Everything you need to know about retirement savings in America

by Adriana Stein
April 21, 2021
Everything you need to know about retirement savings in America

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.

All about retirement savings in America

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. 

Important US English vocab related to retirement accounts

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: 

  • Roth IRA (Individual Retirement Account): Those who make less than $140,000 per year can open this type of plan and contributions are taxed as income
  • Traditional IRA: A plan set up by a financial institution like a bank where taxes don’t need to be paid until the money is taken out
  • 401K: A retirement plan for employees that don’t require tax payments until taken out
  • Taxable Income: The amount of your income that the government deems taxable  
  • Money rollover: The transfer of funds from one retirement account to another without paying taxes
  • SEP (Simplified Employee Pension) IRA: For self-employed individuals to invest as much as 25% of their net earnings, up to $58,000 per year for 2021, and is taxed when the money is withdrawn

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.

What are the different types of retirement plans in America?

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.

401K retirement plan

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.

Roth IRA and traditional IRA plans

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.

SEP IRA plan

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! 

Solo 401K plan

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.

Other types of retirement plans

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. 

How do I know which retirement savings plan is right for me?

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:

  1. What is your annual income? 
  2. Do you enjoy luxury or are you a minimalist?
  3. Around what age do you see yourself retiring?

Now that you’ve reflected, keep your answers in mind as we go through some different components to the plans mentioned earlier.

Tax benefits

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. 

Matching contributions

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

Think about your individual needs

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.

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