Types of Retirement Savings Plans
Learn the principal types of retirement savings plans:
Individually managed retirement savings plans are set up and managed by each individual taxpayer. More commonly known as Individual Retirement Accounts (IRAs). IRAs were first authorized by the Employee Retirement Income Security Act of 1974 (ERISA). Originally, IRAs were limited to workers without pension coverage, but the Economic Recovery Act of 1981 made all workers and spouses eligible to have IRAs.
An IRA is long-term retirement savings account or annuity that you establish directly with a financial institution, such as a bank, brokerage, insurance, or mutual fund company (the “fiduciary”).
The amounts that you contribute must be from wages earned as an employee (Form W-2), commissions, compensation received from self-employment (Form 1099-NEC and/or Form 1099-MISC), and/or taxable alimony. Income received from passive income sources such as interest, dividends and capital gains, pensions and retirement plan distributions, rental real estate, gifts and nontaxable alimony does not qualify as income sources that can be contributed into an IRA.
You can make contributions into an IRA at any time during the current year, and up through April 15th of the following year.
One provision of the SECURE Act 1.0 of 2019 removed the age limit to make contributions into an IRA - as long as you continue to work. Under prior law, the age at which one could make contributions into an IRA had been capped at age 70½.
There are two types of individually managed retirement savings plans:
- Traditional IRAs
- Roth IRAs
A Traditional IRA is a tax-advantaged personal savings plan where the individual may be able to deduct the contributions that they make into a Traditional IRA on their Form 1040 tax return if they meet certain conditions.
Under Federal law, individuals may set aside personal savings into a Traditional IRA up to the limits set in the following table:
Traditional IRA Contribution Limits
| Tax Year | Contribution Limits | ||
|---|---|---|---|
| Under Age 50 | Age 50 or Older | ||
| 2024 | 7,000 | 8,000 | |
| 2023 | 6,500 | 7,500 | |
| 2022 | 6,000 | 7,000 | |
You can make contributions to both Traditional IRAs and Roth IRAs, but the total amount contributed cannot exceed this annual limit.
All contributions made into a Traditional IRA will take advantage of The Power of Compounding over the years. Federal income taxes and any State income taxes (Massachusetts residents only) on the contributions you made, and all interest, dividends and capital gains realized on your Traditional IRA investments will be deferred until the years that you withdraw funds from your Traditional IRA.
Married Taxpayers, Filing "Married, Filing Jointly"
If neither the taxpayer nor their spouse is covered by a retirement plan at work, their full contributions into a Traditional IRA are deductible.
If one spouse is covered by a retirement plan at work whereas the other is not, they may be entitled to only a partial (reduced) deduction for their Traditional IRA contributions, or even no deduction at all, depending on their Modified Adjusted Gross Income (MAGI). The deduction begins to decrease (phase out) when their income rises above a certain amount and is eliminated altogether when it reaches the higher threshold.
Traditional IRA Contribution Deduction Limitations
"Married, Filing Jointly" Filers
Only One Spouse Covered by a Workplace Retirement Plan
| Tax Year | Modified AGI | Deduction Limits | ||||
|---|---|---|---|---|---|---|
| Over |
But Not Over |
Under Age 50 |
Age 50 or Older |
|||
| 2024 | 240,000 + | No Deduction | ||||
| 230,000 | 240,000 | Partial Deduction | ||||
| 0 | 230,000 | 7,000 | 8,000 | |||
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| 2023 | 228,000 + | No Deduction | ||||
| 218,000 | 228,000 | Partial Deduction | ||||
| 0 | 218,000 | 6,500 | 7,500 | |||
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| 2022 | 214,000 + | No Deduction | ||||
| 204.000 | 214,000 | Partial Deduction | ||||
| 0 | 204,000 | 6,000 | 7,000 | |||
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If both the taxpayer and their spouse are covered by a retirement plan at work, they may be entitled to only a partial (reduced) deduction for their Traditional IRA contributions, or even no deduction at all, depending on their MAGI. The deduction begins to decrease (phase out) when their income rises above a certain amount and is eliminated altogether when it reaches the higher threshold.
