An important, but oftentimes stressful aspect of getting older is planning for your retirement. In the past, retirement was much simpler, with most employees getting buy on pension payments and Social Security benefits. While both of these options are still available in 2022, due to increases in cost of living, these payments are not enough to reliably cover living expenses. Instead, you must invest in a retirement plan, with 401ks and IRA funds being two of the biggest options. There are several variants of each retirement option available, giving you plenty of options and flexibility, but also making it harder to narrow down your selection.
Some retirement benefits are available through your employer, such as a traditional or Roth 401k plan. Other options are outside investments, such as an IRA fund, which requires you to place money into the account each year. Listed below is a general overview of your retirement plan options.
Setting Retirement Goals
Before you start selecting retirement plans, it is important to identify your retirement goals. For many, the biggest consideration is when to retire. As of writing, 65 is considered the average age of retirement. This is because 65 is when most Social Security benefits begin in full, with earlier options available, but limiting how much you receive in payments. However, based on a number of factors you may want to continue working past this age, or even retire earlier.
The biggest consideration is the type of lifestyle you want after retirement. If you plan to travel around the world after retiring you will need significantly more money compared to a retiree who wants to settle down near his or her family. Another consideration is medical expenses and whether you have any outstanding debt.
If you are unsure where to begin planning your retirement, consider starting with a retirement income calculator. There are many variants available, but each calculator asks questions regarding your finances and outlines general savings goals to help you identify how much you need to make to reach your desired retirement plans. Speaking with a financial advisor is also a good way to determine your expenses and how much you want to save each year.
Defined Contribution Plans
Defined contribution plans are provided through employers. In recent years, defined contribution plans rose above traditional pension plans. A defined contribution plan is available through your employer, who contributes a portion of your paycheck each year towards a retirement plan. The maximum contribution varies depending on your age, but as of writing the maximum you can contribute in 2022 is $27,000 for employees who are 50 years of age or older.
The most common example of a defined contribution plan is a 401k. Under a traditional plan, your employer contributes to your plan using pre-tax wages. This means you do not have to pay any kind of tax or count the contribution towards your total income. The funds in your 401k continue to grow without any tax requirements until you withdraw the funds. With the majority of 401k plans you are able to withdraw your funds early, but there may be additional taxes or fees you must pay. Under most plans, the earliest you can withdraw your funds without penalty is if you are age 59 ½ or older. A common variation is a Roth 401k, which allows you to withdraw your retirement funds without being taxed, as long as you withdraw after your retirement age.
Many employees prefer a 401k plan because it is a simple way to prepare for retirement. Because the money is automatically withdrawn from your paycheck, you do not need to keep track of your investment. Many employers also offer additional 401k benefits, such as matching your contributions.
There are a few variants of the 401k plan, but the rules are largely the same. The main difference between the plans is who they are intended for. For example, 403b plans are available for nonprofit groups, churches and public-school teachers, while 457b plans are for government employees.
Another popular retirement option are IRAs. Similar to a 401k, there is a set limit of how much you can contribute to an IRA plan based on your age. In 2022, the limit is $6,000 for workers under the age of 50, and $7,000 for employees 50 years of age and older. There are a few variants available, with the basic plan being a traditional IRA.
With a traditional IRA, you choose how much you want to contribute to your plan. Your contributions are considered pre-tax dollars, so you do not have to count it towards your yearly income. Your contributions remain tax free until you withdraw the funds. There are options to withdraw earlier, but the fees are fairly strict, costing more than early withdrawals for other retirement plans.
The most common variant of IRAs comes from a Roth plan. With a Roth IRA, your contributions are classified as after-tax money, so what you contribute is still counted as income. However, when you withdraw your retirement funds, there are no taxes on your income. It is a popular option for employees who want to build a larger savings and avoid having to pay increased taxes upon retirement.
Another variant is the rollover IRA. A rollover IRA is a special account where you take the funds from an existing retirement account and transition it into an IRA. While there is no amount to the number of funds you can transfer from a previous retirement account, you may have to pay taxes based around how much you transfer. This largely depends on where you are transferring the funds from and whether the funds were pre- or after-tax.
While pension plans are not as popular as previous years, they are still offered by many employers. With a pension, employers provide a fixed monthly payment to employees after they retire. One of the reasons pensions are becoming less popular is it is harder for companies to commit to pension payments. Pension payments last for the rest of your life and are based on how much you previously earned as well as how long you worked for the company.
Pensions are a great form of retirement because it offers substantial rewards without having to take anything out of your paycheck or worrying about increased taxes on withdrawing your funds. It can also be used alongside Social Security benefits.