Your 2019 Guide to Retirement Plans

Maurie Backman, Contributor, The Motley Fool
February 8, 2019

If your goal is to retire with enough money to live comfortably, it's important to regularly assess your retirement planning; questioning how you're socking away funds can help ensure you're on the right track in building your nest egg. In addition, different life stages might require a different retirement plan suited for long-term goals. Here's a guide to analyzing your retirement account options and saving strategically for the years to come.

What are the different types of retirement accounts?

Retirement savers have a host of tax-advantaged plans to choose from, and with contribution limits rising across the board in 2019, it's easier than ever to boost your long-term cash reserves. Following are the types of retirement plans you might have access to in 2019, and we'll define them and discuss their respective contribution limits for 2019. Then we'll dive into how to make the most of these accounts in planning for your retirement by leveraging the power of compounding over time and tax advantages.

  • Traditional 401(k)
  • Roth 401(k)
  • 403(b)
  • Traditional IRA
  • Roth IRA
  • SEP IRA
  • SIMPLE IRA
  • Solo 401(k)

Traditional 401(k)s

If your company offers a 401(k) plan, you have a real opportunity to not only save a bundle for retirement in 2019 but also lower your tax bill. That's because traditional 401(k) contributions are made with pre-tax dollars, and your tax savings are a function of your effective tax rate -- meaning if you put $5,000 into your plan this year and your effective tax rate is 25%, you'll shave $1,250 off of your 2019 taxes.

The flipside to this up-front tax break is that you're not allowed to access the money in your 401(k) until you reach age 59 1/2, and once you withdraw money, it becomes taxable in the year you take it. Your money grows on a tax-deferred basis during your career so that you're not paying taxes on your investment gains year after year.

Keep in mind that once you turn 70 1/2, you'll be on the hook for required minimum distributions or RMDs. This is an amount you must withdraw from your accounts each year, and it's calculated based on your account balance coupled with your life expectancy. Like all traditional 401(k) withdrawals, the RMD is subject to taxes.

How much can you save in this account? The annual contribution limit for 401(k) plans in 2019 in $19,000 for workers under 50, and $25,000 for those 50 and over, since older workers are able to put away $6,000 in catch-up contributions.

If you can't max out these limits, contribute at least enough to get your full employer match. Most companies that sponsor 401(k)s also match employee contributions up to a certain degree. For example, an employer might contribute up to 3% of a worker's salary, provided that worker puts in 3% of their own money as well. Therefore, while you're only allowed to contribute up to $19,000 to a 401(k) in 2019 if you're under 50, or $25,000 if you're 50 or older, your total 401(k) contributions for the year might exceed that figure if your employer puts in matching dollars as well.

Roth 401(k)s

The 2019 contribution limits for Roth 401(k)s are the same as those of traditional 401(k)s: $19,000 for workers under 50, and $25,000 for those 50 and over. Roth 401(k)s, however, work a little differently from their traditional counterparts in that they're funded with post-tax earnings. As such, there's no immediate tax break for making contributions, but you don't get taxed later on.

Roth 401(k)s get to grow tax-free, and withdrawals, which can be taken starting at age 59 1/2, aren't taxed in retirement. Benefits include not having to worry about taxes during your golden years. Also, once RMDs become mandatory, these withdrawals won't create an additional tax burden for you in retirement. If you think you'll be in a higher tax bracket in retirement than you're in at present, then a Roth 401(k) might make sense for you, provided your employer's plan has a Roth savings option -- not all 401(k) plans do.

403(b)s

Many folks are familiar with 401(k) plans, but 403(b)s, not so much. A 403(b) works just like a 401(k), only it's a savings plan that's available only to certain types of employees -- specifically, educators, medical professionals and folks who work for nonprofits. The 2019 contribution limits for 403(b)s are the same as those of 401(k)s: $19,000 for workers under 50, and $25,000 for those 50 and over.

Workers with 15 years of service also get special provisions that allow them to boost their contributions. For 2019, that increased limit is the lesser of either (a) $3,000, or (b) $15,000, reduced by the number of additional contributions made in previous years because of this rule, or (c) $5,000 times the number of the employee's years of service within a given organization, minus total contributions made for earlier years.

Traditional IRAs

If you don't have access to an employer-sponsored retirement plan, an individual retirement account, or IRA, is generally your next best bet. Traditional IRAs work similarly to traditional 401(k)s -- contributions are made on a pre-tax basis, but withdrawals, which become available starting at age 59 1/2, are taxable during retirement. Traditional IRAs also enjoy tax-deferred growth, and RMDs kick in at 70 1/2.

The primary difference, however, lies in the fact that traditional IRA contributions limits are substantially lower than those of 401(k)s. For 2019, workers under 50 can contribute up to $6,000, while those 50 and older can contribute up to $7,000. Since IRAs aren't tied to an employer, there are no matching dollars to factor in; all of the money in your IRA comes from you. You can open an IRA at a bank or financial institution -- either in person or online.

