Retirement Plans: Which Account Is Right for You?

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Updated on Wednesday, September 2, 2020

The best retirement plan for you will depend on your work situation and what your employer offers (if you have one), as well as factors like your age and tax bracket. If your company doesn’t offer a 401(k) retirement account, for instance, you can’t participate in one. Read on for guidance on making the pick.

Which retirement plan is right for you?

Not sure what the right retirement savings plan is for you? Here are some options you might consider:

401(k)

A 401(k) plan is an employer-sponsored retirement account that allows you to save and invest work income for the future. There are three main types of 401(k) plans:

  • Traditional 401(k): A traditional 401(k) plan lets you save pretax money to the account and pay taxes only when you withdraw the money in retirement.
  • Roth 401(k): A Roth 401(k) allows you to save post-tax money into your account and pay no taxes on withdrawals in retirement.
  • Solo 401(k): A solo 401(k) is a retirement savings plan for self-employed workers with no full-time employees, and may be a traditional or Roth account.

One of the benefits of a 401(k) plan is the possibility of an employer match for your contributions. This is an option (but not always offered) in all 401(k) plans, although with a solo 401(k) plan, you are essentially matching your own contributions since you are both the employer and the employee.

Retirement PlanBest For...
Traditional 401(k)Earners who would benefit from a tax break now, or who feel that they’re likely to be in a lower tax bracket in retirement
Roth 401(k)Younger earners or those early in their career who feel their taxes may go up in the future or that their tax bracket might be higher in the future
Solo 401(k)Self-employed workers with no full-time employees (except for a spouse)

403(b) and 457(b)

Employees of public educational institutions, nonprofits, church-related organizations and state and local government agencies may have the option of a 403(b) or 457(b) plan instead of a 401(k). The plans are similar – you contribute pretax savings and pay taxes on withdrawals – with potentially fewer investment options, although 403(b) plans offer the ability to make additional catch-up contributions to those with more than 15 years of service.

Unlike a 401(k) or 403(b) plan, a 457(b) plan won’t incur a 10% early withdrawal penalty if you leave your job or retire before age 59 ½. Also, you may be able to make large catch-up contributions in the three years prior to retirement age.

Retirement PlanBest For...
403(b)Employees of public schools, 501(c)(3) nonprofits or churches
457(b)Employees of state or local government or tax-exempt organizations

IRA

IRAs are retirement accounts that you can open at a financial institution. With the exception of a SEP IRA, which is for self-employed workers or small business owners, IRAs have lower contribution limits than 401(k) plans.

Retirement PlanBest For...
Traditional IRAA worker whose employer doesn’t offer a retirement plan benefit or whose adjusted gross income qualifies them to deduct contributions to a traditional IRA
Roth IRAA younger worker or someone at the start of their career who is eligible for a Roth or anyone who expects taxes to be higher in the future
SIMPLE IRAA self-employed person with fewer than 100 employees who wants to allow employees to make contributions to their own SIMPLE (“savings incentive match for employees”) IRA plans
SEP IRAA sole proprietor or self-employed person with few employees, because you must contribute the same amount to your employees’ plans as to your own

How to know which retirement plan is best for you

If your employer offers a retirement plan…

  • 401(k): Allows pretax contributions, earnings grow over time, and you’ll pay taxes on withdrawals in retirement. Save up to $19,500 in 2020 or $26,000 if you’re 50 or older.
  • Roth 401(k): Allows post-tax contributions, earnings grow tax-free, and you pay no taxes on any withdrawals in retirement. Same contribution limits as a 401(k).
  • 403(b): Allows pretax contributions, earnings grow over time, and you’ll pay taxes on withdrawals in retirement. Larger catch-up contributions available if you have 15 or more years of service. Same contribution limits as a 401(k).
  • 457(b): Allows pretax contributions, earnings grow over time, and you’ll pay taxes on withdrawals in retirement. Larger catch-up contributions are available in the three years prior to retirement. Save up to $19,500 in 2020, and state and local government plans may allow catch-up contributions of $6,500 if you’re 50 or older. Tax-exempt organizations with 457(b) plans only allow catch-up contributions three years before retirement, and with certain contribution limits.

