We all want to do what we can to start preparing for retirement (even if it seems like it’s WAY off on the horizon). Retirement planning is something we should all be doing right from our first job until we’re ready to say goodbye to the grind.

Now, of course, many of us don’t start preparing for retirement until much further down the road (when the horizon seems to be getting closer and closer). If you don’t feel like you’ve adequately prepared yet, don’t worry. I’m going to breakdown the most common retirement planning strategies to help you figure out exactly where you stand.

Like most of us, you’ve probably heard terms thrown around like stocks and mutual funds. Maybe you hold company stock in your retirement account, which seems great, right? But what exactly do you DO with that stock when you’re ready to retire?

Here’s everything you need to know about preparing for retirement using the most common retirement plans. Maximize your knowledge so you can maximize your savings for the future you want!

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1.     Planning for Retirement with a 401(k)

401(k) plans are often the retirement planning strategy people are most familiar with. The 401(k) is available through many “for-profit” and “nonprofit” organizations. The wide-spread availability explains why nearly everyone has heard of this type of retirement plan.

The following criteria are the standards for a 401(k):

  • Eligible employees are at least 21-years-old with at least one year of employment (though some employers may be less restrictive).
  • Eligible employees can contribute $19,500 (for 2020). If the employee is 50-years-old and above, they may contribute an additional $6,500 catch-up contribution.
  • There may also be the following considerations for eligible employees:
    • Employer matching
    • Loan provisions
    • Roth 401(k) contributions allowed
    • 10% IRS penalty for early withdrawals (exceptions may apply)

In a 401(k), you make regular contributions to your retirement plan from each paycheck on a pre-tax basis. Now, this pre-tax opportunity is important and just one of the reasons why you should take advantage of a 401(k) if your employer offers it.

The other, even bigger reason to take advantage is if your employer offers a “company match,” meaning they match your contribution up to a certain percentage. For example, if your company match is 4%, if you contribute 4% (again, pre-tax) from your paycheck into your 401(k) account, your company will match your contribution. Now, if you contribute 10% into your 401(k), your company will still only contribute up to the 4% match cap. But you should absolutely take advantage of the company match — this is what we call “FREE MONEY!”

I can’t stress the importance enough — If your company offers to match, please, please, please contribute up to at least that matched amount. If you don’t, you’re just giving away all that free money year after year.

Whatever you’ve contributed to your account is 100% yours, with no vesting schedule. But if your employer has a match, most likely, there is what’s called a “vesting schedule.” The 4% match they’re contributing to your 401(k) isn’t all yours until you’re fully vested.

What does that mean? Well, let’s say you’ve been with a company for three years and put in $5,000 per year. If the company has a five-year vesting schedule, but you leave at the end of the third year, you take your $15,000 (which has hopefully grown based on your risk tolerance and investment allocation). But the company’s contributions are on a 5-year vesting schedule, based on their matching contribution of 4% (20% vesting each year = 100% at the end of year five). Then on year three, you’d only be 60% vested of what their matching contributions were, so you can only take a portion of the employer match.

So, if your company has a 401(k), be sure to take advantage (even if you don’t plan to be with the company for years to come. You can always roll your 401(k) over into an IRA or another retirement planning vehicle when you leave. Don’t pass up on FREE MONEY!

2.     Preparing for Retirement with a 403(b) Plan

A 403(b) plan is another retirement planning option commonly used by 501(c)(3) nonprofit organizations and some public schools. These retirement planning options are accessible for teachers, instructors, or professors, and are similar to a 401(k).

The following criteria and standards usually apply to a 403(b):

  • Typically, all employees are eligible.
  • Employees can contribute $19,500 (for 2020). If the employee is 50-years-old and above, they may contribute an additional $6,500 catch-up contribution.
  • There may also be the following considerations for eligible employees:
    • Employer matching
    • Loan provisions
    • Roth 403(b) contributions allowed
    • 10% IRS penalty for early withdrawals (exceptions may apply)

I want to touch on the “catch-up” provision just a little bit more. As with the 401(k), the catch-up option allows anyone 50-years-old and up (such as yours truly) to add $6,500 (per year) into your retirement account.

The catch-up provision is a great retirement planning option when you haven’t saved quite as much as you would like leading up to retirement. When this catch-up money is funneled into your retirement plan, it reduces your taxable income by the amount you contributed! SCORE!

3.     Retirement Planning with a Governmental 457(b) Plan

A governmental 457(b) plan applies to any state or local government entity. When I think of the 457(b), I automatically think of all the sheriffs I’ve had as clients. Such a fantastic group of people! I’m glad that there’s this excellent retirement planning option offered by most governments and municipalities.

The following criteria and standards usually apply to a 457(b):

  • Eligibility is generally at the employer’s discretion.
  • Employees can contribute $19,500 (for 2020). If the employee is 50-years-old and above, they may contribute an additional $6,500 catch-up contribution.
  • There may also be the following considerations for eligible employees:
    • Employer matching
    • Loan provisions
    • Roth 457(b) contributions allowed
    • 10% IRS penalty for early withdrawals (exceptions may apply)

Like the teachers and nonprofit workers who need to catch-up their 403(b) retirement account, the government workers and sheriffs can also use a catch-up provision to help retirement planning with their 457(b) account.

