Glossary: Types of Retirement Plans
If you're planning your retirement, you're likely asking what the major types of retirement plans are. Continue reading to learn a bit about the major retirement plans.
401(k) Plan: This is a retirement plan where an employee defers part of their current income into a tax shelter where it grows tax-free until the employee withdraws it. The employer has the discretion to match the employee's contributions. Annual contributions of employer and employee are limited to 25 percent of the employee's salary or $30,000. The employee may not contribute more than $22,500 on their own. The plan allows an employee to save for retirement and simultaneously reduce their current income tax bill. Employees are often allowed to make decisions as to the investment of these funds.
Defined Benefit Pension Plan: This is a traditional pension plan that pays workers a specific monthly benefit at retirement. To be eligible, the employee must have worked at the company providing the pension for a set period of time. These plans either state the promised benefit as an exact dollar amount or specify a formula for calculating the benefit. Generally, a company funds the pension plan, and a professional money manager invests the assets of the fund. After retirement, the employee receives a set amount of money monthly.
Individual Retirement Account (Traditional): This is not a qualified retirement plan; it is described under a different section of the Tax Code. An IRA is established by an individual, not a company. Under this plan, an individual can contribute the following:
- If you're under the age of 50, the total that you can contribute is $7,500.
- If you're over the age of 50, the total that you can contribute is $6,500.
If an individual is not eligible to participate in a pension, profit sharing, or 401(k) plan at work, the contributions to the IRA are deductible irrespective of the person's income. If the individual is covered by a company retirement plan, their rights to the IRA deduction may be limited. Traditional IRA earnings are taxed when they are withdrawn.
Keogh Plan: This is a qualified retirement plan for self-employed individuals. Contributions to this plan are tax-deferred. With higher upkeep costs and higher administrative burdens, these plans entail contribution limits that are much higher than simplified employee pension plans. Employees can contribute 25% of their pretax income. As of 2022, employees can contribute up to $61,000. If, however, it is your only retirement plan, you can contribute 100% of your pre-tax income.
The individual can direct the investment of the funds that are put into a Keogh, such as with stocks, bonds, or mutual funds.
Qualified Retirement Plan: A qualified plan is one that is described in Section 401(a) of the Tax Code. A qualified retirement plan is established by a business. The most common types of plans are:
- Defined benefit plans
- Defined contribution plans
Your contributions to a qualified plan are not taxed until you withdraw the money. In addition, any contributions made to the plan on your behalf by your employer are tax deductible.
Roth Individual Retirement Account: This is similar to the traditional IRA except the contributions to a Roth IRA are nondeductible. When you withdraw money from a Roth IRA in retirement, it will be tax-free. You can leave amounts in your Roth IRA for your lifetime.
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