Retirement savings plans are primarily divided into two main categories: employer-sponsored plans and individual retirement accounts (IRAs). Additionally, there are specialized plans designed for self-employed individuals and small business owners.
A key feature of many retirement plans is the option for catch-up contributions which enable individuals aged 50 and over to contribute an additional amount above the standard annual limit.1 This catch-up savings can provide an opportunity to increase savings as they approach retirement. The specific amounts allowed vary by plan type.
Employer-Sponsored Retirement Plans
Employers offer these plans as a benefit to their employees. They generally fall into two categories: defined contribution and defined benefit plans.
Defined Contribution Plans
Within a defined contribution plan, the employee and/or the employer contribute to an individual account for the employee. The retirement benefit is not fixed; instead, it depends on the amounts contributed and the investment performance of the account over time. The employee typically chooses how their funds are invested from a list of investment options provided by the plan.
| Plan Type | Description | Key Features |
|---|---|---|
| 401(k) Plan | The most common type of employer-sponsored retirement plan for private companies. |
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| 403(b) Plan | Similar to a 401(k), but offered to employees of public schools, non-profit organizations, and some religious institutions. |
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| 457(b) Plan | A deferred compensation plan available to state and local government employees, as well as some non-profit employees. |
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| Thrift Savings Plan (TSP) | A retirement savings and investment plan for federal government employees and members of the uniformed services. |
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Defined Benefit Plans
In a defined benefit plan, the employer promises a specific, pre-determined benefit to the employee at retirement. The employer is responsible for funding the plan and bears the investment risk.
| Plan Type | Description | Key Features |
|---|---|---|
| Traditional Pension Plan | Promises a specific monthly benefit at retirement, based on a formula that considers salary and years of service. |
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| Cash-Balance Plan | A "hybrid" plan that is technically a defined benefit plan but looks like a defined contribution plan. It expresses the benefit in terms of a stated account balance. |
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Individual Retirement Accounts (IRAs)
IRAs are retirement savings plans that individuals can open on their own, regardless of whether they have a workplace retirement plan.2
| IRA Type | Description | Key Features |
|---|---|---|
| Traditional IRA | Contributions may be tax-deductible, and investments grow tax-deferred until retirement. |
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| Roth IRA | Contributions are made with after-tax dollars, meaning they are not tax-deductible. |
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Retirement Plans for Self-Employed Individuals and Small Business Owners
Several retirement plan options are tailored to the needs of those who work for themselves or own small businesses.
| Plan Type | Description | Key Features |
|---|---|---|
| SEP IRA (Simplified Employee Pension) | Allows self-employed individuals and small business owners to make contributions for themselves and their employees. |
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| SIMPLE IRA (Savings Incentive Match Plan for Employees) | A retirement plan that can be established by employers with 100 or fewer employees. |
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| Solo 401(k) | A 401(k) plan for self-employed individuals with no employees (other than a spouse). |
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Conclusion
Choosing the right retirement savings plan, or a combination of plans, depends on your individual circumstances, including your employment situation, income level, and retirement goals. It is often beneficial to consult with a financial advisor to determine the most suitable approach for your financial future and retirement security.
Sources
- Internal Revenue Service (IRS). "Types of Retirement Plans." https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans
- Internal Revenue Service (IRS). "IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs)." https://www.irs.gov/publications/p590a
