Retirement Plan Types

Unless you’re a financial professional, you’ve probably found yourself confused about various types of retirement plans.

You're Not Alone.

 

It can be difficult to recall the differences between a Traditional IRA or 401(k). It’s easy to go months, or even years, without really thinking about the different types of retirement plans out there. With each paycheck, you may funnel a little money away into your plan, or perhaps sometimes you make an IRA contribution; but how often do you really consider the basic features of such plans? Below you’ll find some basic information about common retirement accounts, including a quick overview of their tax benefits, contribution levels and other defining features.1

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401(k) Retirement Plans

 
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IRA Retirement Plans

 

Retirement Plan FAQ's

 

Defined Contribution Plans

 

Participating in a 401(k) plan or other employer sponsored defined contribution plan is a common way many Americans save for retirement. With these plans, you contribute money deducted from each paycheck. Some employers even offer a matching contribution or profit sharing contribution on top of the money you contribute yourself.

Traditional plan contributions occur before taxes are paid. These contributions, once invested, can grow without incurring taxes until you withdraw them, at which point you’ll pay income tax on distributions. This is why these type of retirement plans are often called “tax advantaged” or “tax deferred.”

Defined Contribution Plan Contribution Limits (as of 2022)2

 

Contribution limits are the same for many employer sponsored defined contribution plans, but you may have special circumstances that allow you to contribute more or less. Most employer sponsored retirement plan administrators should automatically stop your contributions once you’ve reached the plan’s contribution limit for the year, however, the limits are still useful to know.

  • An annual contribution cap of $22,500 in 2022 for employees (plus any match from their employer)
  • Employees 50 and older are allowed to contribute an additional $7,500 per year in tax-deferred contributions for 2022, plus their company’s match.
  • Your employer’s contributions can combine with yours for no more than $66,000 per year, depending on the plan’s provisions
  •  If you are over 50, the contribution cap between you and your employer for applicable plans increases to $67,500

These limits are constantly changing because of new retirement legislation passed by congress or annual adjustments made by the Internal Revenue Service (IRS). If you have questions about your contribution limits, we recommend contacting your plan administrator or consulting the IRS website for the latest figures. 

Defined Contribution Plan Withdrawals and Distribution Restrictions3

 

Generally speaking, employer sponsored defined contribution plans are meant for retirement savings, therefore there are some restrictions on when you are able to withdrawal funds. If you withdraw funds before a certain age or the withdrawal isn’t for a distributable event specified by the plan, you may be subject to penalties.

  • You may pay a penalty for withdrawing funds before you turn 59.5 (though this can be as early as 55 if your employment is terminated by  the sponsoring employer, or as early as 50 for Public Safety Officers).
  • Under current law, you are most likely subject to Required Minimum Distributions (RMDs) after you turn 72, unless you are still working and do not own more than 5% of the business you work for.
  • Distributable events vary for different types of plans, and different types of contributions or accounts within those plans. The plan is not required to allow distributions for every possible distributable event. We recommend you consult your summary plan description or other disclosure documents to find out the allowable circumstances when you can request a distribution.

 

Required Minimum Distributions (RMDs)4

 

Under current law, The IRS requires you to withdraw a certain percent of your assets from tax-deferred accounts annually once you pass age 72, so the money can be taxed—known as required minimum distributions (RMDs). Otherwise, you will likely be penalized. Even with tax-deferred retirement plans, you must pay taxes at some point.

 

Vesting Periods

 

Employer sponsored retirement plans often come with a vesting period. If your company matches your contributions, the vesting period determines when their matching contributions actually become yours. Usually, this requires you to maintain active employment with the company for a predetermined length of time. If you leave before vesting period is over, the company might take back some or all of the matching funds and a relative percentage of your gains or losses. Many companies spell out the rules, including vesting schedules, for their retirement plans on their employee website or in employee handbooks, so it’s advisable to review those when you start contributing to avoid any unpleasant surprises later.

 

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Traditional IRA's

Unlike employer-sponsored retirement plans, an Individual Retirement Account (IRA) is set up b you—the individual. Traditional IRAs are tax-deferred retirement accounts so taxes are paid as ordinary income once the funds and earnings are withdrawn. They can also be used to hold investments that “roll over” from 401(k)s and other tax-deferred defined contribution plans when you leave your employer. 

