Retirement is a tricky subject, everyone has their own opinions on how much is enough to retire and where you should put your money. Other articles on this website talk about why saving for retirement is important, but not necessarily how to go about saving.
The goal of this exposition is to give an overview of some options for retirement accounts for both W2 employees which make up the majority of my reading population, as well as 1099’s, which I happen to be more familiar with. This list will in no way be comprehensive of all the options out there, but instead will work as a starting point for you to learn about the most common and easiest types of accounts you can put money toward.
Most employees working 9-5 for a well-established company are W2 employees. If you have any doubts about whether or not you are one, check what tax form you filed last year for your job to confirm, or if you are a new employee don’t be afraid to ask your boss or HR department.
Generally, all companies have a retirement plan, and if you’re lucky yours might even have a couple of different ones to choose from. Start by checking your employee handbook if your company offers one to see what information you can gather from the retirement section.
IRA stands for an Individual Retirement Account. You don’t pay any taxes when you put money into your account (tax-deferred) and there are no income limits to contribute. Instead, you’ll pay income when you withdraw funds, which you can start doing without penalty at 59 1/2, and are required to start by 70 1/2. The maximum contribution is relatively low at $6,000 for the year 2020, however you can contribute an extra $1,000 if you’re over age 50. A nice perk of this retirement account is that you have nearly unlimited options to invest in. Unlike some 401(k)s you aren’t limited to a selection of funds! You can put your money in cash, stocks, bonds, mutual funds, gold, or even lesser-known investments like peer-to-peer lending. One caveat is that you can only contribute earned income to your IRA, so if you made $3,000 of earned income last year, the maximum you can contribute is $3,000, not the contribution maximum of $6,000.
Probably the best known of all the retirement accounts is the 401(k). Here we are referring to the standard employer-provided version, not the more potent self-employed version. Most companies offer this to there employees, though the funds you’re allowed to invest in change from company to company. The age requirements are the same as the IRA at 59 1/2 and 70 1/2. The nice thing about the 401(k) is the contribution limit. If you’re under 50 years old you can put in a maximum of $19,500, and if you’re over you contribute a maximum of $26,000. Some employers even offer to match your contribution up to a certain percentage of your income. If your employer offers this, you should start contributing at least the maximum amount that they will match if you can afford it. This is in essence free money that your company is giving you each year so don’t waste it.
Roth IRA’s are similar to normal IRA’s in many ways, but there are also some important distinctions. First of all, Roth IRAs are funded with after-tax dollars. That is, you earn money and pay income tax on it, then it can go into your retirement account, compared to the other two options discussed where you can put earned money directly into them without paying any tax. You then don’t have to pay any income tax when you take the money out, whereas you would have to pay income tax on a tax-deferred retirement account. Another important difference to note is that you can’t contribute to a Roth IRA if you earn too much money. for the year 2020 your MAGI (Modified Adjusted Gross Income) must be less than $139,000 if you’re filing as a single person, and under $206,000 if you’re filing jointly. The contribution limits are the same as a normal IRA though.
There is good news and bad news when it comes to being a contractor. The good news is that you have options! You aren’t tied down to any single plan like some of your employee counterparts. You can pick and choose what you want to do with your money. You choose when you want it taxed (kinda), and there are no limitations on which investments you buy. To sweeten the deal even more, maximums are typically much higher for contractors than employees, so if you’re a hardcore saver or a high earner, you’ll be able to reap the tax benefits on a larger portion of your income!
Now for the bad news. There is no plan set up for you. I know this sounds a lot like the good news, but really they are two sides of the same coin. You’ll have some important decisions to make in investing for retirement, and that will require time and research to even get started. This contrasts drastically from employees who if they really wanted to could just toss money into the retirement account that was made for them and hope for the best.
Setting up a retirement account can be daunting, but you’d be silly not to take advantage of the privileged situation you’re in. This guide will be able to give you a brief overview of some options that you have, but it isn’t all-inclusive, and it won’t be enough to make a decision on. So read on and see what interests you, and kick off your research from there!
There are many names for this 401(k): Self-employed 401(k), SE401(k), Solo 401(k), one participant 401(k) and many others. The gist of the matter is this though: the retirement vehicle is designed for an individual business owner without any workers. Contributions up to $57,000 are allowed in 2020 if you’re under age 50, with an additional $6,500 allowed if you’re over 50.
There are some additional restrictions based on your income, but the rules are a little more complicated and few people reach the limits so I will save the details for another article. If you plan on opening one of these and are a high earner, I highly recommend doing some reading before you start contributing to make sure you’re in compliance with the law.
The SEP IRA and the SE 401(k) are similar in many regards. The contribution limits are the same with the exception of people over 50 who are not allowed to make “catch up contributions”. Additionally, Some of the more in-depth rules may make the maximum amount you can contribute toward your plan lower than the SE 401(k) if you are planning on contributing more than 20% of your income.
There is a good reason to pick this option over the SE 401(k) though: These accounts are typically seen as easier to set up and have slightly more straight forward rules, so if you’re not willing to spend as much time doing reading and research, this could be the plan for you.