Traditional IRA Contribution Deduction Limitations
"Married, Filing Jointly" Filers
Both Spouses Covered by a Workplace Retirement Plan
| Tax Year | Modified AGI | Deduction Limits | ||||
|---|---|---|---|---|---|---|
| Over |
But Not Over |
Under Age 50 |
Age 50 or Older |
|||
| 2024 | 143,000 + | No Deduction | ||||
| 123,000 | 143,000 | Partial Deduction | ||||
| 0 | 123,000 | 7,000 | 8,000 | |||
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| 2023 | 136,000 + | No Deduction | ||||
| 116,000 | 136,000 | Partial Deduction | ||||
| 0 | 116,000 | 6,500 | 7,500 | |||
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| 2022 | 129,000 + | No Deduction | ||||
| 109.000 | 129.000 | Partial Deduction | ||||
| 0 | 109,000 | 6,000 | 7,000 | |||
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Single Taxpayers
If a taxpayer filing as “Single” is not covered by a retirement plan at work, their full contribution to a Traditional IRA is deductible.
If a taxpayer filing as “Single” is covered by a retirement plan at work, they may be entitled to only a partial (reduced) deduction for their Traditional IRA contribution, or even no deduction at all, depending on their Modified Adjusted Gross Income (MAGI). Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches the higher threshold.
Traditional IRA Contribution Deduction Limitations
“Single” Filer - Covered by a Workplace Retirement Plan
| Tax Year | Modified AGI | Deduction Limits | ||||
|---|---|---|---|---|---|---|
| Over |
But Not Over |
Under Age 50 |
Age 50 or Older |
|||
| 2024 | 87,000 + | No Deduction | ||||
| 77,000 | 87,000 | Partial Deduction | ||||
| 0 | 77,000 | 7,000 | 8,000 | |||
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| 2023 | 83,000 + | No Deduction | ||||
| 73,000 | 83,000 | Partial Deduction | ||||
| 0 | 73,000 | 6,500 | 7,500 | |||
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| 2022 | 78,000 + | No Deduction | ||||
| 68,000 | 78.000 | Partial Deduction | ||||
| 0 | 68,000 | 6,000 | 7,000 | |||
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Non-Deductible Contributions into a Traditional IRA
You could make non-deductible contributions into a Traditional IRA. Why would you want to do this? To be able to make what are known as “Back-Door Roth IRA” contributions, as discussed below.
You must report all non-deductible contributions into a Traditional IRA on Form 8606 that is attached to your Form 1040 income tax return each year. Otherwise, the IRS will treat these non-deductible contributions as ordinary tax-deferred contributions and levy Federal income taxes on the non-deductible contributions you made, and all interest, dividends and capital gains realized on your non-deductible contributions in the years that you withdraw funds from your Traditional IRA.
A Roth IRA is a tax-advantaged personal savings plan where contributions are not deductible but qualified distributions may be tax free.
The Roth IRA, named after the late Delaware Sen. William Roth, became a savings option in 1998, followed by the Roth 401(k) in 2006. Creating a tax-free stream of income is a powerful retirement tool. These accounts offer big benefits, but the rules for Roth IRAs can be complex.
There are significant tax benefits to a Roth IRA. Roth IRAs can provide a stream of tax-free income to draw upon during your retirement. Distributions received from Roth IRAs are not counted in the calculation for taxing Social Security benefits, for example, or in the calculation of income tax levied on investment income.
Under Federal law, individuals may set aside personal savings into a Roth IRA up to the limits set in the following table:
Roth IRA Contribution Limits
| Tax Year | Contribution Limits | ||
|---|---|---|---|
| Under Age 50 | Age 50 or Older | ||
| 2024 | 7,000 | 8,000 | |
| 2023 | 6,500 | 7,500 | |
| 2022 | 6,000 | 7,000 | |
You can make contributions to both Roth IRAs and Traditional IRAs, but the total amount contributed cannot exceed this annual limit.
All contributions made into a Roth IRA will take advantage of The Power of Compounding over the years. Normally, no Federal or State income taxes will be levied on the contributions you made, and all interest, dividends and capital gains realized on your Roth IRA investments in the years that you withdraw funds from your Roth IRA. This is discussed in more detail below.
