Understanding Retirement Accounts

When it comes to planning for retirement, there are a variety of savings vehicles to help you save for the future. Each type of retirement account offers its own set of benefits, tax advantages, and eligibility requirements. Whether you are just starting your career or nearing retirement, it’s important to understand the differences between the most common retirement accounts available.

Traditional IRA

A Traditional IRA is one of the most common retirement savings accounts. Contributions are typically tax-deductible, which means you can lower your taxable income in the year you make the contribution. Your investments grow tax-deferred until you withdraw them in retirement, at which point they are taxed as ordinary income.

  • Contribution Limits:
    • 2024 & 2025: $7,000 for individuals; additional $1,000 catch-up contribution for those 50 or older.
  • Tax Benefits: If you don’t have a retirement plan at work, your traditional IRA contributions are fully deductible. But if you (or your spouse, if you are married) have a retirement plan at work, such as a 401(k) or 403(b), your modified adjusted gross income (MAGI) determines whether and how much of your traditional IRA contributions can be deducted. Growth of a traditional IRA is tax-deferred.
  • Withdrawals: Withdrawals are taxed as regular income based on your tax bracket in the year of the withdrawal. After reaching age 59½, you can access funds without penalties or restrictions (there is a 10% penalty for withdrawals taken prior to age 59½). Required minimum distributions (RMDs) begin at age 73 if you were born before 1960 and 75 if you were born after 1960.
  • Deadline: You can make an IRA contribution for a given year anytime between January 1 and the tax-filing deadline of the following year.

Roth IRA

A Roth IRA is a retirement account funded with after-tax dollars, meaning you don’t get a tax deduction upfront. However, when you withdraw funds in retirement, the withdrawals are completely tax-free, as long as you are 59½ or older and have held the account for at least five years.

  • Contribution Limits: 
  • Tax Benefits: Contributions aren’t tax-deductible, but withdrawals are tax-free in retirement.
  • Withdrawals: After 59½, withdrawals are completely tax-free, and there are no required minimum distributions.
  • Eligibility: Income limits apply for Roth IRAs. The phase-out range for single filers is $146,000 to $161,000 for 2024 ($150,000 to $165,000 for 2025). For married couples filing joint returns, the phase-out range is $230,000 to $240,000 in 2024 ($236,000 to $246,000 in 2025).
  • Deadline: You can make a Roth IRA contribution for a given year anytime between January 1 and the tax-filing deadline of the following year.
  • Note: Parents or other adults can open custodial Roth IRAs for children. Minors can contribute the lesser of $7,000 in tax years 2024/2025 or the total amount of money earned during the year.

SEP IRA (Simplified Employee Pension)

A SEP IRA is designed for self-employed individuals, small business owners, or freelancers who want to make larger contributions to their retirement savings.

  • Contribution limits
    • 2024: Up to 25% of income, up to $69,000.
    • 2025: Up to 25% of income, up to $70,000.
  • Tax benefits: Contributions are tax-deductible, and growth is tax-deferred.
  • Withdrawals: Distributions before age 59 ½ are taxed as income and subject to a 10% penalty. Distributions taken after age 59 ½ are taxed as income and SEP IRAs require minimum distributions.
  • Deadline: Employers must contribute to a SEP IRA by the tax filing deadline, which is usually April 15th. If the employer has filed an extension, then the final SEP IRA contribution date is the extension deadline, which is usually October 15th.
  • Note: If you have employees whom the IRS considers eligible participants in your plan, you must contribute on their behalf, and those contributions must be an equal percentage of compensation to your own.

SIMPLE IRA (Savings Incentive Match Plan for Employees)

The SIMPLE IRA is a good option for small businesses. It allows employees to contribute and the employer is required to make contributions as well.

  • Contribution limits:
    • 2024: $16,000 for employees under 50; additional $3,000 catch-up contribution for those 50 or older.
    • 2025: $16,500 for employees under 50, but because of the SECURE 2.0 act, individuals can contribute $17,600 for 2025; additional $3,850 catch-up contribution for those 50-60 year old or 64 or older. For those aged between 60-63 is the catch-up amount of $5,250, for an overall total of $22,850.
  • Tax benefits: Employee contributions are tax-deductible. Employer contributions are tax-deductible as well.
  • Withdrawals: Distributions before age 59 ½ are taxed as income and subject to a 10% penalty. Distributions taken after age 59 ½ are taxed as income and SIMPLE IRAs require minimum distributions.
  • Deadline: Contributions to SIMPLE IRA plans that are taken from an employee’s paycheck as a salary-reduction contribution are due within 30 days of the month in which the deferred payments were made.  Contributions made on the part of the employer are due by the business’ filing due date for the tax year—usually April 15, or Oct. 15 if there is an extension.

401(k) Plan

The 401(k) is one of the most popular employer-sponsored retirement plans. Both employees and employers can contribute to a 401(k), with employers often offering matching contributions. There are two primary types: Traditional 401(k) and Roth 401(k).

  • Employer match: Employers often match employee contributions up to a certain percentage.
  • Contribution limits:
    • 2024: $23,000 for employees under 50, $69,000 for the combined employee and employer contributions. Employees 50 or older eligible for an additional $7,500 in catch-up contributions, raising the employee deferral limit to $30,500.
    • 2025: 23,500 for employees under 50, and $70,000 for the combined employee and employer contributions. Employees age 50 to 59 or 64 or older, are eligible for an additional $7,500 in catch-up contributions. Employees ages 60 to 63 are eligible to contribute up to $11,250 as a catch-up contribution
  • Tax benefits: Pre-tax contributions for Traditional 401(k) are tax deductible and grow tax-deferred; Post-tax contributions to Roth 401(k)s are not tax deductible.
  • Withdrawal: Traditional 401(k)s follow the same withdrawal rules as traditional IRAs and Roth 401(k)s follow the same rules as Roth IRAs.

403(b) Plan

The 403(b) is similar to the 401(k), but it is available to employees of public schools, college and universities, and nonprofit organizations, and certain other tax-exempt entities. The contribution limits and tax treatment are the same as a 401(k), but the investment options in a 403(b) are typically more limited than a 401(k) or IRA.

457(b) Plan

The 457(b) plan is designed for state and local government employees, as well as certain nonprofit employees. It allows participants to defer a portion of their salary, with tax-deferred growth. Unlike 403(b) and 401(k)s, you can withdraw funds from your 457(b) before age 59½ penalty-free if you’re no longer employed by the plan sponsor. But you will still owe income tax on any withdrawals.

TSP (Thrift Savings Plan)

The TSP is a retirement plan specifically for federal employees and members of the uniformed services. It functions similarly to a 401(k), offering both Traditional and Roth options.

When planning for retirement, it is important to take advantage of the available retirement accounts that best suit your financial goals. If you’re unsure which retirement accounts are right for you, Meridian is here to help guide you through the best option for your unique financial situation.

woman at desk holding a dog

Helping special guest Pheobe (Nathan’s Frenchie) think through her retirement options!

 

Categories : Financial Planning

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