In most cases, the plan you choose will depend on what your employer offers, and the majority of employers, if they offer a plan, offer only one choice. For most people, if your employer offers a 401(k) account, that’s a great option. It automates your retirement savings, which is a boon for the average worker, and many employers offer a company match for contributions.

There are caveats: Not every 401(k) is a slam-dunk. If your company doesn’t offer a match, the investment options aren’t great or fees are high, you may be better off with a different investment option. But the pretax status and high contribution limit of a 401(k) make it a hard choice to pass up.

If your employer offers a choice of plans – such as a 401(k) and 457(b) or 403(b) – note that while you can max out both a 401(k) and 457(b) in the same year, contributions to a 401(k) and 403(b) both count toward your contribution limit so you can’t max out both. Take a look at investment options and expenses to see which one offers the best opportunities.

If your employer offers both a traditional 401(k) and a Roth 401(k), you’ll have to determine whether you want to choose one or the other or contribute to both. Your choice will depend on your tax status: Do you need the tax break now, or do you feel your taxes will be higher in the future?

If your employer does not offer a retirement plan…

  • Traditional IRA: You can save and invest pretax money, earnings grow over time, and you pay taxes on withdrawals in retirement. Contributions are limited to $6,000 in 2020 or $7,000 if you’re 50 or older.
  • Roth IRA: You can save and invest post-tax money, earnings grow tax-free, and you pay no taxes on withdrawals in retirement. Contributions are limited to $6,000 in 2020 or $7,000 if you’re 50 or older.
  • Taxable account: You can purchase investments at a brokerage account.

If your employer doesn’t offer a retirement plan, you can choose from either a deductible IRA or a Roth IRA for your savings, depending on eligibility. As with the 401(k) versus Roth 401(k) choice, what you decide will depend on your current tax status. Ask yourself the same questions: Do you need the tax break now? Do you feel your taxes will be higher or lower in the future?

Your choice may also depend on your income and whether you’re eligible for a Roth IRA. To contribute to a Roth for the 2020 tax year, your modified adjusted gross income must be under $139,000 as a single tax filer or $206,000 as married joint tax filers.

If you want to save more than IRA contribution limits allow, you may want to put money into a taxable brokerage account.

If you’ve maxed out your employer-sponsored retirement plan…

  • Traditional IRA: You can save and invest pretax money, earnings grow over time and you pay taxes on withdrawals in retirement. Contributions are limited to $6,000 in 2020 or $7,000 if you’re 50 or older.
  • Roth IRA: You can save and invest post-tax money, earnings grow tax-free and you pay no taxes on withdrawals in retirement. Contributions are limited to $6,000 in 2020 or $7,000 if you’re 50 or older.
  • Taxable account: You can purchase investments in a brokerage account.

If you have an employer-sponsored retirement plan and you’ve maxed it out, you have other retirement options – but there are restrictions.

You can put money into a traditional IRA, but if your adjusted gross income is higher than $75,000 as a single tax filer or $124,000 as a married couple filing jointly, you won’t be able to deduct the contributions. You can still contribute to an IRA, but it will be with post-tax money. You’ll need to keep good records, because you will only owe taxes on earnings – not your original contributions – in retirement.

A Roth IRA is also an option, but you must be eligible to contribute to a Roth. If your adjusted gross income is $139,000 or more as a single tax filer or $206,000 or more as a married couple filing jointly, you’re out of luck.

That leaves a taxable account, which isn’t a retirement account, per se, but you can certainly contribute retirement money to it and there’s no limit on contributions. If you hold investments for more than a year, you’ll owe long-term capital gains taxes – which are generally lower than normal income tax rates – on any gains when you sell.

If you’re self-employed or a small business owner…

  • SEP IRA: A retirement plan for a sole proprietor or small business owner allowing contributions of up to $57,000 in 2020 for yourself and for employees.
  • SIMPLE IRA: A retirement plan for small businesses allowing employee contributions up to $13,500 in 2020 and a mandatory employer match of 2% to 3% of employee compensation.
  • Solo 401(k): A retirement plan for a self-employed worker with no employees aside from their spouse allowing contributions up to $57,000 in 2020.

