While the stock market can be volatile and uncertain, it remains a good idea to open and contribute to a retirement account. If you are uncomfortable investing directly in equities right now, you can place your contribution into a very low-risk or no-risk vehicle such as a money market account until you are ready to take on more market exposure.
Contributing to a retirement account offers several clear benefits. First, contributions often reduce your current-year taxable income by the amount you contribute, which can lower your tax bill today. Second, earnings in many retirement accounts grow tax-deferred, meaning you do not pay income tax on contributions or investment growth until you withdraw funds in retirement. Third, consistently saving for retirement builds the habit of setting money aside so those contributions have time to compound and potentially grow substantially by the time you reach retirement. In many cases, you may also be in a lower tax bracket when you withdraw money during retirement, which can further reduce lifetime taxes on those funds.
Below is an overview of several common types of retirement accounts and how they generally work. This is general information and rules can change, so consult with a professional advisor about your specific situation.
Employer-Sponsored Plans: 401(k) and 403(b)
If you work for an employer, your retirement plan options will often be determined by your employer. For employees of for-profit companies, the most common plan is a 401(k). Employees of not-for-profit organizations often have access to a 403(b) plan. Although the names differ, these plans operate similarly: you contribute a portion of your salary into the plan and often choose investment options offered by the plan.
Contribution limits are set by the IRS and can change from year to year. In 2019, the elective deferral limit was $19,000, with an additional catch-up contribution of $6,000 available for participants age 50 and older. When your employer offers a matching contribution, aim to contribute at least enough to capture the full match—this is essentially free money and maximizes the benefit your employer provides. In general, it is prudent to contribute as much as the law or your employer’s plan permits, subject to your broader financial goals and cash-flow needs.
Individual Retirement Accounts (IRAs)
If you do not have access to an employer-sponsored plan, an individual retirement account (IRA) is a widely used alternative. Traditional and Roth IRAs are the most common variants. In 2019 the maximum contribution to an IRA was $6,000 annually, with a $1,000 catch-up contribution allowed for individuals age 50 or older. IRAs offer tax advantages: traditional IRAs may allow tax-deductible contributions depending on income and participation in employer plans, while Roth IRAs provide tax-free qualified distributions in retirement when certain conditions are met. Your eligibility for tax benefits can depend on factors such as income level and filing status.
SEP IRAs for the Self-Employed and Small Business Owners
The SEP IRA (Simplified Employee Pension) is a retirement option commonly used by self-employed individuals and small-business owners. SEP IRAs allow higher contribution limits than a traditional IRA because the contributions are based on business income. For example, in 2019 the maximum contribution limit was $56,000, but this amount is generally limited to a percentage—commonly up to 25 percent—of your business-reported income. SEP IRAs are a flexible choice for business owners who want to make larger tax-deferred contributions in profitable years and scale back in leaner years.
Other Retirement Options
There are other retirement account types and variations—such as SIMPLE IRAs, solo 401(k) plans for self-employed individuals without employees, and various employer-sponsored defined benefit plans—but most savings flow into the accounts described above. Each account type has unique features, contribution rules, tax treatment, and distribution requirements, so choosing the right option depends on your employment status, income, retirement goals, and tax situation.
Before making decisions, always consult with a qualified tax professional or certified financial advisor who can review your individual circumstances and help you choose the most appropriate retirement strategy. A professional can clarify current contribution limits, tax implications, eligibility rules, and investment options tailored to your goals.
The content of this article is for informational purposes only and is not a substitute for professional financial advice. Always seek the guidance of a certified financial advisor or other qualified professional with any questions about personal finance, investing, or retirement planning.