Navigating the wide range of retirement accounts is a difficult process for both individuals and small business owners alike. From IRAs to 403(b) retirement accounts, there are plenty of choices to suit your unique needs. To help find the best plan for you, we will explore the seven most common retirement plans. In addition, we will reveal three important factors you should consider before deciding on the option that works best for you.  

The Seven Most Common Retirement Plans

401(k) and 403(b)

401(k) and 403(b) plans are among the most common types of retirement accounts available. Both plans allow employees to set aside pre-tax dollars for retirement. The 403(b) is similar to the better-known 401(k), but the 403(b) is designed specifically for certain institutions, such as nonprofit organizations, government agencies and religious institutions. The 403(b) typically has lower administrative fees and is therefore cheaper to offer and maintain.

Outside of this key difference, these retirement accounts function in much the same way. They are offered by employers and typically come with some form of matching contribution. This matching contribution can be distributed annually or per pay period. These accounts are tax-deferred. Due to the employer matching program, these plans are a great way to begin building your very own retirement nest egg.

Pros

• Taxable income may be reduced
• Deferred tax status means you don’t have to pay until distribution
• Employer matching system is a great way to quickly grow your savings
• Emergency withdrawal system can come in handy

Cons

• Some plans lack customized investment options
• Early withdrawal penalties can be quite steep
• Lengthy waiting period before most employees become eligible

Solo 401(k)

The Solo 401(k) is designed specifically for individuals who are self-employed, or business owners with no employees other than a spouse. Otherwise, it is much the same as a standard 401(k), with regard to investment options, contribution limits and emergency withdrawal stipulations.

Because no employees are involved, the Solo 401(k) is not subject to the often-complex rules of ERISA (Employee Retirement Income Security Act). One downside to consider is that you will need to apply for an EIN number for your business. While not overly complicated, this can take a bit of extra time. However, the increased contribution limits for self-employed individuals is often well worth the wait.

Pros

• Generally allows access to more self-directed investment options
• Allows self-employed individuals to contribute more each year to their account
• Emergency withdrawals can be made, as needed
• Contributions can help decrease your taxable income

Cons

• Administration and setup fees tend to be a bit higher
• You will need an EIN number for your business as part of the application
• Not suitable for business owners with employees

IRA

The traditional IRA is another retirement account to consider. This account is meant for individuals only. It allows you to grow your earnings while taking advantage of tax-deferred status. In addition, an IRA is often very affordable, in terms of administrative fees.

One of the biggest advantages to a traditional IRA is that there are no income limitations, making it a popular choice for high-income individuals. If you don’t have a qualifying plan such as a 401(k) at work, your IRA contributions may be tax-deductible.

Pros

• Contributions are tax-deductible for qualifying individuals
• No income limit
• Low administrative costs
• Easy to set up and maintain

Cons

• Lacks loan options
• Cannot make contributions once you’ve reached 70.5 years of age
• Subject to mandatory required minimum distributions

Roth IRA

The Roth IRA differs from other IRAs in that contributions are never tax-deductible. Tax is paid up-front, so distributions are not taxed. To qualify for a distribution, you must be at least 59.5 years old and have maintained the account for at least five years.

The Roth IRA is not subject to age limits, making it an ideal pick for older investors who are looking for a place to grow their savings. Furthermore, it can be used in conjunction with qualifying employer plans, like 401(k) and 403(b) options.

Pros

• No upper age limitation
• Can be used in conjunction with employer retirement plans
• Very affordable and easy to open
• Earnings are not taxed with a qualifying distribution

Cons

• Contributions are not tax-deductible
• Your modified gross income may limit your contribution amount
• No loan option available

SIMPLE IRA

The SIMPLE IRA is designed for small businesses and self-employed individuals. SIMPLE IRAs generally have relaxed filing requirements and lower administrative fees. For this reason, the SIMPLE IRA is very popular for both self-employed individuals and small business owners. To qualify, a company must employ fewer than 100 people each year.

As of this writing, an employee is eligible to participate in this type of plan if they have earned at least $5,000 during any two years prior to the current year and they are reasonably expected to earn another minimum of $5,000 in the current year. Deposits made to these accounts are tax-deductible. Employers must either contribute a flat two percent of each employee’s salary or match the first three percent of earnings dollar for dollar. This gives the business owner a bit more flexibility in terms of the funding structure for their SIMPLE IRA accounts. Employees may contribute as well, but are not required to do so.