Regardless of whether you are covered by a retirement plan at work, you may be able to make a full or reduced contribution to a Roth IRA, or even no contribution at all, based on your Modified Adjusted Gross Income (MAGI). The amount of their contribution begins to decrease (phase out) when their income rises above a certain amount and is eliminated altogether when it reaches the higher threshold.
Roth IRA Contribution Income Limitations
"Married, Filing Jointly" Filers
| Tax Year | Modified AGI | Deduction Limits | ||||
|---|---|---|---|---|---|---|
| Over |
But Not Over |
Under Age 50 |
Age 50 or Older |
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| 2024 | 240,000 + | No Contribution | ||||
| 230,000 | 240,000 | Reduced Contribution | ||||
| 0 | 230,000 | 7,000 | 8,000 | |||
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| 2023 | 228,000 + | No Contribution | ||||
| 218,000 | 228,000 | Reduced Contribution | ||||
| 0 | 218,000 | 6,500 | 7,500 | |||
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| 2022 | 214,000 + | No Contribution | ||||
| 204.000 | 214,000 | Reduced Contribution | ||||
| 0 | 204,000 | 6,000 | 7,000 | |||
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Roth IRA Contribution Income Limitations
"Single" Filers
| Tax Year | Modified AGI | Deduction Limits | ||||
|---|---|---|---|---|---|---|
| Over |
But Not Over |
Under Age 50 |
Age 50 or Older |
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| 2024 | 161,000 + | No Contribution | ||||
| 146,000 | 161,000 | Reduced Contribution | ||||
| 0 | 146,000 | 7,000 | 8,000 | |||
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| 2023 | 153,000 + | No Contribution | ||||
| 138,000 | 153,000 | Reduced Contribution | ||||
| 0 | 138,000 | 6,500 | 7,500 | |||
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| 2022 | 144,000 + | No Contribution | ||||
| 129.000 | 144.000 | Reduced Contribution | ||||
| 0 | 129,000 | 6,000 | 7,000 | |||
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Back-Door Roth IRA
A “Back-Door Roth IRA” is a workaround process to make a contribution into a Roth IRA when one’s Modified AGI exceeds the allowed income limits for a standard Roth IRA contribution.
To start this process, you need to make a Non-Deductible Contribution into a Traditional IRA, as discussed above, and then convert this contribution into a Roth IRA. To make such a contribution, inform your fiduciary that you wish to make “a nondeductible contribution into a Traditional IRA using after-tax dollars, and then convert this contribution into a Roth IRA.” You should make the contribution and the conversion on the same day, if possible.
The challenge with Back-Door Roth IRAs, from an income tax perspective, lies in whether you had made any contributions into a Traditional IRA, or had rolled retirement plan funds over into a Traditional Rollover IRA. If this is the case, then a proportion of the funds in the Traditional IRA will be treated as taxable income in the year that you made the Back-Door Roth IRA contribution, as calculated on Form 8606. Most often, this scenario arises when the taxpayer rolled retirement plan funds over from a former employer’s 401(k), 403(b) or 457 plan into a Traditional Rollover IRA.
The fundamental differences between Traditional IRAs and Roth IRAs are the (a) timing of payment of your income tax liabilities, and (b) character of the distributions (withdrawals) that you will receive. With a Traditional IRA, you receive a tax break for the funds that you contribute into your Traditional IRA each year and later pay income taxes on all distributions. With a Roth IRA, you contribute after-tax dollars into your Roth IRA and receive tax-free withdrawals in retirement.
By accepting the up-front tax breaks for Traditional IRA accounts, you accept the IRS as your partner in retirement. For example, if you're in the 24% tax bracket in retirement, 24% of all your Traditional IRA withdrawals - including your contributions and their earnings - will effectively belong to the IRS. With a Roth IRA, 100% of all withdrawals in retirement are yours.
The Roth IRA strategy of paying income taxes sooner rather than later will pay off particularly well if you're in a higher tax bracket when you withdraw the funds in retirement than when you passed up the tax break offered by contributing into a Traditional IRA. If you're in a lower tax bracket, though, the Roth IRA advantage will be diminished.
The IRS defines two principal types of employer-sponsored retirement savings plans:
- Defined Contribution Plans
- Defined Benefit Plans
Defined Contribution Plans
Defined Contribution Plan is a retirement plan in which the employee and/or the employer contribute to the employee’s individual account under the plan. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans and profit-sharing plans.
