A retirement plan is a form of investment used to replace employment income after retirement. It may be set up by an individual, their employer, the government, trade unions, or other institutions.
The US Congress has created a number of tax incentives to encourage responsible retirement planning. There are several different types of retirement plan in the United States today, each with their own advantages and disadvantages. Here’s what you need to know:
Some employers offer employees 401(k) plans. This workplace retirement account enables workers to contribute a percentage of their pre-tax paycheck to tax-deferred investments, reducing the amount of income tax they pay during that tax year. For example, if an employee earns $50,000 and contributes $5,000 to their 401(k) plan, they would only be taxed on the remaining $45,000.
Investment gains are tax free until the investor begins drawing distributions from their 401(k) plan. If an investor draws distributions from a 401(k) plan before reaching the 59 1/2 years of age, they will usually incur a 10 percent penalty, with distributions also incurring state and federal taxes, subject to limited exceptions.
Some employees match employee 401(k) plan contributions, typically up to 6 percent. Employees who do not contribute up to the company match miss out on a significant employee benefit, effectively turning down “free money.”
Investment choices for 401(k) plans are generally limited and management fees can be high. Contributions to 401(k) plans are limited by the IRS, but are more generous than many other retirement plans. As of 2021, 401(k) plan contributions were capped at $19,500 per year for those aged under 50, and $26,000 for those aged 50 or older.
Individual Retirement Accounts (IRAs)
This tax-favored retirement plan can be used to invest in stocks, ETFs, mutual funds, bonds, and other types of investments. With an IRA, savers may either make investment decisions themselves, hire an expert to do it for them, or choose index funds that track certain aspects of the market.
This popular mode of investment is appropriate for individuals whose employer does not offer a 401(k), or those who have reached their annual 401(k) contribution limit. The contribution limit on IRAs is significantly lower than that on 401(k) Plans. As of 2021, retirement savers aged under 50 could invest $6,000 annually in IRAs, rising to $7,000 for those aged 50 or older.
Traditional IRA contributions are typically tax deductible for those who do not have a 401(k) Plan. Roth IRA contributions are made with post-tax income, but no income tax will be assessed on that income in retirement. As with a 401(k) Plan, investors who draw distributions before reaching the age of 59 1/2 incur financial penalties, attracting taxes on distributions plus a 10 percent early withdrawal fee.
Malta Pension Plans
Hailed as the new, supercharged IRA, Malta Pension Plans have significant advantages over traditional retirement savings vehicles. Unlike 401(k) Plans and IRAs, there is effectively no annual limit on Malta Pension Plan contributions.
Additionally, Malta Pension Plan distributions are generally permitted from the age of 50, at which time the investor can draw up to 30 percent of their pension plan value as a single lump sum payment.
One major advantage of Malta Pension Plans is that investors can invest non-cash assets—such as stocks, real estate, and even works of art—without liquidating them first, conferring significant tax-deferment potential.