Pros

• Administrative fees are often very affordable
• A portion of administrative fees are tax-deductible for business owners
• Most SIMPLE IRAs have multiple investment options to choose from
• Certain employees may qualify for a tax credit based on their contributions

Cons

• Mandatory employer contributions can be a bit rough on small businesses
• Lower contribution limits than standard 401(k) plans
• No loan option for emergency situations

Health Savings Account

While not a retirement program per se, a Health Savings Account (HSA) is another popular option. This account is designed to cover medical expenses for individuals who participate in a qualifying high-deductible health plan. The biggest advantage to participating in this type of program is that it allows you to set aside pre-tax money for future medical bills.

Unfortunately, some people find it hard to maintain a Health Savings Account in later years, as health problems increase, because they need health insurance with a lower deductible. Still, an HSA is a great way for certain individuals to decrease their taxable earnings while setting aside money for future health expenses. Any remaining balance can be cashed out without additional penalties at age 65.

Pros

• Builds savings for medical expenses while reducing your tax load
• Can be used for a wide variety of qualifying medical expenses
• Earnings grow tax-free for the duration of the account
• Most plans have multiple ways to request disbursements

Cons

• Requires active participation in a qualifying high-deductible health plan
• Records of qualifying medical purchases must be carefully maintained
• Like any investment, the value of the HSA may drop with certain market conditions

SEP IRA

A popular retirement plan that is designed for self-employed individuals and business owners with employees is the SEP IRA. By law, all qualified employees who are at least 21 years old and have worked for the company three out of the past five years must be allowed to participate, but an individual business has the option to relax those requirements.

Employees do not make contributions to the SEP IRA; the business owner does. Self-employed individuals make contributions to their own plan as the owner of the business. One distinct advantage to this plan is funding flexibility. Instead of a set contribution amount, the business can adjust the disbursement amount based on how much liquidity the company currently has. In addition, the SEP IRA generally has fairly low administrative fees and is very easy to open.

Pros

• Generally has significantly lower administrative fees
• Flexible funding options are ideal for seasonal businesses
• Simple to set up, with no filing requirements
• Contributions are tax-deductible

Cons

• Lacks loan option for emergency disbursement, but funds may be withdrawn with a penalty
• Employee eligibility requirements are fluid
• Immediate vestment period can increase plan costs for business owners with high turnover

Three Important Factors to Consider When Choosing a Retirement Account

Contribution Amounts

One of the most important things to consider when choosing a retirement account is your annual contribution amount. Each account type mentioned in this article is subject to its own unique annual contribution limit.

For a 401(k) or 403(b), the total maximum yearly contribution limit is $18,500, as of 2018. For IRAs and some other account types, the annual contribution limit is significantly lower for 2018. The maximum yearly contribution is currently $5,500 for individuals under 50 and $6,500 for those who are older.

Some people decide to combine multiple account types. The most common example you will likely encounter is combining a traditional 401(k) and a Roth IRA. If you are considering this, consider your modified adjusted gross income to determine your eligibility.

Tax Implications

Tax implications are an important factor to consider when shopping for a retirement plan. With the account types discussed here, your earnings will grow in a tax-sheltered account. This allows earnings to compound quickly, since the money is not subject to tax withholding while kept in a qualifying account.

Where things get a bit tricky is deciding whether to pay taxes up front or when money is withdrawn. With most retirement accounts, you pay tax when you take a qualifying distribution at retirement age. These accounts allow you to deduct your contributions each year up to the current set amount established by the IRS. This allows employees to theoretically take advantage of a lower tax rate at retirement.

However, some individuals may be subject to a higher tax rate when they reach retirement age, as compared to the rate they pay now. If you are in this situation, a Roth IRA may be the best fit. Your contributions will not be tax deductible, but qualifying distributions will be tax-free.

Employment Status

Employment status plays a huge role in determining the type of retirement account that is right for you. Employees of a company or government agency will likely have access to a 401(k) or 401(3) account. These accounts are nice because they come with an employer match and are an excellent way to put away savings automatically with each paycheck.

Self-employed individuals have many more options to consider. If you own a small business that consists of either just you or you and your spouse, the Solo 401(k)  is an ideal choice. Similar to a traditional 401(k), this account will help you save money automatically, and it is not subject to strict reporting requirements.

Small business owners will likely want to consider the wide range of IRA options. While not offering as high of a contribution limit as standard 401(k) accounts, IRAs are much cheaper to set up and easier to maintain. In addition, disbursements made by your company are often tax deductible. With a Roth IRA, an individual can set up their own account and make extra contributions, up to the set maximum amount for their tax rate. This is a great option for just about anyone, regardless of their employment type.

Now Get Started!

No matter what retirement account you choose, rest easy knowing that you are taking the first step in saving for your future. Also, keep in mind that your investment strategy might one day include investing in several of the above plans, but it’s critical that you start with one sooner than later: the earlier you start, the more you will save. Just remember to carefully consider the important factors mentioned above. By taking those factors into consideration, you are likely to find the right retirement account for your unique needs.