The Best Type Of Retirement Plan To Have If You Want To Retire Early

There used to be a time when pension and social security benefits were enough for sustainability after retirement, but today, the story is a different one. Without a solid retirement plan, most persons suffer penury in their old age. Hence saving money for the days ahead retirement is the best form of investment any individual can engage in. 

Although, many people think the best time to start saving for retirement is when you are close to the retirement age, this is not true. Saving for your retirement should be a conscious decision you make from the youthful age. Planning your retirement early would help secure the remaining days of your life. With a good retirement plan, your money continues to grow and you reap a better peace of mind and good health after retirement. 

What Is A Retirement Plan?

This is a special kind of mutual fund that automatically spread your money across stocks and bonds. Retirement plans are accounts managed with the goal of providing you with the ability to produce a monthly income that is distributed to you. 

The goals of mutual funds often vary. Sometime to achieve an objective of producing higher monthly income, mutual funds would use part of its principal, at other times, mutual funds aim for a lower monthly income so as to save their principal. In such a situation, you can access your money at any time. However, withdrawing your principal would affect your monthly income.

As important as retirement is to the future, not all employees understand the benefit of having a retirement plan. According to a January 2019 studies carried out by the Employee Benefit Research Institute, only half of the current employees in America understand the benefits of retirement.

Benefits Of Having A Retirement Plan

Virtually all retirement plan offers tax-free benefits irrespective of whether the retirement plan is upfront during the saving phase or it is when the person is taking a withdrawal. Take, for instance, 401(k) retirement plan made it possible for investors to save with pre-tax dollars, the advantage of this is that taxable income is reduced. However, unlike a 401(k) plan, Roth IRA is funded with the after-tax dollar but withdrawal is generally tax-free.

Some retirement plans allow matching of contributions from your employer while others do not. A good example of retirement plans that allows matching of contributions is the 401(k) plan. This is why, when trying to choose between an individual retirement account (IRA) and a 401(k) account, it is advisable to go with a 401(k) plan if you can get a company match or better still you choose both if you can afford it.

If your company automatically enrolled you to a 401(k) account, check to ensure you are taking full advantage of the company's match. Also, consider increasing your monthly contribution to the account. This is because, most times, retirement plans start with a paltry deferral level not even enough to guarantee retirement security. According to a report by Vanguard, about half of 401(k) that operates automatic enrollment makes operate a deferral rate of just 3 percent. However,  T. Rowe Price maintained that to achieve a solid retirement plan, you should “aim to save at least 15 percent of your income each year.”

The retirement plan is not only limited to those working in a company or under an employer, but it also cut across to the self-employed. If you are self-employed, there are lots of retirement plans you can choose from. You can also choose between starting a retirement plan in a Roth IRA or a traditional IRA account. Below are the best retirement plans you can consider.

1) Defined Contributions Plans

This retirement plan was introduced in the early 1980s but today, about 84 percent of Fortune 500 companies operate DC plans as a replacement for the well known traditional pension. DC plans include the 401(k), 403(b) and 457(b) retirement plans.

DC 401(k) plans is the most popular among employers of all calibers while their 403(b) plans are available for employees of some specific tax-exempt companies and workers in public schools. Added to this DC plans offer 457 plans which are common among both state and local governments. 

Also, most DC plans operate a Roth version. The contribution method for the Roth version is after-tax, after which the money can be withdrawn tax-free at retirement.

In 2020, the minimum contributions to each plan are $19,500, and $26,000 for those above the age of 50years.

• 401(k) Plans

This is a tax advantage plan that gives both employees and employers the opportunity to save for retirement. Contributions to the plan are regarded as pre-tax wages, hence, they are generally not taxed. The 401(k) plan allows the contributions to grow at a tax-free advantage until the time of withdrawal. However, any withdrawal made before the age of 59½ is subjected to taxes and penalties.

Pros: 401(k) plan is one of the easiest ways to save for retirement, this is because you can easily schedule the money to come out of your paycheck and be automatically paid into your 401(k) account.

Also, the money in your 401(k) plan can be invested in some high paying investment such as stocks. The beauty of this investment opportunity is that 401(k) enables you to be exempted from tax on gains until withdrawal time.

