Best Retirement Plans for Investors
One of the biggest mistakes that investors make when planning for retirement is they associate it with a specific age. For example, many people naturally plan of retiring at 60 or 65.
The truth is that age and retirement have little to do with one another. Sure, there is some financial crossover. For example, you can start withdrawing an IRA at age 59 ½ (more on this below) without penalty. And Social Security benefits can start kicking in at 62 (though you may want to delay your benefit to get bigger monthly payments).
Regardless, exactly when you retire — and the lifestyle you live in retirement — is completely up to you.
When it boils down to it, you are in full control over your retirement planning. The sooner you realize this, the better off you will be.
This article explores some of the various retirement plans and investment options that you can use to start getting ahead and planning your financial future.
Types of Retirement Plans to Consider
Employer-sponsored Retirement Plans
One of the most common ways investors plan for retirement is to use employer-sponsored retirement plans. As the name suggests, an employer-sponsored plan is one that organizations offer to employees.
The most common employer-sponsored plan is the 401(k). In this type of offering, employees can allocate a portion of each paycheck to their account. Companies sometimes provide employer matches as well. For example, a company might decide to offer a 50% employer contribution match up to 6% of the employee’s salary.
For tax years 2020 and 2021, workers are allowed to contribute up to $19,500 to a 401(k). Those who are at least 50 years old may be eligible to make a catch-up contribution of an extra $6,500 per year.
A 401(k) provides tax-deferred savings, enabling workers to pay taxes on distributions while lowering their taxable income upfront, since you can write off 401k contributions as tax deductions, lowering your income tax obligations.
In addition, some plans allow workers to access 401(k) loans. When you use a 401(k) loan, you borrow from the retirement plan and pay it back. If the goal is to reach retirement, you’ll probably want to avoid scooping into this account unless it’s critical.
A Roth 401k is similar to a standard 401(k), as they can provide long-term tax advantages. The difference is that Roth 401(k) contributions won’t reduce your taxable annual income.
However, distributions are tax-free in retirement. If you’re looking to lower your tax rate in the future, a Roth 401(k) may be a good option.
Certain organizations — like public schools and some religious organizations — are allowed to offer 403(b) retirement plans to workers.
This type of plan is also very similar to a 401(k), as it comes with the same annual contribution limits and tax advantages.
This plan is designed to reward employees who spend a long time with one employer. If you work for your company for at least 15 years and your organization is eligible to offer a 403(b), you can contribute an extra $3,000 per year to the account for additional savings.
The 457 retirement plan is available for workers of state and local governments. In addition, some nonprofit employees may be eligible as well.
With a 457, you also get the same contribution limits as a 401(k). However, you can add a whopping $39,000 in catch-up contributions during the last three years before you retire.
Individual Retirement Accounts
Employer-sponsored retirement accounts are a great thing — if you’re eligible. However, many organizations, particularly smaller ones, do not offer retirement plans for employees, leaving them to fend for themselves.
If your employer doesn’t offer a 401(k) plan or pension plan, don’t be dismayed. This is where individual retirement account (IRA) plans can come in handy. Think about IRAs as a retirement savings plan that you control yourself.
In some cases, those who don’t have a 401(k) actually tend to save even more aggressively to make up for it. What’s more, IRAs typically offer more flexibility and variety than employer-sponsored retirement plans. You’ll manage your IRA in your own brokerage account and you can invest funds however you want, adding ETFs, index funds, and mutual funds as you see fit.
Some also choose to use an IRA alongside a 401(k) for maximum tax savings. For example, if you max out your 401(k) by reaching the annual contribution limits, and you make a healthy salary, you may choose to use an IRA for further tax savings. You can open one or more IRAs and make $6,000 in total contributions for the 2020 and 2021 tax years.
One last thing to point out: If you have a 401k and leave your job, you can move those funds over to an IRA using a 401k rollover.
Most of the time, when you contribute to a traditional IRA you can deduct the amount you put in from your taxable income. For example, if you make $50,000 per year, you can reduce your taxable income to $44,000 if you max out your IRA because traditional IRAs are funded with pre-tax money.
The catch is that you’ll pay taxes when you withdraw money from your IRA during retirement. This is a great option if you anticipate being in a lower tax bracket at retirement age.
