When you are young, retirement may seem a concern for a very distant future. But don’t let perception fool you. There’s no better time than the present to start thinking about retirement: the sooner you start planning for it, the better off you’ll be when the time to retire comes.
In the US, once you reach 62 years of age and have worked long enough to be insured, you will receive a basic pension called the Old-Age and Survivors Insurance (OASI). However, most people choose to set up a private retirement pension fund to complement the OASI.
Retirement plans offer tax advantages to both employers and employees, and they guarantee a higher pension will be received at the moment of retirement. You may have to work for a specific number of years before you have a permanent right to any pension benefits under a plan. This is generally referred to as "vesting". If you leave your job before you are fully vested in an employer's defined benefit plan, you won’t be entitled to all of the plan's pension benefits.
There are many types of retirement plans, but the 2 most popular ones are the Defined Contribution Plans and the Individual Retirement Account (IRA).
Defined Contribution Plans are covered by the Employee Retirement Income Security Act of 1974 (ERISA) and are funded by the employee, the employer, or both. They do not promise a specific amount of money per month; instead, they usually set a rate of, for example, 5% of annual earnings to be invested on the employee’s behalf. This means that employees are left with the contributions plus or minus investment gains or losses. Some examples of defined contribution plans include the 401(k) plans, the 403(b) plans, the employee stock ownership plans, and the profit-sharing plans. Let’s take a closer look at the 401 (k) plan, the most popular one.
It is a cash or deferred arrangement in which employees accept to set aside a portion of their salary towards a retirement fund. Employees assume complete responsibility for setting up their retirement funds and increasing them by making their own investments. There’s a limit on how much of your salary you can defer per year. Learn more about it here.
There are 4 types of 401(k) plans:
The first decision you’ll have to make is whether to set up the plan yourself or consult a professional or financial institution - such as a bank, mutual fund provider, or insurance company - to help you establish and maintain the plan.
Broadly speaking, you must follow four steps to get a tax-advantaged 401(k) plan:
Every year, a plan’s annual report must be filed with the Federal government. This is known as Form 5500, which is generally completed and filed electronically by your employer or plan manager by using EFAST2-approved third-party software or using IFILE.
To learn more about form 5500 visit the official U.S Department of Labor webpage.
By the time you retire, you’ll be able to choose the way your pension will get paid. You can opt for:
The Individual Retirement Savings Account (IRA) is a U.S. savings plan aimed at contributing pre-tax dollars towards retirement. Unlike other types of savings plans that involve an employer, the IRA is managed entirely by the plan holder.
There are four main types of IRA:
They can be obtained through any institution approved by the Internal Revenue Service (IRS), such as a bank, an investment company, an online brokerage, or a personal broker.
Just like with Defined Contribution Plans, your trustee, or the issuer of your individual retirement arrangement (IRA) will need to file form 5498 with the Federal government to report annual contributions. Learn more about this here.
Once you have reached retirement age, you must contact the company where you have subscribed and arrange how you want to receive your payments with them. If you die before your IRA assets are exhausted, they will pass to the person you mentioned as your beneficiary when you set up the account. Because IRAs are meant for retirement savings, there is usually an early withdrawal penalty of 10% if you take money before your retirement age.
We hope the information we compiled has been useful. For more information on other types of Savings Retirement Plans, visit the official Internal Revenue Service (IRS) webpage.