Navigating retirement can be overwhelming, especially figuring out the best way to save and weighing the pros and cons of the different retirement plans.
A recent GOBankingRates survey found that 47% of Americans are saving for retirement by using a 401(k) or other employer-based accounts. Based on these results, it is clear that utilizing a 401(k) plan is incredibly common across the U.S.
Benefits of a 401(k) Plan
A 401(k) is a retirement plan offered by employers that allows employees to decide how much they want to contribute to the account. There are both traditional 401(k) accounts and Roth 401(k) accounts. When employers offer a traditional 401(k), this allows contributions to be taken out of the employee’s paycheck before the income taxes are calculated. On the other hand, a Roth 401(k) account allows contributions to come out of the employee’s paycheck after income is taxed.
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“There are a lot of benefits to a 401(k) plan, including lowering your taxable income, letting your taxes grow deferred and getting an employer match to your contribution as part of the benefit plan,” said David Rosenstrock, director and founder of Wharton Wealth Planning. “401(k) (plans) also offer the easiest way to save for retirement.”
When looking for a job, determine whether your employer provides 401(k) contribution matching and how much you need to contribute in order to maximize the match. This type of savings account allows employees to save some of their pay toward retirement and enjoy an extra boost in their account from employers.
Disadvantages of a 401(k) Plan
While a 401(k) plan may be popular and has many tax advantages, the plan contains some drawbacks that are important to know before committing to this type of retirement account.
“Disadvantages associated with a 401(k) may include limited investment options, high-fee investment options and administrative fees, and not being able to access the money until (age) 59 1/2 without penalties for early withdrawals,” Rosenstrock said.
The withdrawal penalty for this type of account is 10% — a hefty price to pay if you need to make any withdrawals before age 59 1/2. Additionally, by age 72, you are obligated to make withdraws from the account, whether you need the money or not.
Other Retirement Plan Options
There are many retirement plans available, and it’s helpful to be aware of all of the options in order to figure out which plan works best for you. According to GOBankingRates’ survey, 22% of Americans are saving for retirement using an individual retirement account (IRA), 13% are using a Roth IRA and 24% are using an individual brokerage account.
Looking at this data, it is clear that IRA accounts are a widely used form of retirement savings. These types of accounts are great for people who do not have access to 401(k)s through employers.
If you’re thinking about retirement, it’s important to know what makes an IRA account unique from other retirement savings plans. A traditional IRA allows you to deduct contributions on your tax return, and you won’t have to pay capital gains taxes on investment returns.
A Roth IRA also allows for tax-free growth, although contributions to this type of account are made after taxes.
Like all retirement savings accounts, while investing in an IRA has many advantages, it also comes with some drawbacks. There are strict limitations on how much you can add to an IRA. The maximum contribution per person is $6,000 for 2022 ($7,000 if you are 50 or older). In order to contribute, you or your spouse needs to be earning income.
Similar to a 401(k) plan, a traditional IRA has a 10% penalty for any withdrawals before the age of 59 1/2. However, a Roth IRA allows contributors to withdraw a sum equal to their contributions tax- and penalty-free at any time.
Aside from an IRA, there are many other options available to self-employed individuals.
“ SEP and SIMPLE IRAs are similar to traditional IRAs,” Rosenstrock said. “As with traditional IRAs, your money grows on a tax-deferred basis as long as it stays inside the account. This option also allows you to select from a very wide range of investment options.”
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This article originally appeared on GOBankingRates.com: Retirement: Here’s How Nearly Half of Americans Are Saving