If you are a sole proprietor with no employees except for your spouse, a solo 401(k) gives you the most flexibility. The plan allows you to contribute up to the traditional 401(k) limit of $19,500 in 2020 (plus a catch-up contribution of $6,500 if you’re 50 or older), but it also allows an employer match (that’s also you) of up to 25% of your salary or net self-employment income. That said, if you also participate in an employer-sponsored 401(k) plan at a full-time job, your 401(k) contributions are limited to $19,500 (plus catch-up if applicable) across both accounts.

It’s also worth noting that some solo 401(k) plans now offer a Roth 401(k) option, meaning that you can save post-tax money to your 401(k) account up to contribution limits. There is no eligibility ceiling on a Roth 401(k).

As a sole proprietor, you can also choose a SEP IRA, but the contribution formula may limit what you can save. Each year you can save the lesser of 25% of employee compensation or $57,000 – or, if you’re calculating your own contributions, 20% of your net earnings from unemployment. If your net earnings are $50,000 a year, you’d be limited to a contribution of just $12,500.

If you have a few employees and you want to provide them with some retirement benefits, a SEP IRA allows you to do that. Employees themselves cannot contribute to the plan, but you (the employer) can make contributions. Note that if you make contributions to your SEP IRA, you must make the same percentage contribution to employee plans, and for all employees eligible for the plan, so this retirement plan is best for small businesses with few employees.

If you have fewer than 100 employees, a SIMPLE IRA allows your employees to contribute to their own accounts. SIMPLE IRA contribution limits are lower than a 401(k) plan at $13,500 in 2020, and employer contributions are mandatory, either matching up to 3% of employee pay or contributing 2% of employee pay up to a maximum salary of $285,000.

What else to consider when choosing a retirement account

Your age

The right plan for you will somewhat depend on your stage in life. If you’re younger, you may want to opt for a Roth-type account that allows after-tax savings and no taxes on withdrawals in retirement. If you’re older, you may want to take advantage of a plan that allows for heartier catch-up contributions.

How much you can contribute

Different retirement plans have varying contribution limits and formulas for determining how much you can save, and that’s important.

If you have a full-time job and make some extra money with a side gig, a solo 401(k) might allow you to put more away than a SEP IRA, which limits you to a percentage of compensation. And if you have a 401(k) plan at work, you’d likely choose to save pretax money there first – up to $19,500, or $26,000 with catch-up contributions – versus an IRA, which limits you to $6,000 or $7,000 with catch-up contributions.

Your tax bracket now – and later

If you’re in a low tax bracket and believe you’re likely to pay higher taxes in the future, a Roth account might be the best choice for you. However, if you’re paying high taxes, getting the tax break now by contributing to a traditional plan might be more valuable.

Even if you believe tax rates might be higher in the future, you might also believe that you’ll be in a lower tax bracket in retirement. In that case, saving pretax money allows you to take the tax break now, let your earnings grow over time and withdraw the money in retirement when you may qualify for a lower tax rate.

How to start a retirement plan

Once you’ve chosen the right retirement plan for you, the next step is to set it up and start contributing. If you’re dealing with an employer-sponsored plan, this might be as simple as completing your HR paperwork, selecting a contribution level and choosing investments. Some company 401(k) plans even enroll you automatically when you start your job.

If you’re opening an IRA or a self-employed retirement account, you must make more decisions:

  • Choose an investing style: Do you want to make all the investing decisions yourself, or do you want a little help from something like a robo-advisor? A robo-advisor will use algorithms to create a portfolio for you based on your answers to questions on goals, time horizon and risk tolerance, and fees are lower than full-service advisors – you might pay 0.25% of assets per year, for instance.
  • Choose a financial institution: Once you’ve decided a DIY-investing strategy versus robo-advisor, pick a financial institution that offers the type of account and the kind of investments you’re seeking – for most people, a brokerage offering low-cost mutual funds will be the best option.
  • Open an account: Follow the company’s directions on how to open an account. This may involve IRS paperwork (if you’re establishing a plan for your small business), or it may be as simple as providing your personal information and funding the initial deposit. Much of this can be done entirely online, although you may need to print forms and mail or fax them, depending on IRS requirements.

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