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Types of Retirement Funding

By Business & Finance Last updated Wednesday, June/12/2024

There are many ways to fund your retirement. While some people will rely entirely on the resources paid into Social Security funds, others are able to take advantage of the many types of supplemental retirement programs that allow you to save toward retirement through tax-sheltered accounts. Aside from government programs, retirement funding can be broken down into three main areas: employer-based plans, IRA funds and annuities.

Employer-Based Plans

An employer-based plan is a retirement plan that is set up by your employer and funded through either salary reductions or employer contributions or both. The IRS categorizes employer-based plans as being either IRA accounts, 401(k) plans, 403(b) plans or 457(b) deferred compensation plans. In these accounts, the employer must establish the plan and maintain the administrative costs. The type of plan an employer chooses may depend on the size of the company and number of employees it has.

Employer-based IRA plans include SIMPLE IRAs, SEP IRAs and payroll deduction IRA plans that the employer establishes for the employee, unlike personal IRA accounts. In most cases, employee contributions are pre-tax money with the funds added to ordinary income after age 59 1/2. Employer contributions are either 100 percent vested, meaning they are the employee's money at the time of contribution, or they must follow a vesting schedule. Vesting schedules are established by employers to encourage loyalty with employees, giving contributions to retirement funds but not allowing them to keep the assets until they have given a specified number of years of employment. Employee contributions are always 100 percent vested.

Outside of employer-based IRA plans, there are two types of IRAs that a person can fund to supplement retirement: traditional and Roth. Both types of accounts allow a person to contribute a maximum of $5,000 annually based on 2010 IRS regulations. If you are age 50 or older, you can make a "catch up contribution" of $1,000 allowing you to contribute a total of $6,000 per year.

Traditional IRAs fund the account with pre-tax dollars, allowing you to take a deduction in the amount of the contribution on your adjusted gross income. The money is added to ordinary income when you take distributions. The IRS mandates Required Minimum Distributions at age 70 1/2 on all traditional IRA accounts.

Roth IRA accounts are post-tax contributions, so they do not reduce your annual adjusted income in the year you make the contribution. The money must be held in the Roth IRA for a minimum of 5 years. When distributions are taken, the money is free of any tax liability as long as you are at least 59 1/2 years of age.

Annuities are a tax-sheltered investment structure offered through insurance companies. While an annuity can be an employer-based or personal IRA plan, it doesn't need to be. You can have a non-qualified annuity that gets a fixed income rate or invests in mutual funds that grows tax-deferred. The money you put in the account is not limited, so you can place large amounts in the account and allow it to grow. The principal does not receive a deduction on taxes but will not be taxed upon distribution, either. Only the earnings are added to ordinary income when you take funds out after age 59 1/2. As with all retirement plans, early distributions result in a 10 percent tax penalty on distributed funds.