If you have young kids or you’re still building your career, retirement may not be top of mind at this point in your life. But someday, if you’re lucky and save on a regular basis, it will be.
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To help ensure you have a financially secure retirement, it’s wise to create a plan early in life – or right now if you haven’t already done so. By diverting a portion of your paycheck into a tax-advantaged retirement savings plan, for example, your wealth can grow exponentially to help you achieve peace of mind for those so-called golden years.
Retirement benefits are so important that they should be a top consideration when you’re shopping for a new job. Yet only about half of current employees understand the benefits offered to them, according to a January 2019 survey from the Employee Benefit Research Institute.
“Plan design is individualized, so one company’s benefit formula may not be as generous as others,” explains David Littell, professor of taxation and retirement planning expert at The American College of Financial Services. “It’s really important that you read the summary plan description that is provided to all participants so that you can understand the design of the plan.”
Key plan benefits to consider
Virtually all retirement plans offer a tax advantage, whether it’s available upfront during the savings phase or when you’re taking withdrawals. For example, 401(k) contributions are made with pre-tax dollars, which reduces your taxable income. Roth IRAs, in contrast, are funded with after-tax dollars but withdrawals are tax-free.
Some retirement savings plans also include matching contributions from your employer, such as 401(k) plans, while others don’t. When trying to decide whether to invest in a 401(k) at work or an individual retirement account (IRA), go with the 401(k) if you get a company match – or do both if you can afford it.
If you were automatically enrolled in your company’s 401(k) plan, check to make sure you’re taking full advantage of the company match if one is available. And consider increasing your annual contribution, since many plans start you off at a paltry deferral level that is not enough to ensure retirement security. Roughly half of 401(k) plans that offer automatic enrollment, according to Vanguard, use a default savings deferral rate of just 3 percent. Yet T. Rowe Price says you should “aim to save at least 15 percent of your income each year.”
If you’re self-employed, you also have several retirement savings options to choose from. In addition to the plans described below for rank-and-file workers as well as entrepreneurs, you can also invest in a Roth IRA or traditional IRA, subject to certain income limits, which have smaller annual contribution limits than most other plans.
The best retirement plans to consider in 2020:
1. Defined contribution plans
Since their introduction in the early 1980s, defined contribution (DC) plans, which include 401(k)s, have all but taken over the retirement marketplace. Roughly 84 percent of Fortune 500 companies offer DC plans rather than traditional pensions.
The 401(k) plan is the most ubiquitous DC plan among employers of all sizes, while the similarly structured 403(b) plan is offered to employees of public schools and certain tax-exempt organizations, and the 457(b) plan is most commonly available to state and local governments.
The contribution limit for each plan is $19,500 in 2020 ($26,000 for those age 50 and over).
Many DC plans offer a Roth version, in which you use after-tax dollars to contribute, but you can take the money out tax-free at retirement. “The Roth election makes sense if you expect your tax rate to be higher at retirement than it is at the time you’re making the contribution,” says Littell.
A 401(k) plan is a tax-advantaged plan that offers a way to save for retirement. An employee contributes to the plan with pre-tax wages, meaning contributions are not considered taxable income. The 401(k) plan allows these contributions to grow tax-free until they’re withdrawn at retirement. At retirement, distributions create a taxable gain, though withdrawals before age 59 1/2 may be subject to taxes and additional penalties.
Pros: A 401(k) plan can be an easy way to save for retirement, because you can schedule the money to come out of your paycheck and be invested automatically. The money can be invested in a number of high-return investments such as stocks, and you won’t have to pay tax on the gains until you withdraw the funds. In addition, many employers offer you a match on contributions, giving you free money – and an automatic gain – just for saving.
Cons: One key disadvantage of 401(k) plans is that you may have to pay a penalty for accessing the money if you need it for an emergency. While many plans do allow you to take loans from your funds for qualified reasons, it’s not a guarantee that your employer’s fund will do that. Your investments are limited to the funds provided in your employer’s 401(k) program, so you may not be able to invest in what you want to.
What it means to you: A 401(k) plan is one of the best ways to save for retirement, and if you can get bonus “match” money from your employer, you can save even more quickly.
A 403(b) plan is much the same as a 401(k) plan, but it’s offered by public schools, charities and some churches, among others. The employee contributes pre-tax money to the plan, so contributions are not considered taxable income, and these funds can grow tax-free until retirement. At retirement, withdrawals create a taxable gain, and distributions before age 59 1/2 may create additional taxes and penalties.
Pros: A 403(b) is an effective and popular way to save for retirement, and you can schedule the money to be automatically deducted from your paycheck, helping you to save more effectively. The money can be invested in a number of investments, including annuities or high-return assets such as stock funds, and you won’t have to pay taxes until you withdraw the money. Some employers may also offer you a matching contribution if you save money in a 403(b).
Cons: Like the 401(k), the money in a 403(b) plan can be difficult to access unless you have a qualified emergency. While you may still be able to access the money without an emergency, it may cost you additional penalties and taxes, though you can also take a loan from your 403(b). Another downside: you may not be able to invest in what you want, since your options are limited to the plan’s investment choices.
What it means to you: A 403(b) plan is one of the best ways for workers in certain sectors to save for retirement, especially if they can receive any matching funds.
A 457(b) plan is similar to a 401(k), but it’s available only for employees of state and local governments and some tax-exempt organizations. In this tax-advantaged plan, an employee can contribute to the plan with pre-tax wages, which means the income is not taxed. The 457(b) allows contributions to grow tax-free until retirement, and when the employee withdraws money, it becomes taxable.