If you are just getting started with your finances, you might not realize how many different types of retirement accounts currently exist.
After all, it can be confusing when you see the types of accounts and the different regulations around them.
But don’t worry! It’s easier to understand than you might think, once each account type is broken down into more straight forward terms.
Below you’ll learn more about investing for retirement, the different retirement accounts, and some tools to help you reach your retirement goals.
Table of Contents
Investing for Retirement
The main reason you should start investing for your retirement as soon as possible is because of a very effective rule called compound interest.
Your investments are the only “savings” that will compound exponentially over time, making you thousands of dollars by the time you’re retired.
The longer your investments are in the market, the more your money will grow over time.
In your 20s and 30s, retirement might seem like something that’s far away and not worth planning for. But this mentality quickly catches up with you, and many people in their later years wish they had started investing sooner.
Not only that, but building retirement investments can be harder when you’re older since you’ll start having larger and more expensive commitments (house, children, etc). Plus, compound interest has less time on its side, which means you need to invest even more aggressively.
Although you may not have much money when you’re younger, you do have time. Just starting with $100 per month and investing regularly for years will put you at a large advantage over older generations.
By investing with your retirement accounts, you’ll also benefit from an employer match (free money!) and tax-free growth.
Employer-Sponsored Retirement Accounts
Employer-sponsored retirement accounts are those investment accounts that you have access to through the company you work for. They offer several different types of investment accounts and may also include a company match.
Here are different types of retirement accounts:
A 401k is an employer-sponsored plan that will allow you to contribute to retirement savings through your employer. There are a few types of 401k plans:
Your contributions will grow over time tax-free, and you’ll pay income tax when you withdraw them after the age of 59 ½. Your employer may offer a 401k match as a company benefit.
Your money also grows tax-free, but you’ll be contributing to this account with your after-tax income. Once you withdraw, you won’t need to pay taxes on any of the growth. If your company offers a match, however, you will need to pay taxes only on the match.
A 403b is a lot like a 401k but instead, it’s for public schools, churches and public service employees. Employees contribute money before taxes, and contributions grow tax-free. They can withdraw after the age of 59 ½ and pay income tax.
A 457 plan is available to employees that work for local and state governments, and other specific organizations. Just like the 401k, the contributions are pre-tax, grow tax-free over time, and then are taxed when the employee withdraws for retirement.
Pensions are also known as “defined benefit plans” and are a more traditional type of retirement account.
With these plans, you work for one employer for several years, and once you retire they pay you a check every month.
Today, only union members, people who work in public sectors or are from older generations (usually baby boomers) use a defined benefit plan.
Self-Managed Retirement Accounts
These types of retirement accounts are separate from your employer and are optional. They also offer some tax advantages, as well as more choice when it comes to picking your investments.
Taxable Brokerage Account
A taxable brokerage account is your standard investing account. There are no contribution limits, income limits and you have more choice.
You can contribute and withdraw at any time you want and you don’t have to worry about pre-tax contributions or waiting till you retire.
However, the main drawback of taxable brokerage accounts it that you will need to pay taxes on any capital gains.
For this reason, a taxable brokerage is best to contribute to once you’ve maxed out your 401k and IRA. Or if you don’t have a company 401k and your maxed out your IRA.
The traditional IRA is an account that is separate from your employer and will allow you to grow your money tax-free.
With a traditional one, you contribute pre-tax money and your contributions grow tax-free. When it’s time to withdraw, you’ll pay income tax.
What’s great about the traditional IRA is there are no income limits on your contributions. This means it doesn’t matter what your income is, you’ll be able to make your money work for you!
The Roth IRA works in reverse: your contributions are after-tax, but your withdrawals are tax-free. You do need to wait until retirement age to withdraw and there are some limits to how much you can contribute depending on your level of income.
Similar to the IRA, your contribution limits are smaller than a 401k. But if you max it out every year, it can still leave you with a healthy sum of money when you reach traditional retirement age.
However, the Roth IRA has some regulations. If your income is too high, you won’t be able to take advantage of a Roth IRA.
For 2020, the current income limits are $124,000 for individuals and $196,000 for married couples filing jointly. Like a 401k contribution limits, these will be adjust in the future, so be sure to check into the IRS Website about Roth IRAs.
You can get around this with the backdoor Roth, but not something I’ll get into here. But know, there is a legal way to get more into your Roth IRA.