Additionally, 401(k) retirement plans give room for matching contributions. This allows you to benefits from gains and gets more money just for saving.

Cons: one major disadvantage of the 401(k) plan is that money cannot be withdrawn for an emergency. If such should happen, the withdrawal would be subjected to tax and other penalties.

Also, while other types of investment funds might allow you to take some loans from the contributions, this is not guaranteed with a 401(k) plan.

Your investment cannot exceed the ones stipulated by your employer, hence you are restricted in your choice of investment.

However, a 401(k) plan is a very effective way to save for retirement. With the additional matching contribution, you make more money and your income grows quickly.

• 403(B) Plan

A 403 (B) retirement plan very similar to a 401(k) plan. The only difference is that it is only available to public schools, churches and charity organizations. Like the 401(k) plan, contributions are pre-tax and no withdrawal is allowed until retirement or from age 59½.

Pros: like the 401(k) plan, you can also schedule your contributions to your 403(b) account to be withdrawn automatically from a paycheck. This would ensure that you save more effectively.

Also, the money can be invested in different investment opportunities including an annuity. You also won't have to pay any tax on the gain until the time of withdrawal 

It also offers matching contributions to allow you to earn more from your employer.

Cons: limited investment choice. Your choice of investment is restricted to the choices made by your employer.

You can't assess the money until retirement or above the age of 59½.

• 457(B) Plans

This is very similar to the 401(k) and the 403(b) plan, the only difference is that this is only available for workers in the state and local government and also some tax-exempt companies. The contributions into the 457(b) plan are generally tax-exempt. That is it is paid with pre-tax wages. Contributions to the account are allowed to grow until time for withdrawal.

Pros: the 457(b) is another effective way to save for retirement as it also offers tax-exempt retirement benefits. However, unlike 401(k) and 403(b), 457(b) offers some benefits to older workers and it is generally considered as a supplementary account.  As a result of this, there is no tax payment or penalty for withdrawal made before the stipulated age 59½ in other plans.

Cons: 457(b) plans do not offer an employer's match as prevalent in other plans. This made it less appealing than 401(k). 

Also, despite offering the opportunity to withdraw before the age of 59½, it is more difficult to withdraw from a 457(b) plan than it is in other plans like the 401(k) and 403(b) plans.

2) IRA Retirement Plans

IRA retirement plans are a series of retirement plans brought to the place by the United States government to enable workers to save ahead of their retirement period. There are various types of IRA retirement plans, however, in this article, these seven would be our focus: traditional IRA, Roth IRA, rollover IRA, spousal IRA, SIMPLE IRA and, SEP IRA. 

• Traditional IRA

This is one of the most popular retirement plans. A traditional IRA is a tax-advantaged retirement plan that allows you to save a significant tax-free amount for your retirement. With traditional IRA, contributions are made with pre-tax dollars. This implies that all contributions to the account are not taxable until the time of withdrawal. While tax payment on money is only when you want to withdraw the money, earlier withdrawal before the retirement age is subjected to tax and penalty.

Pros: traditional IRA is one of the best accounts to operate for retirement because of its tax-free advantage.

The account also allows you to invest your money in stocks and other available investments. It offers an almost limitless number of investments - stocks, securities, bonds, real estate, CDs and other things.

The greatest benefits of the account are that irrespective of the investment you choose to make and the gain you make, no tax would be placed on gains. Your money continues to grow until the time of withdrawal.

Cons: money in a traditional IRA is difficult to withdraw before the stipulated 59½ retirement age. Any withdrawal before this age is subjected to additional taxes and penalties.

Traditional IRA does not suggest the investment opportunities to you. You make the choice of the type of investments you want to make yourself. The choice of whether to invest in stocks or bonds or other kinds of securities is solely your decision. 

• Roth IRA

This is a subdivision of the traditional IRA but offers more opportunities than the traditional IRA. The first most important thing to note about the Roth IRA is that contributions to the account are made with after-tax money, that is, tax on the money would be paid before the contribution is made. But in exchange for after-tax money, you won't have to pay tax on your overall money when it's time to withdraw. No tax would be charged on contributions and earnings.

