An Overview of Retirement Plans

• 403(b)s
• 457(b)s
• SEP IRAs
• SIMPLE IRAs

How Retirement Plans Work

1. Set up an account: You establish a retirement plan account through your employer, a bank, a financial services firm, or an insurance company.
2. Contribute money to the account: Depending on the plan, you can contribute by deducting money from your paycheck at each pay period or by depositing money from your savings into your retirement account whenever you choose. The amounts you can contribute depend on several factors, including the plan’s contribution limits and your income.
3. Invest the money in your account: Most plans allow you to choose among various investment options, such as stocks, bonds, and mutual funds.
4. Sell your investments and withdraw money: Though you can withdraw money from a retirement account at any time, for most plans you’ll incur a 10% penalty for withdrawing money before age 59 1/2, unless you qualify for certain exemptions. Depending on the type of plan you have, you may or may not owe taxes at the time of withdrawal on gains (profits) you’ve earned from your investments in the account. Though early withdrawals may be penalized, you can buy and sell investments within the account at any time.

Why Invest in Retirement Plans?

Tax Advantages of Retirement Plans

• Up-front tax incentives: These include income tax deductions or credits that you receive immediately upon contributing to certain retirement plans. A tax deduction is an amount of money that you can deduct from your gross income in order to reduce your total tax liability. For instance, if you have $100,000 in gross income, and tax deductions worth $10,000, you’ll pay tax on only $90,000 of your income. A tax credit reduces your actual tax bill by a certain amount. For instance, if you owe $10,000 in tax and have a tax credit of $3,000, your tax bill would fall to $7,000.
• Tax-favored treatment of investment gains: Some retirement plans, called tax-free plans or Roth plans, allow you to pay no tax whatsoever on gains. Other plans, called tax-deferred plans, allow you to avoid paying taxes on gains until retirement. Some plans are available in two versions: a tax-deferred version and a tax-free (Roth) version.

Financial Discipline and Retirement Plans

Employer Contributions

• Employer matching contributions: The company contributes on an ongoing basis a certain percentage of the amount that you contribute.
• Profit-sharing contributions: The company makes a lump-sum contribution at certain intervals, such as every year or every six months.

How to Set Up a Retirement Plan Account

• Enrolling through an employer: Many employers sponsor, or offer, at least one type of retirement plan. These plans, known as employer-sponsored plans, include 401(k)s, 403(b)s, 457(b)s, SIMPLE IRAs, and SEP IRAs. In this kind of setup, you company’s human resources or benefits department works with an outside bank, financial services firm, or insurer to administer employee retirement plan accounts. Some companies automatically enroll all eligible employees in their plan, while others require you to opt in. If you need to opt in manually, you’ll be required to complete a few forms to set up an account. From there, you’ll likely work directly with representatives from the outside firm to set deposit amounts, select investments, check account balances, and so on.
• Enrolling through banks, financial services firms, or insurers: By establishing a retirement account with a bank, financial services firm, or insurance company, you can set up, invest in, and manage certain types of retirement plans entirely on your own. The most common types of plans that individuals invest in through banks, financial services firms, and insurers are IRAs (Individual Retirement Accounts). To enroll, you complete a few forms online, in person, or by mail and make an initial deposit (usually at least $500–1,000) to fund the account. You then need to decide, either on your own or with a financial advisor, which investments to make within your plan.