The amount in the account at distribution includes the contributions and investment gains or losses, minus any investment and administrative fees. Generally, the contributions and earnings are not taxed until distribution. The value of the account will change based on contributions and the value and performance of the investments.
401(k) Plans
401(k) Plan is a defined contribution plan where an employee can make contributions from his or her paycheck either before or after-tax, depending on the options offered in the plan. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan. In some plans, the employer also makes contributions such as matching the employee’s contributions up to a certain percentage. SIMPLE and safe harbor 401(k) plans have mandatory employer contributions.
401(k) plans were created as a provision of the Revenue Act of 1978. In 1981, the IRS issued new rules that allowed employees to fund their 401(k) through payroll deductions. This kickstarted the 401(k)’s popularity. Within a couple of years, nearly one-half of all large companies were offering 401(k)s to their employees.
Safe Harbor 401(k) Plan is similar to a traditional 401(k) plan, but the employer is required to make contributions for each employee. The safe harbor 401(k) eases administrative burdens on employers by eliminating some of the rules ordinarily applied to traditional 401(k) plans.
Employee Stock Ownership Plan (ESOP) is a type of defined contribution plan that is invested primarily in employer stock.
Profit-Sharing Plan is a defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise). The plan contains a formula for allocating to each participant a portion of each annual contribution. A profit-sharing plan may include a 401(k) feature.
How 401(k) Plans Work - If your employer offers a 401(k) and you meet the plan’s eligibility requirements, you can enroll in the plan and begin making contributions via payroll deductions.
401(k)s come in two distinct flavors: Traditional and Roth. Although at their heart they aim to achieve the same purpose — to encourage Americans to save more for retirement by offering tax incentives — they do this in drastically different ways. Here are the main ways they differ.
Traditional 401(k) - Your contributions are made before Federal and State income taxes were withheld from your income. Over the years your retirement money compounds and grows tax-deferred. This means the contributions you make help lower your taxable income now, and you won’t pay any Federal or State income taxes on either your contributions or investment earnings until you begin making withdrawals in retirement. At that point, the money will be taxed as ordinary income.
Roth 401(k) - Your contributions are made after Federal and State income taxes were withheld from your income. However, your retirement money compounds and grows tax-free for life. Because you already paid the income taxes up front, when you withdraw money during retirement, you won’t have to pay any additional income taxes on the amount invested nor on the investment earnings. The Power of Compounding a substantial sum of money tax-free over one’s lifetime is a very attractive retirement savings feature – one that should be pursued diligently!
The Roth 401(k) is a retirement savings plan which represents a unique combination of features of the Roth IRA and a traditional 401(k) plan. Roth 401(k)s were created as a provision of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001. In 2006, U.S. employers were allowed to amend their 401(k) plan documents to allow employees to elect Roth IRA type tax treatment for a portion or all their retirement plan contributions.
Which one you choose will depend on several factors, including whether your company offers both (Roth 401(k)s are not as commonly offered as traditional 401(k)s) and whether you want a tax break now or later.
403(b) Tax-Sheltered Annuity (TSA) Plan
403(b) Tax-Sheltered Annuity (TSA) Plan is a retirement plan offered by public schools and certain tax-exempt organizations. An individual’s 403(b) annuity can be obtained only under an employer’s TSA plan. Generally, these annuities are funded by elective deferrals made under salary reduction agreements and nonelective employer contributions.
403(b) plans had their origin in 1958, when Congress approved a tax-deferred savings device for employees of certain 501(c)(3) organizations by adding Section 403(b) to the Internal Revenue Code. In 1961, Congress extended IRS 403(b) to employees of educational institutions including colleges and public universities, with investments limited to annuities. Mutual funds held in custodial accounts were added in 1974. The program was intended to be a relatively simple way for employees to supplement retirement savings by using their own voluntary pre-tax dollars. Supplementing retirement savings has become increasingly important with widespread reductions in benefits being made to the state retirement system plans for those employees.
The same change in law (see “Roth 401(k)”, above) allowed Roth IRA type contributions to 403(b) retirement plans.