According to the IRS, as long as you didn’t turn 70 ½ in 2019, you are required to take minimum distributions from your IRA once you turn 72. It’s also worth noting that there aren’t any income limits associated with IRAs. So, no matter how much money you make, you can fund an IRA.
When you open a Roth IRA, you fund the account with after-tax dollars. In other words, you pay taxes upfront instead of when you withdraw your money in retirement.
As a result, you can’t deduct Roth IRA contributions from your annual taxes. However, you can still leverage tax-free growth. Many people prefer parting with taxes upfront and not having to worry about it down the line.
A Roth IRA is generally for people who anticipate being in a higher tax bracket at retirement age.
IRA eligibility depends on how much you make. If your annual income exceeds $139,000 for the 2020 tax year or $140,000 for tax year 2021, you won’t be able to use a Roth IRA.
If you are a high-income earner, meaning you make $75,000 or more, and you also have an employer-sponsored retirement plan, then you are not allowed to deduct your IRA contributions from your taxes. This rule also applies to married couples who make $124,000 or more and have an employer-sponsored plan.
This is called a nondeductible IRA. In a nutshell, with a nondeductible IRA, you pay taxes up front but are allowed to have tax-deferred gains which you pay when you make withdrawals in retirement.
Some workers are eligible to receive an inherited IRA, which occurs when someone dies and leaves an IRA to a beneficiary.
Unfortunately, you can’t contribute to an inherited IRA. There are also restrictions on when you can withdraw the money — usually between 5 or 10 years.
If you withdraw an inherited IRA before age 59 ½, you won’t pay early withdrawals. However, you are going to owe taxes on the money.
Heading out on your own and launching a business can be a frightening concept from a financial perspective. However, you have options — especially from a retirement standpoint.
For example, you can use a simplified employee pension IRA (SEP IRA) if you are self-employed or a small business owner. Contributions to a SEP IRA are tax-deductible.
For tax year 2021, an employer can’t exceed the lesser of either 25% of the employee’s compensation or $58,000. As you can see, this is a sizable increase from a traditional IRA or 401(k).
The Savings Incentive Match Plan for Employees (SIMPLE) is for a small business with less than 100 employees.
With a SIMPLE IRA, you can contribute up to $13,500. Those who are 50 years or older can contribute up to $16,500.
Although a Solo 401k doesn’t fall within the IRA family, it’s a fantastic option for those who don’t have employer-sponsored plans.
If you’re a self-employed individual with no full-time employees, you can contribute up to $58,000 for the 2021 tax year. Those who are 53 or over can contribute $63,500.
The great part about a solo 401(k) is there is no income limitation. Solo 401(k) can be set up as a traditional or Roth account.
This is an excellent option for self-employed, high-earning individuals who want to maximize retirement savings.
Tips For Meeting Your Retirement Goals
As the above examples demonstrate, there is no excuse to not be investing for retirement. There are many ways to save and defer taxes — whether you’re working full-time, as an independent contractor, for the government, or anything in between.
Here are some tips to help you get on track for retirement.
1. Don’t touch your retirement savings
One of the hardest things about putting money away for retirement is watching it grow without being able to touch it. It takes a lot of discipline — especially if you get into a situation where you desperately need money.
The best thing to do is treat the money like it’s not there. Don’t dwell on how much interest it’s accumulating and how rich you’re getting or you’re going to be tempted to access it — even if it means paying penalties and taxes.
Lock your money away until retirement and throw away the key. Your future self will thank you.
2. Consider automatic withdrawals
If you use a personal retirement account like an IRA, consider setting up automatic withdrawals until you reach your contribution limits. This is an easy way to make sure that money continuously goes into your account.
The other option is to fund your account yourself, which is much harder. Most investors find it easier to have funds automatically deducted and funneled into their account, so they don’t even miss it. Manual funding can lead to long gaps with no investments, which will set your retirement plan back.
3. Keep making more money
There’s no getting around it — planning for retirement is hard work. To illustrate, suppose you put $500 per month into a retirement account. That’s $500 that you won’t get to spend on groceries, utility bills, rent, or entertainment.
To overcome this challenge, the best thing you can do is find a way to make more money. If you put $500 per month into a retirement account, challenge yourself to bring in an extra $1,000 per month.
This may sound hard. But it’s not impossible. Ask for a raise or consider changing jobs and looking for a bigger salary. You can also opt to start a side hustle to bring in more cash. You might choose to drive for Uber or Lyft or work online jobs in your spare time.