Contributions to IRAs are sometimes tax deductible, but there are limits set by the IRS. You may not be able to deduct contributions once exceed a certain annual income threshold. Deducting IRA contributions can reduce current tax burdens while at the same time shielding money within the account from taxes as it grows.

 

Traditional IRA Contribution Limits (as of 2022)5

 

While there is no income limit for contributing to a traditional IRA, there are income limits for what contributions can be considered tax deductible.

  •  If you are under age 50, the annual contribution limit is $6,500.
    • The annual IRA contribution limit is $7,500 for those 50 and older.
    • The IRA contribution limit does not apply to rollover contributions or qualified reservist repayments.
  • Depending on your adjusted gross income (AGI) and filing status with the IRS, you may have stricter tax deductibility caps.6 We recommend consulting a tax adviser when determining how much you can deduct.
  • These limits are constantly changing because of new retirement legislation passed by congress or directives from the IRS. If you have questions about your contribution limits, we recommend consulting the IRS website for the latest figures or a financial professional.

Traditional IRA Withdrawal and Distribution Restrictions 7

 

There are restrictions on when you can withdraw funds from your IRA that you should pay attention to or it can cost you. In most cases, if you withdraw money before you turn 59.5, you are charged a 10% penalty, but there are few exceptions:

  • If you are terminated by your employer after age 55 and haven’t turned 59.5 yet, you can take penalty free withdrawals from your IRA.
  • You can also avoid withdrawal penalties if you use the funds for specific reasons outlined by the IRS—such as a first-time home purchase or medical expenses. We recommend you consult your tax adviser or financial professional if you have questions about whether or not you can withdrawal funds from your IRA penalty free.
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Roth Accounts

Roth accounts are another popular retirement account option some people are taking advantage of. The primary difference between Roth and Traditional is when you pay taxes on contributions. You make Roth contributions after you’ve paid taxes, unlike Traditional accounts where contributions haven’t been taxed yet. The money grows tax-free, then, when you are eligible to take the money, you pay no taxes on withdrawals as long as certain criteria are met.

Establishing a Roth IRA should be relatively easy. Most financial institutions that offer Traditional IRAs also offer Roth IRAs as well. You may contribute to both a Roth and Traditional IRA, but the IRS has more stipulations on what can be considered tax deductible and how much you can contribute. Its best to seek advice from your financial professional or tax adviser regarding contributions and withdrawals for IRAs.

Some defined contribution plans offer Roth options as well—such as a Roth 401(k) and Roth 403(b). Roth defined contribution plan contribution limits are generally higher than Roth IRA contribution limits, making them a great retirement savings option for people whose employers offer this plan. If you have questions about your retirement plan, please contact your plan administrator. They should be able to provide you with more details on your retirement plan options.

 

What’s Next?

 

Now that you have a basic introduction to the different types of retirement plans, you might be wondering which one is right for you. The fact is, your individual circumstances likely determine which accounts you can invest in. While most people can find a bank or brokerage firm where they can establish an IRA, employer plan sponsors decide what types of plans and investments  their employees can invest in. You might also find it useful to work with a tax professional, financial adviser and your retirement plan administrator all the same time.  

If you’re still struggling to decide which types of retirement plans provide the best way to save, consider working with Fisher Investments. We offer portfolio-management and access to financial-planning services designed to help qualified investors 8 create a clear path to their retirement goals.

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1The contents of this document should not be construed as tax advice. Please contact your tax professional.

2Source: Internal Revenue Service, Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits.

3Source: Internal Revenue Service, When Can a Retirement Plan Distribute Benefits?,https://www.irs.gov/retirement-plans/plan-participant-employee/when-can-a-retirement-plan-distribute-benefits.

4Source: Internal Revenue Service, Retirement Topics — Required Minimum Distributions (RMDs),https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds.

5Source: Internal Revenue Service, Retirement Topics - IRA Contribution Limits, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits.

6Source: Internal Revenue Service, 2022 IRA Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions If You ARE Covered by a Retirement Plan at Work, https://www.irs.gov/retirement-plans/plan-participant-employee/2022-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work 

7Source: Internal Revenue Service, Retirement Topics - Hardship Distributions, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions.

8Fisher Investments requires a minimum $500,000 investment.


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