½ (or 55 in some cases) without incurring a hefty penalty fee of 10%, in addition to regular income tax.

IRAs

An IRA (Individual Retirement Account) is a tax-advantaged investment vehicle designed to hold assets purchased with earned income for retirement purposes. IRAs provide tax benefits to encourage retirement savings.

• The IRS limits the amount of money that you can contribute to IRAs each year, whether it’s in one or multiple IRA accounts.
• You might not qualify to make IRA contributions depending on to what type of IRA you want to contribute and your earned income levels.
• You may elect a Traditional IRA, or a Roth IRA. Traditional IRAs provide a tax deduction now, but all of the earnings are taxable in retirement, whereas a Roth IRA is funded with after-tax contributions, and it will grow tax-free.
• If you make early withdrawals from an IRA before age 59 1/2 , some or all that money may be subject to income taxes, as well as a steep 10% penalty.
• IRAs typically offer more investment options than 401(k)s. This could be to your advantage, but if you don’t want the added responsibility or pressure of choosing from the options available to you, you might want to consider seeking advice of a financial professional.

SEP-IRA

A SEP-IRA, or Simplified Employee Pension Individual Retirement Account, is often used by small businesses and self-employed workers to provide retirement benefits for themselves and their employees. Contributions are tax-deductible for the employer and grow tax-deferred for the employee. It’s important to note that contributions are subject to a certain annual limit. SEP IRAs accept only employer contributions.

• SEP-IRAs invest funds similarly to other IRAs. Withdrawals from SEP-IRA funds are taxed at ordinary income tax rates when qualified distributions are taken after the age of 59 ½.
• For self-employed individuals with no employees, administration costs for a SEP-IRA are typically minimal. For businesses, however, contributions must be made for all eligible employees.

SIMPLE IRA

SIMPLE stands for Savings Incentive Match Plan for Employees. A SIMPLE IRA is another type of employer-provided retirement savings plan. A SIMPLE plan allows both the employer and employee to make contributions.

• SIMPLE IRA plans commonly involve employer-matching contributions or only employer contributions. Employer contributions to employee accounts are usually tax deductible, and contributions to the plan are tax-deferred for both employers and employees. However, there are limits on both employer and employee contributions.
• A SIMPLE IRA has lower employer costs compared to 401(k) and is suitable for smaller employers. SIMPLE IRA is still subject to ERISA and its related regulations.

Call it a Draw: When the Answer Can Be “Both”

Depending on your circumstances, viewing 401(k) plans and IRA plans in either/or terms might mean a missed opportunity. You can have both. Many investors use IRAs to complement an employer-sponsored 401(k) plan.

Please consult with a financial professional to determine suitability. Investments are subject to market risks including the potential loss of principal invested.

Before deciding whether to retain assets in a 401(k) or roll over to an IRA, an investor should consider various factors including, but not limited to, investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Please view the Investor Alerts section of the FINRA website for additional information.

To learn more, visit our website at cnccpa.com or call us at (509) 663-1661.