Self-Employed and Small Business Owners
The Solo 401k is just like a 401k but is specifically designed for the self-employed or business owners. As a business owner, you can choose to defer some of your profit to a Solo 401k and then withdraw and pay taxes once you retire.
Learn more about the regulations and contribution limits with a Solo 401k.
A SEP IRA is just like a traditional IRA but is specifically designed for small business owners and employees. As an employer, you contribute to the plan on behalf of all your employees.
Once you reach retirement age, your employees can withdraw and use it for their retirement. The higher contribution limits make it a good retirement account for the self-employed.
Learn more about the regulations and contribution limits with a SEP IRA.
SIMPLE IRAs allow employers to match contributions even if an employee is not contributing anything to their retirement accounts, and is designed for businesses that have less than 100 employees.
They provide workers with an opportunity to use pre-tax dollars without having to contribute themselves and are usually simpler to implement and use than a 401k plan.
Learn more about the regulations and contribution limits with a SIMPLE IRA.
Which Types of Retirement Accounts Are Best for You?
There are quite a few retirement accounts out there, so here are some tips to help you figure out which ones are the best for you:
Choose the company match
Does your company offer a retirement account match? Many employers will match your retirement contributions until a certain amount (usually around 4%).
This is essentially free money from your employer since you’ll be able to withdraw and use it once you retire. If your company offers a match, make sure to open the correct type of account that receives the money.
And this type of retirement account should be for your first choice.
Learn the difference between IRAs
There are different types of IRAs, and each one may work better for you depending on your circumstances. If you would prefer paying taxes before your contributions, you’ll want to look into a Roth account.
If you would rather pay income tax when you’re withdrawing after the age of 59 ½, then look into a Traditional IRA. You can also choose to contribute to both if you are within the income limits for Roth contributions!
Start as early as possible
It’s always better to start investing as soon as possible, especially if a company match is offered by the company you work for. And if you work for yourself or own a small business, get a plan started.
You don’t need to invest a lot of money right away, but figure out your budgeting and ensure you make room to invest for your future.
If you need further help you can consult a financial advisor. But ensure you ask any financial advisor these important questions, as many will charge unnecessary fees or try to upsell you on investments you don’t need.
Investing Tools For Retirement
Naturally, if you are taking advantage of an employer-sponsored plan then you’ll be joining whichever financial institution they are working with.
Sometimes the plan could be good and sometimes, they are plans that have funds with high fees. However, you must take advantage of the company match that may be offered!
But if you don’t have a company 401k, looking to invest outside of the 401k, or want some insights into maximizing your investments — you’ll find some solid investing tools below.
Tools to help your investments:
Thanks to technology, there is an arsenal of personal finance software to choose from currently. And one way to ensure your investments and retirement goals are on the right path, is to use some free tools.
- Personal Capital: They offer some financial services to help your investments, but the platform is also free. You’ll get insights into your net worth, how your investments are doing, and even budgeting insights too. Sign-up for free here.
- Blooom: One of my favorite and simple investing tools is Blooom. You can link up your 401k or IRA’s to get insights into your current investments, uncover hidden fees, and get tailored recommendations to improve your results. Sign- up for free here.
Investing your money elsewhere:
Whether you are looking to invest more, diversify elsewhere, or invest with little money — these tools can set you up nicely. Each of these platforms offer different types of retirement accounts as well.
- Ally Invest: With Ally Invest’s managed portfolios, you can start investing with as little as $100. Minimum work, no advisory fees, and you pick a portfolio type based on your needs and interests. Learn more and get started here.
- M1 Finance: If you are looking to invest in a more “hands-off” approach, M1 Finance can be a great option. You can invest for less with fractional shares, no fees, and more. Learn more and get started here.
- Stash: Investing with little money is easy with Stash, where you can get started with just $5. You can invest in fractional shares, open an IRA, automate your investments, and more. Learn more and get started here.
- Acorns: Another popular micro-investing platform is Acorns, which also lets you invest spare change! They also offer various portfolio types, so you can pick what matches your goals. Learn more and get started here.
Hopefully the above has given you enough insights to the various types of retirement accounts you have to choose from. Your choices will be unique to you and your family, but the real common theme is that you should get started sooner rather than later!
Looking for more? Here’s how you can figure out when you can retire. It might be earlier or later than you think! But planning ahead and running the numbers can ensure you are properly prepared.