4.     Using a Simple IRA Plan for Retirement Planning

A simple IRA is another excellent retirement planning option. Simple IRAs are employer-sponsored retirement accounts that apply to for-profit, nonprofit, or government organizations with less than 100 employees.

The following standards and criteria are typical for a simple IRA:

  • Eligibility for those employees who have had at least $5,000 of compensation in any two previous years of service, and  who anticipate their salary of at least $5,000 in the current year.
  • Employees can contribute $13,500 (for 2020), or $16,500 (for 2020) for employees 50-years-old and above.
  • There may also be the following considerations for eligible employees:
    • Employer contributions are required
    • No loan provisions
    • No Roth contribution option
    • 25% penalty on early withdrawals during the first two years; 10% penalty after that (exceptions may apply)

As a professional, I don’t see many simple IRA retirement plans around anymore, but it certainly doesn’t mean they don’t exist! They definitely do. As you can see from the basic simple IRA criteria above, there are more restrictions than other retirement planning options, but they’re also available on a much smaller scale.

 5.     Profit-Sharing Plan for Retirement Savings

This next grouping of retirement planning option is a little different, in that the employer is the sole contributor; this is particularly obvious with the profit-sharing plan. Profit-sharing plans are offered primarily in for-profit organizations, though nonprofits and government employers may also establish a profit-sharing plan.

Profit-sharing plans are useful for preparing for retirement. It’s important to be aware that any contributions made to this plan are solely at the discretion of your employer. I’ve had clients who felt that the contributions made into their company’s profit-sharing plan weren’t nearly what they expected based on how well (they thought) the company was doing. So, while profit-sharing plans are useful, I would caution against using them as your sole method of retirement planning.

The following standards and requirements are typical for profit-sharing plans:

  • Eligible employees must have worked for the company for two years at a minimum of 1,000 hours of service per year, if there is immediate vesting (with a vesting schedule, one-year and 1,000 hours of service are the typical requirement).
  • The employer pays 100% of compensation, up to $57,000 (for 2020). The employer’s deduction is capped at 25% of eligible payroll.
  • There may also be the following considerations and features:
    • Employer contributions are discretionary
    • Loans may be available
    • May feature a vesting schedule
    • The employee usually directs investments

6.     SEP Plans for Retirement Planning

SEP (Simplified Employee Pension) plans are typically available at for-profit, nonprofit, and government organizations. When I think of a SEP plan for retirement, I always think of small businesses. I believe these retirement plans work quite well when you’re a small family business/owner, wanting to provide a retirement plan for your family members. Of course, SEP plans work well in other areas where it’s applicable, but they work exceptionally well in the family small business niche.

The following standards and features are typical of SEP plans:

  • Eligible employees are 21-years-old and above.
  • Eligible employees have performed service in at least three of the prior five plan years and received at least the required minimum compensation in the current year; the minimum compensation is $600 (for 2020).
  • Employer pays 25% of compensation, up to $57,000 (for 2020).
  • There are also the following features of SEP plans:
    • Employer contributions are discretionary
    • No loan provisions
    • Immediate vesting
    • The employee always directs investments

7.     Saving for Retirement with a Pension or Defined Benefit Plan

Many of us have heard the term “pension.” It seems like an old school retirement planning tool, but it’s still around. Pensions and defined benefit plans are available in for-profit, nonprofit, and government organizations.

Pension plans are the king of kings when it comes to employer-sponsored retirement plans. These are the old gold standard. But you’ll find fewer and fewer pension plans offered as you pursue new job opportunities and explore the retirement benefits. It’s almost as if pension plans are on the verge of extinction.

Remember back in the day (waaay back) when dear ol’ Dad (or now Grandpa) would work at the same company for 30 years? He would attend a retirement party, thanking him for all those years of dedicated service where they would gift him with a gold watch. From there, he would sail into the sunset and start collecting on his pension.

You might recall the free money we were talking about earlier? With this employer-sponsored retirement plan, you don’t add a dime! However, your employer must!

So what is a pension? Some features and criteria of pension plans are:

  • Employees are eligible to participate with one year and 1,000 hours of service.
  • Contribution limits are the lesser of $230,000 or 100% (for 2020) average compensation for the highest three consecutive years.
  • Additional features of a pension plan typically include:
    • Mandatory employer contributions
    • Loans are allowed, but usually not available
    • May include a vesting schedule
    • Employer directs investments

Pensions are now few and far between, as far as retirement planning goes. But if you find a company that offers a pension plan, and you absolutely love the job (and better yet, they love and respect you right back), jump on it!

As more people retire, companies have to pay those people every year, and the margin of return on many businesses isn’t enough to sustain that payout. It’s become expensive for large companies to continue paying.

Now for a disclaimer about companies who still offer this type of retirement plan. You may find that some of those great benefits are grandfathered in, which means YOUR benefits as a newcomer may be slightly different. Regardless, it’s a retirement plan that you’re not funding, so who wouldn’t love that?!

Hopefully, this guide to preparing for retirement has given you some clarity on the types of retirement plans out there, what they offer, and the differences. Take advantage of these plans, even if retirement seems far off — I promise it will be here before you know it!

If you’re ready to get financially organized or take your finances to the next level, I’m happy to schedule a consultation with you. Click here to learn more about my financial consultation services. Together, we will help you get control of your finances so that they won’t control you!