401(k) and 403(b) Plan Contribution Limits
Tax Year |
Contribution Limits |
|
|
Under Age 50 |
Age 50 or Older |
|
| 2023 | 22,500 | 30,000 |
| 2022 | 20,500 | 27,000 |
| 2021 | 19,500 | 26,000 |
Defined Benefit Plan
The Defined Benefit Plan, more commonly known as a traditional Pension Plan, promises the participant a specified monthly benefit at retirement. Often, the benefit is based on factors such as the participant’s salary, age and the number of years he or she worked for the employer. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service.
Pension plans were offered by most employers well into the 1990s. However, as the popularity of 401(k) and 403(b) plans continued to grow, and employers wrestled with the ever-increasing costs of funding and managing their pension plans, most private-sector pension plans were phased out or converted into 401(k) or 403(b) plans. Today, it is rare to find a private-sector employer who offers a pension plan benefit. It seems that only Federal, state and municipal government agencies still offer pension plans.
Self-Employed Plans (Content coming soon)
Inherited retirement savings plans (“Inherited Plans”) are retirement plan funds that one received from the settlement of the estate of a person who had passed away – usually a parent or other relative, but sometimes a friend. Virtually all Inherited Plans are transferred to the beneficiary via a Direct rollover.
Inherited Plans are distributed only in the form of Traditional IRAs or Roth IRAs, depending upon the original character of the Plans when they were established by the deceased owner.
Employer-Sponsored plans such as Defined Benefit Plans (i.e., 401(k) plans, 403(b) plans, etc.) or Defined Benefit Plans (i.e., pension plans) are not eligible to be directly distributed to the recipients as the recipients were not the participants in such Plans. Instead, the Executor of the estate instructs each Plan’s fiduciary to convert that Plan’s assets into a Traditional IRA or Roth IRA first, depending upon the original character of each Plan when they were established, and then distribute the assets of each converted Plan to the beneficiaries according to the terms of the deceased owner’s will.
Distribution Requirements
Prior to 2020, Inherited Plan recipients had to start taking withdrawals from their Inherited Plans in the year immediately after the decedent’s death. The amount of the withdrawals, known as Required Minimum Distributions (RMDs) were determined by size of the Inherited Plan’s assets and by the IRS’ actuarial life expectancy tables that extend all the way out to age 115.
A nonspousal beneficiary of an IRA could “stretch” the receipt of these RMDs over his or her remaining actuarial life expectancy. This estate planning strategy allowed one to extend IRA distributions over future generations while the IRA continued to grow tax-deferred. Under this scenario, the younger the beneficiary, the better, as the RMD would be smaller, and the account could grow tax-deferred for a longer period of time. Younger beneficiaries have longer actuarial life expectancies, resulting in smaller RMDs taken in the beginning, growing larger over time. The “stretch IRA” strategy minimized the amount that must be withdrawn from the IRA each year and avoided a large, taxable, lump-sum distribution to the beneficiary.
SECURE Act of 2019
Under the "Setting Every Community Up for Retirement Enhancement Act of 2019,” also known as the “SECURE Act”, individuals who inherit an IRA after December 31, 2019 are required to withdraw all IRA plan assets within 10 years of the original account holder’s death. There are no RMDs during the 10-year period, as long as the entire IRA balance is withdrawn within 10 years of the date of death. §401 of the SECURE Act essentially eliminated “stretch” IRAs that could be stretched over the life of the beneficiary and grow tax-deferred for an extended period. §401 of the SECURE Act does not apply to account holders who died prior to December 31, 2019, and in this scenario, a beneficiary may still “stretch” distributions over his or her own lifetime. It is important to review client estate plans as the 10-year payout rule will come as a surprise to many and could undermine the original intent of the estate plan.
§401(a)(2) of the SECURE Act does allow for a few exceptions to the 10-year payout rule. Spouses, account holder’s children who have not reached the age of majority, beneficiaries less than 10 years younger than the account holder, and chronically ill or disabled beneficiaries are NOT subject to the 10-year distribution rule and are considered “eligible designated beneficiaries.” These individuals are eligible to withdraw inherited IRAs over their life expectancy as was customary prior to 2020, bypassing the 10-year rule. Designated beneficiaries include any person (i.e., not an entity or institution) subject to the 10-year rule.