Everything you need to know about retirement savings in America
Published on April 21, 2021 / Updated on November 7, 2022
Because retirement is the biggest savings investment of your life, I want to make sure you have all the tools you need to sip pina coladas on a tropical beach after you make the decision to retire.
In this guide, you’ll learn about the types of retirement plans and how to determine which retirement options are right for you.
If the number of options out there gives you choice paralysis, don’t fret. Below you’ll learn about the different types of retirement plans for both employees and freelancers so that you can determine which one is right for your lifestyle.
First things first, there’s a ton of bureaucracy and complexity surrounding retirement savings in America, so first let me explain some US English vocabulary words you should get acquainted with:
Quick note on pension vs retirement: in UK English, the equivalent of the US term “retirement” is “pension”. The basic concepts are more or less the same, but the policies around them are different due to different legal regulations. Because this article covers US policies, I will use the term “retirement” for consistency.
The US gives you multiple choices for retirement funds. However, many of them are only available for US citizens or people who are registered to work in the US and have taxable income there due to having a Social Security Number. To find out which types of retirement funds you’re eligible for, contact your bank or financial institution for further information.
A 401K is for W-2 employees only and it’s the only way to get it. This plan is great because it’s tax-deductible. It’s additionally beneficial because most companies match it, meaning whatever you pay, your employer also pays.
Say for example they match 3% – that’s double your savings, which is free money (and who doesn’t like free money!?) The most you can save per year is $19,000 and if you’re 50 years or older, you can save an extra $6,500 a year.
There are two types of IRA options for employees, the first being a Roth IRA. A Roth IRA is for anyone, and you can open one if you make less than $140,000 per year. Each year you’re allowed to contribute up to $6,000.
For example, if you began contributing to your Roth IRA in January of this year, then you’d have until the end of this year plus up until taxes are due to contribute that $6,000 (basically a year and 4 months). Roth IRA options allow you to pay tax on your savings now so you don’t have to when you’re retired.
A traditional IRA is the other kind of IRA. The basic difference is that with this plan, you choose to pay the taxes when you retire and not now.
Next up is the SEP IRA, which is for self-employed individuals. With the SEP IRA, you can invest up to 25% of your net self-employment earnings or $58,000 per year (whichever one comes first) and it’s taxed like a traditional IRA – you only pay taxes when you retire.
Another secret most people don’t know is that if you’re an employer with a 401K and you have a side hustle, you can also obtain a SEP IRA, which doubles the amount you can save!
Lastly, there’s the Solo 401K which is similar to a traditional IRA but instead of a company sponsoring you, you sponsor yourself. So, you guessed it, this one’s for those who are self-employed. The maximum amount you can save per year is $19,000.
Aside from the typical plans mentioned above, there’s also Profit-Sharing Plans (PSP) which is a type of retirement savings in which you can receive a percentage of a company’s profits based on its earnings per year. Similarly, an Employee Stock Ownership Plan (ESOP) is a retirement plan that allows you to invest in the stock of your company.
Raise your hand if you’ve thought about the lifestyle you want to live during retirement. If your hand isn’t raised, ponder these questions to get a better idea:
Now that you’ve reflected, keep your answers in mind as we go through some different components to the plans mentioned earlier.
Your income largely determines which plan is best suited for you based on tax benefits. If you have a high income, you might benefit more from pre-tax contributions like the Roth IRA. If you’re on the opposite end, then a traditional IRA might be more beneficial to you.
Let’s chat further about free money. One of the appeals of being an employee is having your company match your contributions. A company will match either dollar-for-dollar or by percentage to what you’re contributing.
If you’re investing 4% of your monthly paycheck and they vow to match that by 100%, that’s double your savings. Every company has different regulations for this so consider this when you negotiate your employment contract.
If you’re in pursuit of the FIRE (financial independence retire early) movement, or maybe you love living in luxury, these individual lifestyle choices play a huge factor moving forward with retirement planning. It’s also worthwhile to consider the quality of life you’d like your family to maintain now versus in the future, as well as what you’d like your children to inherit.