Pros: the first important advantage of the Roth IRA is that no tax is paid on all your income when it is time to withdraw the money. However, to avoid additional penalties, you can only withdraw from age 59½ and above. 

The account allows some flexibility. Hence, you can withdraw from your contributions at any time but you cannot withdraw from your earnings until age 59½.

Cons: as seen in the traditional IRA, in Roth IRA, you would be in full charge of your money including the various types of investments you would like to get started with.

Also in the Roth IRA, there is a limit to the contributions you can make, however, there is a back door saving account that can be used to evade this.

• Spousal IRA

Basically, IRA is made available for workers to save for their retirement. Spousal IRA is strictly for a spouse who is working and wants to open a retirement account on behalf of his or her spouse who is not working. The condition attached to this is that the working spouse taxable income must be more than the contributions made to an IRA account. Spousal IRA can either be a traditional IRA or a Roth IRA account.

Pros: the most significant benefit of the Spousal account is that it allows the non-working spouse to enjoy all the benefits attached to the IRA account either the traditional or the Roth account.

Cons: no specific downside to a Spousal account except that you would have to take responsibility for any of the available investment you want to engage in.

• Rollover IRA

A Rollover IRA account is created when a retirement account such as 401(k) or any of the IRA account is converted into a new IRA account. When this happens the money in the previous account is rolled to the new account. The account owner then becomes eligible for all the benefits attached to the new IRA accounts. The new IRA account can either be a traditional IRA account or a Roth IRA. 

Rollover IRA can be established in any institution that permits you to operate it. The rollover account could be from a traditional account to a Roth IRA or from other types of retirement accounts. However, it is necessary to be cautious of how the money is being transferred to avoid incurring tax during transfer. 

Pros: a rollover account makes you eligible for attractive tax benefits. Whatever might be the reason you are leaving a former retirement account to the new IRA, you would be eligible for the tax benefits attached to IRA accounts. 

Also, you would be eligible for the numerous choices of investments.

Cons: the major challenge with a rollover IRA is the tax that might come up when making the transfer but this can be avoided if you are very careful. 

Also like all IRA account, you have to be very careful with how you invest your money. 

• SEP IRA 

This is very similar to the traditional IRA but works for small businesses. In the SEP IRA, only the employer can contribute to the account. Also, all contributions are remitted to the SEP IRA and not to a trust fund like the other IRA accounts. The account is basically for small business owners and self-employed individuals.

The limit of contributions to the account in 2020 is 25 percent of compensation or $57,000 depending on the lesser one. For self-employed individuals, sorting out their contribution limit is a little bit difficult.

Pros: this is a freebie account for employees. Also, the high contribution rate makes it a go-to for many self-employed individuals.

Cons: there is no stipulated amount of money employees can make from the plan.

• SIMPLE IRA

This simply bypasses most of the requirements found in 401(k) and other retirement accounts because virtually all the accounts operate the same benefits. Hence, in SIMPLE IRA, employers are given the choice to choose between contributing a 3% match or make a 2% non-elective contribution.

Pros: basically, a SIMPLE IRA is designed to create a match, as a result, it provides workers with the opportunity to make pre-tax salary and to receive a matching contribution. 

Cons: As at 2020, the contribution limit for the plan is $13,500 in comparison to other plans that allow a contribution limit of $19,500. Although most people don't contribute this much.

3) Solo 401(K) Plan

This retirement plan is popularly referred to as a Solo-k, One-participant K or Uni-k. The plan is basically for the business owner and his or her spouse. It is similar to but different from a spousal IRA. The account is run by both the husband and the wife, one of which must be a business owner.

Because employer and employee is the business owner, the account allows elective deferrals of up to $19,500 and up to 25 percent of compensation up to a total annual contribution of $57,000 for non-elective contribution for incorporated businesses. This is excluding catch-up contributions. The contribution limit for unincorporated businesses is 20 percent.

Pros: if you manage the business alone and does not have any employees, operating a solo account is better than a SIMPLE IRA. This is basically because you can contribute more money to the account.

Cons: the Solo-k account is a little bit technical to operate. Also when your assets exceed $250,000, you will be required to file an annual report on Form 5500-SE.