When you’re in your prime earning years, you need to make the most of it. Now is the time to work hard and make as much money as possible. Truth be told, making money should be one of your top goals.
4. Use a high-yield savings account
As you put money aside for retirement, don’t forget to stash money in a flexible savings account. This is important if you plan on retiring before your IRA or Social Security payments kick in.
A high-yield savings account (HYSA) is a type of high-interest savings account offered by an online bank. It typically offers a much higher interest rate than what you will find at a traditional retail bank, and it can be linked to a checking account for easy access.
As an added bonus, an HYSA can provide flexible income that you can use to fund pre-retirement ventures. For example, you can stash money in an HYSA and then put a down payment on an investment property or use it to launch a business.
Just keep in mind that HYSA interest is taxed at the end of the year. So, if you make $500 in interest over the course of a year, you’ll have to pay taxes on that amount.
5. Create a vision board
It’s important to stay excited about retirement planning. But some days, it can be downright hard if you have bills to pay and a large portion of your monthly salary is going toward retirement.
It might sound hokey. But one thing you can do is create a vision board to motivate yourself for retirement. Put a picture of the sailboat that you’ll be lounging on during retirement. Or hang up an image of the jungle you’ll be exploring.
These visual queues are going to remind you of the financial independence journey that you’re on — and the reward that awaits for all the hard work that you’re putting in now.
Frequently Asked Questions
Can I use life insurance as a retirement vehicle?
There are some life insurance policies that can provide flexible living benefits and tax-free growth. The nice part about this type of plan is that you can put money away for retirement while still gaining benefits for your family in the event of your death.
Talk to a life insurance specialist about setting up a flexible life insurance policy to see if it’s right for your needs.
Can you exceed an IRA contribution limit?
If you exceed $6,000 in annual IRA contributions, you are going to face an excise tax for each year the excess money remains in your account. Unless you love paying additional taxes, you definitely don’t want to exceed your IRA contribution limit.
This is something you should watch out for if you’re automatically funding an IRA account or if you are contributing to more than one IRA. Keep a close watch to avoid going over the contribution limit and getting penalized by the IRS.
You will face a similar excise tax if you exceed the 401(k) contribution limit.
What is a target-date fund?
Some retirement funds can be set up as target-date funds, which automatically rebalance as you inch closer to retirement age.
Young investors are usually encouraged to plan aggressively for retirement by investing heavily in equities. However, equities are risky. As you get older and approach your retirement years, it’s generally recommended to ease off of equities and put your money into cash equivalents and bonds.
A target fund can automatically handle this transition, providing a hands-off approach to retirement planning.
What is an annuity?
An annuity is a type of long-term investment that involves making regular payments at set intervals. After doing so, you receive fixed disbursements at regular intervals at a set period of time.
Annuities are funded through a process called accumulation. The contract reaches maturity when disbursements begin.
By setting up an annuity, you can potentially receive a guaranteed income stream in your golden years. This is one way to fund retirement.
Are annuities risky?
One of the downsides to using annuities is they can lock your money for a set period of time — called the surrender period. As a result, you won’t be able to access the money without paying a penalty. In most cases, surrender periods taper off over time.
It’s also important to note that many annuities come with high fees, which can eat into your retirement gains quite substantially.
Make sure to read the fine print before signing up for an annuity — or any retirement plan for that matter — to avoid getting roped into something that you’re not prepared for or an investment that doesn’t make sense for your needs.
How much do you need in retirement savings at 30?
The general rule of thumb is to have the equivalent of your annual income in retirement savings by the time you’re 30. So if you’re making $60,000 per year, you should have at least that much or more put away so that it can grow.
How much you save for retirement depends on how long you have been working, your cash flow, and your retirement goals. Spend some time outlining how you want to retire and use this vision to influence your retirement strategy.
The Bottom Line
Putting money aside for retirement is one of the best investment decisions you can make. You’ll be taking care of your future needs, and putting money aside so that you can live a better life in retirement — whenever that may be — while taking advantage of tax benefits.
The retirement plans outlined in this article can play an instrumental role in helping you take a hold of your financial future. Browse your available options from various financial institutions like Vanguard and Schwab, understand how they work, and consider talking to a financial advisor to help form a robust plan.
Remember: Retirement planning is your responsibility and yours alone. Nobody is going to do it for you. Take command and secure your future today. Your future self is already patting you on the back.
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