Navigating Retirement Plans: Exploring Investment Options

Retirement plans are an important way to ensure financial security for the future. There are many different types of retirement plans, each with its own advantages and disadvantages. Some of the most common types of retirement plans include defined contribution plans, such as 401(k)s and IRAs, as well as employer-sponsored plans, such as 403(b) and 457(b) plans. When choosing a retirement plan, it is important to consider factors such as contribution limits, tax advantages, investment options, and whether there is an employer match. It is also important to start planning for retirement as early as possible to take advantage of the power of compounding and to ensure that you have enough saved for your retirement goals.

Defined contribution plans

There are two main types of defined contribution plans:

• 401(k) plans: These are the most common type of defined contribution plan and are offered by private companies. Employees can contribute to the plan with pre-tax wages, meaning contributions are not considered taxable income. The plan allows these contributions to grow tax-free until they are withdrawn at retirement. However, withdrawals before the age of 59 1/2 may be subject to taxes and additional penalties. The maximum employee contribution limit for a 401(k) plan is $23,000 in 2024 ($30,500 for those aged 50 and over).
• 403(b) plans: These plans are offered to employees of public schools, charities, some churches, and other nonprofit organizations. Similar to 401(k) plans, employees contribute pre-tax money, which grows tax-free until retirement. Withdrawals are treated as ordinary income, and early distributions before the age of 59 1/2 may result in additional taxes and penalties. The Roth 403(b) allows employees to save after-tax funds and withdraw them tax-free in retirement.

Other types of defined contribution plans include the 457(b) plan, which is available to employees of state and local governments and some tax-exempt organizations, and the Thrift Savings Plan (TSP), offered to federal government employees.

Individual retirement accounts (IRAs)

There are several types of IRAs, each with different rules regarding eligibility, taxation, and withdrawals:

• Traditional IRA: Contributions are typically tax-deductible, and taxes are paid on withdrawals during retirement.
• Roth IRA: Contributions are made with after-tax funds and are not tax-deductible, but earnings and withdrawals are tax-free.
• SEP IRA: Allows employers, typically small businesses or self-employed individuals, to make contributions to a traditional IRA established in the employee's name.
• SIMPLE IRA: Available to small businesses that do not have any other retirement savings plan. The SIMPLE IRA allows employer and employee contributions, with simpler, less costly administration and lower contribution limits.

The main advantages of IRAs are that they put you in control of your investment decisions and, depending on the type of IRA, you can decide how and when you get a tax break. IRAs usually provide a much wider range of investment choices than workplace retirement plans.

However, IRAs have lower annual contribution limits than most workplace retirement accounts. In 2024, the maximum amount that can be put into an IRA is $7,000, with an additional $1,000 allowed as a catch-up contribution for those aged 50 or older.

Spousal IRAs

A spousal IRA is a retirement savings strategy that allows a working spouse to contribute to an individual retirement account (IRA) in the name of a non-working spouse. Typically, an individual must have earned income to contribute to an IRA, but the spousal IRA is an exception, allowing a spouse with earned income to contribute on behalf of a spouse who doesn't work for pay.

There is no special "spousal" account type. Spousal IRAs are just a typical IRA, but used by a person who's married. That is, each spouse can use traditional or Roth IRAs, or both. The key is that the working spouse must earn at least as much money as is contributed to all of the couple’s IRAs.

For example, say one spouse is working, making $100,000 a year, and the other is not working. The working spouse can contribute to their own traditional IRA, up to the maximum, but they can also contribute up to the maximum to their partner's IRA.

Who owns the funds in the account?

The spouse whose name is on the IRA legally owns the funds in the account even if they were not the person who funded the account. The spousal exception simply defines how contributions can be made.

Contributing to a spousal IRA can provide important retirement savings for non-working spouses, who may not have access to a retirement plan through their own employer. Therefore, the intention behind spousal IRAs is to still provide retirement-saving opportunities for those who would otherwise not have them.

Additionally, contributions to a traditional IRA may be tax-deductible, while contributions to a Roth IRA are made with after-tax dollars but can provide tax-free withdrawals in retirement. Therefore, a spousal IRA (whether traditional or Roth) provides taxpayers with long-term tax benefits that impact current or future taxable income.

For 2024, the contribution limit is $7,000 per individual ($8,000 for those aged 50 or older). For 2023, the limit was $6,500 ($7,500 for those aged 50 or older).

How to open a spousal IRA

You can open an account at any online IRA broker or robo-advisor. Opening an account is easy: you'll need to provide some personal information, including the account holder's name, birth date, and Social Security number, but that's about it.

Annuities

Fixed vs. Variable Annuities

With fixed annuities, you know ahead of time how much you will receive once the insurer starts making payments. This is because the rate of return is fixed for a predetermined number of years or for life. Variable annuities, on the other hand, base your return on the performance of a basket of stock and bond products, called subaccounts, that you select. Variable annuities offer a bigger opportunity for growth but also come with more risk during recessions.

Immediate vs. Deferred Annuities

Immediate annuities provide regular payments right away, whereas deferred annuities are a more long-term tool. With deferred annuities, you pay in and then don't collect until a specified date in the future. During this time, your money can accrue interest (for fixed annuities) or benefit from market gains (for variable annuities).

Benefits of Annuities

• Income for Life: Annuities generally provide income that you can't outlive, making them a good supplement to Social Security.
• Deferred Distributions: Annuities offer tax-deferred status, meaning you don't have to pay taxes until you withdraw the funds, giving you some control over when you pay taxes.
• Guaranteed Rates: Fixed annuities offer a predictable income stream, as you know what your rate of return will be for a certain period.

Drawbacks of Annuities

There are several potential drawbacks to annuities:

• Hefty Fees: Annuities often come with high fees compared to other investment options, including upfront sales charges and annual expenses that can exceed 2%.
• Lack of Liquidity: Many annuities have a surrender fee if you try to withdraw within the first few years of the contract, which is typically a six- to eight-year period.
• Higher Tax Rates: Withdrawals from annuities are taxed as ordinary income, which can be higher than the capital gains tax rate.
• Complexity: Annuities can be complex and hard to understand, especially with the emergence of new and exotic variations.

Defined benefit plans

The employer is responsible for managing the plan's investments and assumes all the investment and planning risks. They typically hire an outside investment manager to oversee the plan. Employees usually need to work for a specific amount of time before becoming eligible to participate in the plan and there may be a waiting period after breaks in service.

The benefits in most defined benefit plans are protected by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC). Upon retirement, employees can receive their benefit as a fixed monthly payment (annuity) or, in some cases, as a lump sum. If the employee dies, their surviving spouse typically continues to receive benefits.

Due to the costs and risks involved, defined benefit plans are becoming less common, with only 17% of private sector workers having this option in 2018, compared to 83% in 1980.

Frequently asked questions