Types of Retirement Funds

If you’re exploring retirement options, you’ve already taken a step in the right direction. After all, most people would like to spend their later years doing exactly what they prefer–whether that’s seeing the seven natural wonders or seeing your seven grandkids grow up (or both!).

Today, however, 20 percent of Americans aren’t saving any of their annual income and those who do aren't saving very much.¹

So, what’s an aspiring saver to do? And how do retirement funds work? It can help to start with the basics as you review retirement account options that may work best for your lifestyle and long-term goals. The most important thing can be simply getting started.

Isn’t Social Security enough?

It’s true: When you pay taxes, you’re probably already paying into Social Security. This federal government savings plan provides retirees with monthly benefits, but it was never meant to be your sole source of income in retirement.

It goes without saying that the more you save (and the earlier you start), the more you’ll have waiting for you when you retire. But don’t let a delayed start date discourage you. Anytime is a great time to start saving for retirement.

Here are answers to some common questions that may help inspire you to tuck away even more:

Should I manage my own retirement account?

That’s a good question and the answer, as you may suspect, is different for everyone. But as you begin, it can be very helpful to have a dollar figure in mind. That way, you can figure out how much you’ll need to save between now and retirement.

Once you know that approximate figure, you could divide it by the number of months you have left to work, try putting that amount aside each month and maybe even adjust your budget as necessary. A retirement calculator may help you break it down a little further.

As for setting up your own retirement account or enlisting the help of an expert, that may depend on the type of account you’re interested in. For example, employee-sponsored accounts like a 401(k), 403(b) or pension are often designed to be simple to participate in. You may have to decide how much of your paycheck you’d like to contribute or choose from types of investments (stocks vs. bonds), but your plan administrator can usually provide recommendations based on your unique needs.

There are also retirement plans that you can set up through your bank or financial institution like a traditional IRA or Roth IRA. The following overview may help you decide which type of account is right for you:

How does a 401(k) work?

A 401(k) retirement account is the most common employer-sponsored savings plan.² These plans allow you to set aside a percentage of your paycheck before it’s taxed. If this pre-tax retirement savings stays put it can grow, tax-deferred, until you withdraw the funds. Anything you put in this account will likely lower the amount you have to pay in annual income tax. Employees can typically invest up to a certain dollar amount each year, for example, $23,000 in 2024.²

In some cases, your employer will even match your contributions, dollar for dollar, up to a limit. That’s free money that may help you reach your retirement goals a little faster.

Just keep in mind that your right to the funds your employer contributes may have to be earned over time. That’s what the term "vested" is all about. It may take five years, for instance, to be "fully vested" in your 401(k). So, while the money that you contribute to the account can be taken with you to your next place of employment, you may not have full access to the money matched by your employer if you switch jobs before certain terms are met.³

A personal 401(k) account can be an effective way to save because it’s essentially "savings on autopilot." Since money is deducted from your paycheck and invested automatically, you won’t need to decide whether to save each month. Just remember that there’s usually a 10 percent penalty fee if you pull money out before retirement age of 59½.² This is meant to keep people from withdrawing money early.

But don’t worry, if anything happens with your job or company, your savings should be protected. You can even transfer your 401(k) balance into an IRA to avoid penalties. Either way, you’re generally expected to start withdrawing money by age 73.⁴

And how long does it take to get your 401(k) via direct deposit once you make a withdrawal? Although it varies by bank, direct deposits usually take about three business days from the date the payment is made—possibly longer with a 401(k). If you opt to have checks mailed to you, it may take a week or so.⁵

How does a traditional IRA work?

An IRA is a retirement plan (separate from your employer) that can be opened through your bank, credit union, insurance company or investment broker. With a traditional IRA, your contributions are tax-deductible and grow tax-free while in the account. You pay taxes on the money and earnings only when you make a withdrawal.

Contributions don’t have limits based on income, but there are other guidelines that must be followed. For 2023, total annual contributions are capped at $6,500 for those under age 50 and $7,500 for people 50 and older.⁶

As with a 401(k) plan, there’s usually a 10 percent penalty if you withdraw money before retirement age, with certain exceptions.

Maybe you’re wondering if you can withdraw money from an IRA for educational expenses. Generally, you can do so without incurring a 10 percent penalty, the idea being that investing in your education is investing in your future.⁷

What is a Roth IRA?

A Roth IRA is similar to a traditional IRA, except that it is funded with money that has already been taxed. This can be a great option for younger savers who can pay lower tax rates now and then watch their money grow tax-free in the account over the years.

Once you reach 59½, funds can be withdrawn tax-free. Total annual contributions are again capped at $6,500 (under age 50) or $7,500 (age 50 and older) for 2023, but there is no mandatory withdrawal age, making it a bit more flexible than a traditional IRA.⁸ You can even keep contributing after you retire. If you need to take out money before retirement age, there’s only a 10% penalty on earnings, not on the money you put into the account.¹¹

To contribute the maximum to a Roth IRA, however, your salary must meet an income threshold. Single people must make less than $129,000 and married couples must jointly make below $204,000 in 2023.⁹

What is a 403(b) plan?

A 403(b) plan operates just like a 401(k) plan but is only offered for certain non-profit organization employees, public schools and religious organizations. They include the same tax-deductible contributions, employee matching, tax-deferred growth of earnings and penalties for early withdrawal.

What are pension plans?

Pensions, once typical, are becoming less and less common. They’re also one of the most costly plans for employers to provide.¹⁰ With pensions, an employer pays directly into an employee’s retirement account, which is invested on the employee’s behalf. At retirement, employees receive a fixed pension amount each month from account earnings.

On the plus side, pensions are automatic savings plans. On the minus side, the majority of pensions don’t offer a cost-of-living adjustment, so your monthly payout stays the same no matter your age. If you’d like to keep the same lifestyle over time, it may be wise to explore additional retirement options even if a pension is coming your way.

How are retirement accounts set up?

An employer-sponsored account can be set up through your place of work. An IRA can be set up online through a bank or with a broker. You will likely have to provide personal information such as your name, date of birth, social security number, address and employment information.

One way to maximize your savings efforts is to look for low service fees and pay attention to any required account minimums. It may also be helpful to check with your tax consultant prior to opening any new accounts. Once your retirement account is up and running, you can monitor or adjust your investments to help keep your retirement goals on track.

Your retirement is in your hands

Saving isn’t always easy, but it can pay off down the line. Retirement plans can help you save on taxes, earn free money from employer contributions and hopefully get excited about retirement (instead of feeling anxious about it).

Even if you’re self-employed, saving money without a 401(k) is possible thanks to IRAs and other pre-tax investment options. Most people find that a combination of retirement accounts best covers their needs.

To stay motivated, remember the goals that inspire you most, whether it’s seeing the northern lights or just spending more time with family. Financial planning can help you make the most of this special chapter of life.