Nesting 101: Types of Retirement Savings Plans
Written by James Chan   


Choosing the right type of retirement savings plan for your specific needs is crucial to maximizing your nest egg. There are many options out there today; the 401k and IRA are always popular, but there are also other options like the stock purchase plan and “defined benefit” plans. Here’s a brief overview of some of the many options out there:


IRA: The Individual Retirement Arrangement, or IRA, is a managed investment plan, designed specifically for retirement savings. People with IRAs are allowed to make a limited amount of contributions per year, and will be able to withdraw money from the account once they reach age 59½ in most cases.

The advantage of an IRA is that deposits (except for Roth IRAs) and investment gains are tax free, but withdrawals (again, except in the case of Roth IRAs) are treated as ordinary taxable income. Furthermore, early or unqualified withdrawals are subject to a 10% tax penalty on top of normal taxes. IRA plans come in many different varieties; to read more, check out our section introducing IRAs.


401k Plans: These are company-sponsored plans that allow employees to elect to contribute a portion of their wages towards a retirement plan, which is managed by the employer. Like the IRA, deposits and capital gains are tax-free, while withdrawals are treated as ordinary income (except in the case of Roth IRAs, where deposits are made with post-tax dollars and withdrawals are tax-free). These plans can either be participant-directed (the employee decides on the investment options) or trustee-driven (the employer appoints people to decide investment options). For more information, check out our section on 401k plans.

Note: 403(a) plans are 401k plans for non-profits, and are managed the same way.


“Defined Benefit” Plans: This is the traditional pension plan, now mostly offered by the government and very old companies such as GM. Under this system, employees are promised a set monthly pension payment upon retirement based on a formula that includes the employees’ age, length of tenure, salary, and some other considerations. Payments are made out of a tax-deferred “pension fund”. Visit IRS - Pension and Annuities for further details.

While the employee doesn’t have to pay into the plan as with 401k plans or IRAs, he or she has to retire from the same company in order to receive the benefits. Since employees rarely stay within the same company for their whole careers anymore, this kind of plan has become increasingly rare.


Employee Stock Purchase Plan: Also known as stock options, this plan involves employers using a portion of their employees’ income to buy discounted stock for their company every six months, with the employees being able to sell that stock whenever they want to.

On the surface, it seems like a good deal: you’re buying stock for less than it is worth. However, there are a few risks and caveats: selling the stock makes you subject to capital-gains taxes (15% as of 2010), the value of the stock is dependent on the company’s performance, and you can be left extremely vulnerable if your company goes bankrupt- just look at Enron.



 
Last Updated on Wednesday, 22 December 2010 06:05