How to Choose the Right 401(k) Plan
We all have different ideas of what we want for retirement. Some want to retire early, while others plan a more traditional retirement. Regardless of the type of retirement, it requires a plan to get there. Retirement planning puts your goals and dreams into action. There are many great retirement account options from which to choose. There are individual retirement accounts (IRAs), 401(k) plans and so forth, each with different variations. On the surface, it wouldn’t seem to matter which retirement plan you select. That is not the case. To maximize your retirement planning, you need to choose the account option that’s best for your needs.
Keep Taxes in Mind
Taxes are an important part of retirement planning. Just as you should diversify your investments, you want to be properly diversified from a taxation perspective. In some cases, you get the tax benefit in your current tax year, though you will be taxed upon withdrawing the funds in retirement. In other cases, you get the tax benefit upon withdrawal and not in the current year. When in doubt of which to choose, speak with a tax professional to determine what’s best for you. That being said, taxes play a significant role in what kind of 401(k) plan you choose for your business. (For more, see: Which Retirement Plan Is Best?)
The traditional 401(k) is the most common 401(k) offered to most employees. A traditional 401(k), much like a self-directed traditional IRA, allows you as an employee to contribute pre-tax funds each pay period. The Internal Revenue Service (IRS) allows you to contribute a maximum of $18,000 a year, as of 2015, and an additional catch-up contribution of $6,000 if you’re 50 or over. The amount you put away is always your money and can be rolled over into other plans. The amount an employer matches may be yours as well though this depends on their particular vesting schedule.
A Roth 401(k), just like the self-directed Roth IRA counterpart, allows you as an employee to make after-tax contributions. This allows you to take the tax benefit upon retirement. The Roth 401(k) was introduced in 2006 as a way to give employees additional options for retirement savings. More companies are offering Roth 401(k) plans, especially larger companies. While contribution limits are the same as the traditional 401(k), there is debate as to which is best. Make sure to do your homework before choosing between the two. (For more, see: An Introduction to the Roth 401(k).)
A Solo 401(k), which is also known as an Individual 401(k), is a plan intended for small business owners. The plan is meant for businesses with no employees or a business run by two spouses. Like the traditional 401(k), participants can contribute $18,000 per year, as of 2015. One key difference the IRS allows is to contribute 25% of compensation that is defined by your particular plan. This creates an opportunity for small business owners to potentially put aside a significant amount of money for retirement. While they miss out on a 401(k) match, they can put away more in this plan. (For more, see: Business Owners: Rules for Qualified Retirement Plans.)
A Simple 401(k), like the Solo 401(k), is designed for small businesses. However, the Simple 401(k) is meant for firms with 100 or fewer employees who made at least $5,000 in compensation during the prior year. Thus, this plan is intended for small firms with employees. It’s important to note, however, that the firm may not offer any other type of retirement plan if they choose to offer a Simple 401(k). The IRS allows employees to contribute $12,500 per year, as of 2015, to a Simple 401(k). Those aged 50 and older may contribute an additional $3,000 per year. (For more, see: Retirement Plan Options for Small-Business Owners.)
The Bottom Line
There are many things to consider when you choose a 401(k) plan. If you are a small business owner, you need to project ahead to determine if you will ever have employees. For the individual, you need to determine how taxes play into your decision. Take your time in choosing a 401(k) plan so you can best position yourself for retirement. (For more, see: The Best Retirement Account for You.)