Retirement Account Types and Their Differences

There are many different retirement account types and some combinations of types. Annuities, IRA's, 401K, Pensions, and so on. You may have more than one type in your portfolio or benefit plans.

On this page, you'll find just a brief description of some of the more common types. You should consult your financial advisor or benefits office at work to get specific details about your account types.

Annuities

Annuities are insurance products. You pay insurance premiums in exchange for a regular income at a future date. The premiums can be paid over time like a savings account deposit or in one lump sum.

Here is an example of a "period certain" annuity:

When you are ready to retire early at age 55, you convert $300,000 of your savings to an annuity that pays you around $2900 per month for 10 years.

At the end of 10 years, you will be close to "full retirement age" and your income source will be Social Security instead. (You exchanged the $300,000 for 10 years of paychecks.)

If you calculate the sum of your income, you find that your $300K was actually worth $348,000.

Instead, if you had put the $300,000 in a savings account and withdrew from it each month you would only have covered just over 8.5 years. (Not a good idea because you would also need to consider the tax obligations if you take the $300k from a retirement account.)

A good alternative is to keep the $300,000 invested in your 401(k) and withdraw a fixed amount each month. Invested correctly, you could end up with more in total than the $348,000 in annuity payments.

It depends on how you feel about a guaranteed income versus moderate risk of your keeping money invested in the financial markets.

Personal Pension

Annuities can be used to create your own personal pension by purchasing an annuity that pays you for life. It can also be setup to provide benefits to a spouse or even a death benefit to your heirs.

There can be many scenarios and types of annuities, so consult an expert for specific details and advice. And shop around for the best deal! Be sure to check with an objective advisor who can speak to pros and cons of annuities versus other investments, as well.

Retirement Account Types: 401K

Many employers offer the option of contributing to a 401k retirement savings account. Sometimes you will need to wait some amount of time after you start working for the company before you will be eligible to enroll, but you should make sure you enroll when you can.

You will designate either a percentage of your pay or a specific amount which will be deducted before taxes are withheld. This means you won't pay taxes on the money you contribute. Because of this, your true actual cost of the contribution is less than the amount you designate to contribute.

Let's say your take home pay is usually $500 and you decide to contribute $100 to your retirement account. You paycheck will still be more than $400 because the $100 comes out before taxes are calculated, and because your net pay is less, the taxes that are deducted will be lower.

Did you know that even the self-employed, independent contractors, and small businesses can have a 401k?

Get Free Money

On top of this "tax discount", your employer may offer a matching contribution. If we assume your $100 contribution is 6 percent of your pay for the period and your employer offers a 50 percent match, your contribution plus your employers match would be $150. If your paycheck was only reduced by $90, you end up with $60 in free money. You are in effect "buying" $150 for $90.

Who would pass up a deal like that?! Some employers match dollar for dollar, so for every $100 you put into your retirement account, your employer will put in $100. This time, you'll be buying $200 for $90 (for example). That's a great benefit!

One thing about the match to be aware of: there is almost always a vesting schedule attached to the match. This means you only get to keep the matching funds if you work for the company for so many years, for example 3 years. Once you are fully vested, all of the match becomes 100 percent yours, for keeps.

Note: some of the terms in the above examples will vary, so you need to check into your employer's specific plan details to find out if there is a match and how it works.

Go here for details on using your 401k for early retirement.

401K Rules To Know

If you are thinking about withdrawing 401k money, you will need to know the rules. This section is from the retirement section of the IRS website:

All 401k withdrawals are subject to tax withholding, and before age 59 1/2 you will pay an additional penalty for early withdrawals, except as shown below.

Key points

You can begin withdrawing without a penalty from your 401k account at age 59 1/2.

But, you will not owe the 10% penalty if you quit your job in the year you become age 55 or later and take withdrawals (early retirement), as described in the IRS exceptions for withdrawals shown here, from the irs.gov website:


See this article at IRS.gov - on early retirement taxes and various retirement account types.
excerpt from IRS.gov



Retirement Account Types: IRA

What You Can Do with an IRA: Non-traditional retirement account types

An IRA is one of the retirement account types that is not usually funded through your employer. If your employer doesn't offer retirement savings accounts such as 401k, this is the way to setup your own retirement account and still get tax benefits.

If you change jobs you may need or want to rollover the 401k account to an IRA. Over the years, you may need to roll over more than one account.

There are lots of choices of financial services companies where you can place your IRA. A few examples include Vanguard, Fidelity, TIAA-CREF, Wells Fargo, and many others.

Besides investing in stocks, bonds, and mutual funds, it is possible to have more direct control over the investments in your IRA.

Do you need to know more about investing? If so, check out this page, What are Mutual Funds

See this page for more details about IRA accounts and more information about rules on IRA withdrawals.

Self-Directed IRA

By setting up a self-directed IRA, you can invest in real estate properties or business ventures. There are rules about who can and cannot be involved with these investments, but for some of the more adventurous people this feature can be much more profitable (but possibly more risky) than traditional investments. Using a self-directed IRA, it is possible to invest in a business, for example, or purchase a rental property.

I suggest not using all of one's assets this way, but it could be fine for a small portion of the whole. Consult a specialist in self-directed IRAs to be sure all the IRS requirements are met.

Retirement Account Types: Pensions

A pension is one of the retirement account types that is offered by some employers for workers who stay with the company for many years. This type of account is becoming more rare, but some of the older companies may still offer them. AT&T is one example of a company that still offers pensions.

Typically, pensions are "annuitized" or setup similarly to annuities where the monthly benefit is based on the value of the account, age of retirement, life expectancy, etc.

Some pension plans allow for either a lump sum distribution or a set amount per month for life. For married persons, the spouse may be able to continue to receive benefits after the death of the original pensioner. Usually, to provide this benefit the monthly payout is reduced by some amount.

If your employer didn't or doesn't offer a pension plan or pension benefit, you can create your own by purchasing an annuity using your savings.

If the security of a paycheck for life is important to you, this could be the way to go.

You won't need to spend time managing investments or worrying about what the stock market is doing, and this could be an attractive benefit, especially when markets are volatile or during a down period.

Which retirement account types will you use for your future retirement income?


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