TYPES OF RETIREMENT PLANS
An individual retirement account (IRA) is a tax-advantaged investing tool that individuals use to earmark funds for retirement savings.
A Roth IRA is an individual retirement account (IRA) that allows qualified withdrawals on a tax-free basis provided certain conditions are satisfied. Established in 1997, it was named after William Roth, a former Delaware Senator.
A 401(k) plan is a tax-advantaged, defined-contribution retirement account offered by many employers to their employees. It is named after a section of the U.S. Internal Revenue Code. Workers can make contributions to their 401(k) accounts through automatic payroll withholding, and their employers can match some or all of those contributions. The investment earnings in a traditional 401(k) plan are not taxed until the employee withdraws that money, typically after retirement. In a Roth 401(k) plan, withdrawals can be tax-free.
A 403(b) plan is a retirement account for certain employees of public schools and tax-exempt organizations. Participants include teachers, school administrators, professors, government employees, nurses, doctors, and librarians. The 403(b) plan is in many ways similar to its better-known cousin, the 401(k) plan. Each offers employees a tax-advantaged way to save for retirement, but investment choices are often more limited in a 403(b), and 401(k)s serve private-sector employees.
A SIMPLE IRA is a retirement savings plan that most small businesses with 100 or fewer employees can use. “SIMPLE” stands for “Savings Incentive Match Plan for Employees,” and “IRA” stands for “Individual Retirement Account.” Employers can choose to make a non-elective contribution of 2% of the employee’s salary or a dollar-for-dollar matching contribution of the employee’s contributions to the plan up to 3% of their salary.
A simplified employee pension (SEP) IRA is a retirement savings plan established by employers—including self-employed people—for the benefit of their employees and themselves. Employers may make tax-deductible contributions on behalf of eligible employees to their SEP IRAs.
Payroll Deduction IRA
A payroll deduction plan refers to when an employer withholds money from an employee’s paycheck for a variety of purposes, but most commonly for benefits. Payroll deduction plans may be voluntary or involuntary. One common example of an involuntary payroll deduction plan is when an employer is required by law to withhold money for Social Security and Medicare. A voluntary payroll deduction plan happens when an employee opts for — and gives written permission to — an employer to withhold money for certain purposes, such as a retirement savings plan, healthcare, or life insurance premiums, among others.
Profit Sharing Plan
A profit-sharing plan is a retirement plan that gives employees a share in the profits of a company. Under this type of plan, also known as a deferred profit-sharing plan (DPSP), an employee receives a percentage of a company’s profits based on its quarterly or annual earnings. This is a great way for a business to give its employees a sense of ownership in the company, but there are typically restrictions as to when and how a person can withdraw these funds without penalties.
Defined Benefit Plan
A defined-benefit plan is an employer-sponsored retirement plan where employee benefits are computed using a formula that considers several factors, such as length of employment and salary history.1 The company is responsible for managing the plan’s investments and risk and will usually hire an outside investment manager to do this. Typically an employee cannot just withdraw funds as with a 401(k) plan. Rather they become eligible to take their benefit as a lifetime annuity or in some cases as a lump-sum at an age defined by the plan’s rules.
Money Purchase Plan
A money purchase pension plan is an employee retirement benefit plan that resembles a corporate profit-sharing program. It requires the employer to deposit a set percentage of the participating employee’s salary in the account every year. The employee is not permitted to contribute to the fund but may choose how to invest the money based on options offered by the employer.
An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company. ESOPs give the sponsoring company, the selling shareholder, and participants receive various tax benefits, making them qualified plans. Companies often use ESOPs as a corporate-finance strategy to align the interests of their employees with those of their shareholders.
Government Plans (please add 457)
Generally speaking, 457 plans are non-qualified, tax-advantaged, deferred compensation retirement plans offered by state governments, local governments, and some nonprofit employers. Eligible participants are able to make salary deferral contributions, depositing pre-tax money that is allowed to compound without being taxed until it is withdrawn.
TYPES OF ANNUITIES
These are fixed interest investments issued by insurance companies. They pay guaranteed rates of interest, typically higher than bank CDs, and you can defer income or draw income immediately. These are popular among retirees and pre-retirees who want a no-cost, modest, and guaranteed fixed investment.
These allow investors to choose from a basket of subaccounts (mutual funds). The account value is determined by the performance of the subaccounts, and a rider can be purchased to lock in a guaranteed income stream regardless of market performance — a key hedge if subaccounts perform poorly. These are popular among retirees and pre-retirees who want a shot at capital appreciation in tandem with guaranteed lifetime income.
These are essentially fixed annuities with a variable rate of interest that is added to your contract value if an underlying market index, such as the S& P 500, is positive. They typically offer a guaranteed minimum income benefit, and the chance of principal upside pegged to a market-based index. A drawback is that upside potential is limited by a so-called participation rate, caps or a spread — all methods in which your return in a rising stock market is trimmed. Consequently, buyers of these annuities never keep pace with a robust market. These appeal to retirees and pre-retirees who want to conservatively participate in potential market appreciation without fuss and with downside principal protection.
These are basically a mirror image of a life insurance policy. Instead of paying regular premiums to an insurer that makes a lump-sum payment upon death, the investor gives the insurer a lump sum in return for regular income payments until death, or for a specified period of time, typically starting one to 12 months after receipt of the investment. Payments are typically higher than other annuities because they include principal, as well as interest, and so also offer favorable tax treatment. These are popular among retirees and pre-retirees who need a higher-than-average stream of income and are comfortable sacrificing principal in exchange for higher lifelong income.
These delay payments until a future date (greater than one year). They enable people to increase their income stream later in life for less money because the insurance company is not on the hook as long when income payments are deferred. These appeal to people who want guaranteed income in the future, not now, or who want to create a ladder of income over different periods later in life. For example, they may want to work in retirement but know that eventually, they will stop working and, at that point, and not before, will need guaranteed income from an annuity.
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