Roth IRAs

The annual contribution limit for Roth IRAs in 2019 is the same as for traditional IRAs: $6,000 for workers under 50, and $7,000 for those 50 and over. Like Roth 401(k)s, Roth IRA contributions are made with after-tax dollars, so there's no immediate tax break to enjoy. Once funded, however, Roth IRAs grow tax-free, and withdrawals aren't subject to taxes. Furthermore, Roth IRAs are the only tax-advantaged retirement plan out there that don't impose RMDs, which means that if you save in one, you'll have the option to leave your money alone to grow indefinitely and pass it on to your heirs.

The primary drawback associated with Roth IRAs is that higher earners can't contribute to them directly. This is what Roth IRA income limits look like for 2019:

Tax Filing Status

Contributions Phase Out Once Income Exceeds:

Contributions Are Barred Once Income Exceeds:

Single, head of household, or married filing separately (and you didn't live with your spouse during the year)

$122,000

$137,000

Married filing jointly or qualifying widow/widower

$193,000

$203,000

Married filing separately (and you lived with your spouse at any point during the year)

$0

$10,000

DATA SOURCE: IRS.

If you're barred from contributing directly to a Roth IRA because of your earnings, you can put money into a traditional IRA and then convert it to a Roth after the fact. You'll then need to pay taxes on the sum you convert, but from then on, you'll get the same benefits as those who save in Roth IRAs off the bat.

SEP IRAs

If you're self-employed, there are a few extra tax-advantaged retirement plans that may be available to you, like the SEP IRA. Short for "simplified employee pension," a SEP IRA is a retirement plan designed for independent workers and small-business owners, and it offers one key advantage over traditional and Roth IRAs: higher annual contribution limits. For 2019, you can contribute up to 25% of your net business earnings -- your earnings minus your business expenses, SEP contribution, and half of your self-employment taxes -- for a maximum of $56,000.

An important thing to know about saving in a SEP is that if you're a small-business owner with employees, you must make the same contributions, in percentage terms, to your workers' accounts as you do to your own. If you set aside 15% of your earnings in a SEP, for example, you'll need to contribute 15% of each employee's earnings to his or her account as well, which could get expensive for you. But if you work for yourself and don't have employees, this won't be a concern.

Otherwise, SEP IRAs work like traditional IRAs: Contributions go in tax-free, growth is tax-deferred, withdrawals become available at 59 1/2, and RMDs begin at 70 1/2.

SIMPLE IRAs

Another option for self-employed folks is the SIMPLE IRA. Short for "savings incentive match plan for employees," the SIMPLE IRA is a retirement account designed for self-employed workers, and like the SEP, its contribution limits are higher than those of a traditional or Roth IRA.

For 2019, you can contribute up to $13,000 to a SIMPLE IRA if you're under 50, or $16,000 if you're 50 or older. If you run a small business and employ other people, you must offer matching contributions for their accounts in one of two manners. You can either match employees' contributions directly up to a maximum of 3% of their compensation or contribute a fixed 2% of their compensation.

Another thing you should know is that if you're self-employed, you can contribute to your own account as both an employer and employee. That means you can put in up to $13,000 or $16,000, depending on your age, but also match your own contributions as per the aforementioned rules. For example, if you're 45, earn $75,000 a year, and decide to max out your SIMPLE IRA at $13,000, you can also contribute another 3% of your earnings, or $2,250, on top of that $13,000.

Like SEP IRAs, SIMPLE IRA contributions go in tax-free. Growth is then tax-deferred, withdrawals become available at 59 1/2, and RMDs become mandatory at 70 1/2.

Solo 401(k)s

Though 401(k) plan participation often hinges on having an employer who sponsors such a plan, folks who are self-employed can save for retirement in a Solo 401(k), which you open and manage yourself.

Solo 401(k)s work just like traditional 401(k)s -- contributions go in tax-free, growth is tax-deferred, withdrawals start at 59 1/2, and RMDs kick in at 70 1/2. The main difference is that the annual contribution limits are significantly higher than those of traditional and Roth 401(k)s. For 2019, you can contribute up to 25% of your self-employment income -- minus your business expenses, plan contribution and half of your self-employment taxes -- for a maximum of $56,000 if you're under 50, or $62,000 if you're 50 or older.

Which retirement plan is right for you?

Now that you're familiar with your retirement plan options for 2019, the question becomes, which plan best serves your needs? Generally speaking, if you have the option to participate in a 401(k) with an employer match, it makes sense to put your money there, as opposed to opening up an IRA. That's because you might get free cash from your employer, provided you contribute enough to get that match. That said, Roth IRAs offer the major advantage of not imposing RMDs, so even if you have a 401(k), it might pay to divert some income into a Roth IRA as well.

