I recently wrote a post on individual retirement accounts in How to Fund Retirement and focused on three accounts available to college students. After graduation, however, even more possibilities will be available to students. It’s important to understand what these accounts are as well so you can start contributing to them as soon as you have access to them.
Let’s start from the one account I most wish I had access to:
These accounts are tax-deferred like a Traditional IRA, meaning that you do not pay taxes on the money you put into the account, only the money you withdraw. You can start withdrawing at age 59.5 but have to start withdrawing at 70.5.* Unlike a Traditional IRA, 401(k)s have significantly higher contribution limits. In 2016, contribution limits for a 401(k) is $18,000 for those under 59.5 and just $5,500 for Traditional IRAs.
If you want access to your money before 59.5, you typically have to pay an extra 10% tax on top of income tax. Any withdrawals after 59.5, including the mandatory withdrawals after 70.5, are subject to income tax.
Typically you get a 401(k) through the company or organization you work for. Some companies are amazing and make 401(k)s even better by offering an employer match. This is basically free money, if there ever was such a thing, that employers commit to give based on an employee’s contributions. Say, for example, your employer says that they will contribute 3% of your salary to your 401(k). If you make $50,000 a year, then your employer is contributing $1,500 to your 401(k). Even better, employer matches do not count towards the employee’s contribution limit. So you can contribute up to the $18,000 limit and still receive an employer match.
It is also important to note that 401(k) plans vary from company to company. It really depends on who the company uses to help manage their employees’ retirement accounts. Some companies also do not offer an employee match.
Of course, if you go out on your own and start your own business, then you can always set up an individual 401(k). You would have the flexibility to determine which company you want to set up your 401(k) with and you can contribute both as an employee and an employer offering an employee match. Fun stuff.
Similar plans to a 401(k) that require working for a certain type of organization
The cousin of a 401(k) is a 403(b). A 403(b) is only for certain organizations, such as schools and non-profits, but provide basically the same services.
The second cousin would be the 401(a) Plan which requires employers to contribute to the 401(a). However, an employee is fully vested, meaning that they need to stay with the organization for a certain number of years to enjoy the benefits of employer contributions to their retirement account. This plan is also mainly for government or school employees.
A 457 Plan is also similar to a 401(k) plan, except better. While a 457 Plan is tax-deferred, there is no penalty for withdrawing your money before the age of 59.5 (other than paying mandatory income tax).
Furthermore, if your organization offers both a 457 Plan and a 401(k) or 403(b), then you can contribute the maximum contribution limits to both. For 2016, that means you could contribute a maximum of $36,000 a year.
The catch? This type of plan is exclusively offered to government employees and certain non-profits.
A Roth 401(k) is pretty much the same as a 401(k), except contributions are taxed and withdrawals are tax-free. It is also possible to withdraw money from a Roth 401(k) early without any taxes if it counts as a qualified distribution (e.g. medical expenses).
The full name is Saving Incentive Match Plan for Employees Individual Retirement Account (they probably made the name fit to the acronym?). This are for small businesses with 100 or less employees. Contributions are tax-deferred and employers have to make some type of contribution even if employees do not.
Any small business owner with less than 100 employees (even the owner is the only employee) can open up a SEP IRA (Simplified Employee Pension Individual Retirement Account). A SEP IRA, however, functions in the same domain as a Roth or Traditional IRA. This means that you can only contribute $5,500 to a SEP IRA, Roth IRA, and Traditional IRA altogether. If you put $5,500 into a SEP IRA, for example, then you cannot contribute to your Roth or traditional IRA for that tax year.
Typically, however, funding a SEP IRA is the employer’s responsibility and they can determine whether to contribute annually.
To compare each of these accounts more easily, check out this chart that focuses on the main retirement accounts**:
|401(k)||Roth 401(k)||SIMPLE IRA||SEP IRA|
|Available to…||An employee||An employee||Employee at small business (<100 employees)||An employee|
|Contribution Limits (for 2016)||$18,000||$18,000||$12,500||$5,500 (although the employer can contribute more)|
|Tax Benefits||Tax-deferred||Taxes on withdrawals||Tax-deferred||Tax-deferred|
|Employee Match||Depends on company||Depends on company||Required||Determined on an annual basis|
Note: for all of these, your company needs to offer the plan in question. You cannot get a SIMPLE IRA if your organization offers a 401(k).
These are among the other retirement accounts that will be available to us college students after landing our first career. The option available to you will depend on where you end up working, but it is essential to be aware of the retirement accounts available to you. Should you change companies, however, or retire early, then it is possible to rollover any of these plans to a different type of individual retirement account, such as a Roth IRA. With these savings vehicles, you have the opportunity to save a lot of money on taxes while building a good nest egg for the future.
* I’m still at a loss as to why they are so set on the ½. 59.5. 70.5. Why aren’t the numbers just rounded instead of making people figure out when they are halfway to 60 or 71? If someone would like to reveal this mystery for me, I would be extremely grateful.
**Check out the “Similar Plans to 401(k)” section to see more specialized retirement options. I left them out of the chart, however, since they aren’t readily available to everyone.
I left out some retirement accounts, for the sake of brevity (or ignorance). If you have any others to share, please do so in the comments below!