But with all the options available to help you save, it can be easy to get confused about what plan is right for your needs.
Because each plan has different tax consequences and implications to keep in mind, it’s important to know more about these savings plans and how they might work for you. After all, we believe that if you know more about your money, you'll feel better about your money — and you'll probably be able to make better decisions as well.
Today, we’re simplifying and breaking down some common retirement savings plans, explaining what you need to keep in mind with each. Read on to learn more!
401(k) Employer Retirement Plans
One type of retirement savings plan that many are familiar with is a 401(k). There are also a few plans that are very similar to a 401(k), including a 403(b) and a 457 plan.
These are all plans that you get through your employer. You will have a 403(b) if you work for a non-profit, while you’ll likely have a 457 plan if you work for the government or any type of government entity. These plans are all virtually the same, except they have different rules for the different types of companies (for-profit, non-profit, or government workplace).
In general, 401(k)s, 403(b)s, and 457s all provide you with the ability to not only add money to the plan yourself from your income, but also allow your employer to add their own money to your plan to help you save for retirement.
When the company is contributing to your plan, they’ll often call it a “matching contribution.” That’s when they set out rules, which can look something like, “100% matching contribution up to the first 4% of your salary and 50% to the next 2%.”
With these rules, your employer is saying is that if you put in a dollar, they’ll match it 100% by also putting in a dollar, up to a certain amount. Then after that, they’ll put in 50%, or half a dollar, up to another amount. Once you’ve hit your employer’s matching threshold, you can put in as much money as you want, but you won’t get any more from the company.
In this example, if you put in 4%, you get 4% matched. If you put in 6%, you get 5% put in by the company. It would be great if you put in even more than 6%, but remember your company maxed out at 5% and won’t be adding any more beyond that.
In 2020, the most you can contribute to your 401(k), 403(b), or 457 plan from your paycheck is $19,500. The rules around these plans are set by the company or whoever puts the plans together. They can determine when the open enrollment period is, whether you can make adjustments, and what percentage or dollar amount you can contribute with every paycheck.
With 401(k)-type investments, we generally recommend that you find out what your matching contribution looks like, and whatever it is that your employer is giving you as a match, try to max that out. If your company is going to give you an extra 4.5% into your retirement, that's like a 4.5% pay boost!
However, one mistake a lot of people make is thinking they’ve maxed out their 401(k) contribution.
We hear from people all the time that say, “I’m maxing out my 401(k)” when really, they’ve just maxed out how much their employer is matching for them, or they remember an old dollar limit from 20 years ago like $10k per year. If you believe you are ‘maxing out your 401(k)’ please check the IRS limit on 401(k)’s which for 2020 is $19,500. In fact, if you're over 50 years old, you can put another $6,500 on top of the regular limit as a catch-up contribution to help you save for retirement - that would be $26,000 total!
It’s also important to keep in mind that things change, and the rules for your 401(k)-type plan may have changed over the years. Different companies have different plans. Make sure you find out what your plan is offering and don't rely on your past knowledge from a prior plan or prior IRS 401(k) rules.
SEP & Simple IRAs / Small Business Retirement Plans
If you work for a smaller company, they might have something called a SEP plan, or a Simplified Employee Pension. Like a 401(k), this is a plan that your company sets up for you — but you can't put any money in by yourself. The company will contribute to your plan, but if you want to contribute your own money, you could consider using traditional and Roth IRAs.
Unlike the SEP IRA, the Simple IRA is something that the employee can have more control over. This type of account is a lot like a 401(k), except you can only put in $13,500 yourself in 2020, plus another $3,000 in catch-up contributions.
There's also a difference between a Traditional 401(k) or a Roth 401(k). Some plans now allow you to contribute money that's after-tax dollars, meaning that you don't get the tax break this year, but later on, you get it tax-free. However, with these types of accounts, a lot of people believe that they can only contribute $6,000 because that is the limit for an IRA. But with a Roth 401(k), it’s still a 401(k); you can still put in $19,500 plus the additional $6,500 as a catch-up contribution if you’re over 50.
Some people also believe that if they have a Roth 401I(k), they can't use a Roth IRA. That’s not true. The traditional and Roth IRA are separate from 401(k)s. You can have your 401(k) and max it out while also maxing out your IRA. And when it comes to a traditional or Roth IRA, the maximum contribution amount is $6,000 per person plus an additional $1,000 catch-up contribution.
However, if you have a Roth IRA and a separate traditional IRA, the total that can go into both IRA accounts is either the $6,000 or $7,000 limit (if you’re over 50). The government doesn't care if you do traditional or Roth inside each of your accounts, but they just don’t want you to go over your max for the total amount in your IRA accounts — it's not per account.
Retirement Age Considerations
There are so many ages you need to remember when planning for retirement. At 62 years old, you can start collecting Social Security. 65 is when you reach Medicare age. And 59 ½ is when you can take money out of IRAs or your 401(k) without penalties.
But did you know that there's a special exception for these 401(k)s?
The government has realized that sometimes people retire before 59 ½ , so they have a rule that if you retire after 55, you can take money out of that 401(k) from the place that you’re working without a penalty.
However, you can't get your old 401(k) from a company you worked for 10 years ago and take it out without penalty, and you can't get your IRA and withdraw without penalty. If you’re between 55-59 ½ when you retire, you can only take out money from the 401(k) that’s from the place that you're working for. With these retirement plans, there are many other complexities that can come into play — which is why it’s always important to consult with an advisor who can help fit all of your retirement puzzle pieces together for your needs.
401(k) vs. IRA Rollover
To better understand the differences between an IRA and 401(k), let’s outline some of the reasons why you might want to keep your money in a 401(k) or why you might, instead, choose to move it into an IRA through a ‘rollover.’
Some reasons why you might choose to move your money out of a 401(k) into a rollover IRA:
You're limited to the choices that the company came up with for you, whereas with an IRA, you can call up just about any place you want and find just about any investment you want.
The 401(k) rules can often be that once you take a dollar out, you’re required to take the whole thing out, so it can feel like you’re being forced to withdraw your money on the company’s terms, not your own. Or they may only allow you 1, or 4 withdrawals per year.
On the other hand, here are some reasons why you might want to keep your money in a 401(k):
Generally, the more money your company has, the lower the fees are with a 401(k) — so investments inside your 401(k) might be cheaper than if you were to get the exact same investments outside of the 401(k).
If you have money in a 401(k) and retire at 55 or later, you don’t have to wait until 59 ½ to take out those funds.
Stable value funds are allowed inside of 401(k)s, but not outside of 401(k)s. So if you’re looking for a stable interest rate, it might be better inside a 401(k).
To find out what your 401(k) does (or does not) allow you to do, look for something called a summary plan description. Look into your website for your 401(k) or ask your HR team about it. This summary plan description (SPD) will give you the investment options for the account, along with the rules on how you can take out money and any other restrictions.
Deciding how much to save, and where to save in your 401(k), 403(b), 457, Roth IRA, Traditional IRA, Simple IRA or SEP IRA can be one of the most important decisions you make.
If you still have questions about the types of plans that are out there and what might be right for you, please do not hesitate to give us a call!