One thing you should know about 401(k)s is that they generally offer a narrower range of investment options than IRAs. In a 401(k), you might be limited to a few dozen mutual funds to select from, whereas if you save in an IRA, you might have far more choices, including funds and individual stocks and bonds, which you won't find in 401(k) plans.

Why are investment choices important? Well, for a couple of reasons. First, the more options you have, the easier it'll be to find investments that align with your goals and tolerance for risk. Just as importantly, having more choices makes it easier to avoid hefty investment fees -- fees that can ultimately eat away at your returns. Actively managed mutual funds tend to charge the highest fees since you're paying for the expertise of a manager who's constantly overseeing that fund. Index funds, by contrast, are passively managed; they simply track existing market indexes, like the S&P 500, and as such don't tend to charge the same fees.

Another important thing to do, no matter what type of account you save in, is diversify your investments. That means putting money into various sectors of the market, as opposed to loading up on a single type of security, and allocating your retirement assets so that you have some money in stocks, but also some in bonds.

The younger you are when you start saving for retirement, the more of your assets you should feel comfortable putting into stocks. As retirement nears, however, you'll want to shift into more conservative choices, like bonds, because if the market has a couple of bad years, you'll have an easier time recovering -- or, rather, you probably won't lose as much to begin with.

To figure out how much of your portfolio should be in stocks versus bonds, a good formula is to take your age, subtract it from 110, and put that percentage of your assets into stocks. For example, if you're 40 years old, you should have about 70% of your retirement savings in stocks. But there is some wiggle room here. If you're really risk-average, you might limit your portfolio to 60% stocks. And if you're not afraid of risk at all, you might go as high as 90% of your portfolio in stocks.

If you're self-employed, consider the benefits and drawbacks of the SEP IRA versus the SIMPLE IRA versus the Solo 401(k). Both IRA types will give you a vaster array of investments than you'd get with a Solo 401(k), but ultimately, Solo 401(k)s let you save the most if you're older and are a higher earner. And if you own a small business and have employees, funding a SEP could get costly if you're seeking to contribute a fair amount to your own account. The good news, however, is that you don't necessarily have to limit yourself to a single retirement plan, though doing so will make it easier for you to keep tabs on your savings.

How much should you save for retirement in 2019?

As a general rule, you should always aim to set aside 15% to 20% of your earnings for the future. That means if you earn $80,000 in 2019, you should, ideally, aim to save $12,000 to $16,000. That said, saving any amount is better than saving nothing at all, so if that 15% to 20% target isn't doable, pledge to at least do better than you did the previous year.

Of course, if you're earning $80,000 a year but have the ability to max out a 401(k), you should go for it. There's certainly nothing wrong with saving above that 15% to 20% threshold, and if you put that money into a traditional 401(k), you'll get an even larger tax break up front. Similarly, if you're older and behind on savings, it pays to push yourself to make those catch-up contributions -- even if doing so puts you well beyond 20% of your 2019 income.

Save now; enjoy retirement later

If you've yet to start saving for retirement, make 2019 the year you ramp up. That's because the more time you give yourself to grow your savings, the more you'll get to take advantage of compounding growth.

Compounding is the concept of earning interest on previous interest. When you invest your retirement savings and make money on your investments year after year, you get to reinvest those gains in full rather than lose a portion of them to taxes along the way -- hence the tax-deferred or tax-free growth we talked about before. As such, you get to make additional money from those gains. The following table illustrates how compounding in a tax-advantaged retirement plan can help you accumulate wealth:

If You Start Saving $300 a Month at Age:

Here's What You'll Have by Age 67 (Assumes a 7% Average Annual Return):

22

$1.03 million

27

$719,000

32

$498,000

37

$340,000

42

$228,000

Data source: CALCULATIONS BY AUTHOR.

Giving yourself a 45-year window during which to save gives you more opportunity to capitalize on compounding than by waiting. In our example, saving $300 for 45 years means contributing $162,000 out of pocket. But thanks to compounding, that $162,000 ultimately turns into over $1 million. Saving $300 for 25 years, on the other hand, means contributing $90,000 out of pocket and ending up with $228,000. That's still a decent gain, but nowhere close to the gain we considered a moment ago.

Another thing: The 7% average annual return is a couple of percentage points below the stock market's historical average. If you go heavy on stocks during your savings window, there's a good chance you'll score that sort of return or higher.

Of course, $300 a month, or $3,600 a year, is probably nowhere near the 15% to 20% savings threshold we talked about earlier unless you're a low earner. The point, however, is to illustrate the power of compounding so you're more motivated to save at present. Regardless of whether you save for retirement in an IRA, a 401(k), or a combination of both, the more money you set aside in 2019, the more you'll be doing to set yourself up for the retirement of your dreams.

 

This article was written by Maurie Backman from The Motley Fool and was legally licensed through the NewsCred publisher network. 

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