Choosing a retirement plan can seem like a complex and daunting task. Here are answers to some of the most frequently asked questions about retirement accounts and planning for your retirement:
Q: What is a "qualified" retirement plan?
Qualified plans for retirement are whatever the IRS decides they are, but generally are special accounts that qualify for favorable tax treatment. Typically, it means the money you contribute to the account will not be taxed until the money is later withdrawn. So even though you "earn" money, if you place it in a qualified account, it will generally not be taxed, or will be taxed more favorably. The end result is that you earn tax-free, or nearly tax-free, money, which can add up to tremendous savings in the long term.
Q: What are 401(k) plans?
401(k)s are the most well-known and popular qualified retirement plan. 401(k)s derive their name from the relevant tax code (section 401, subsection k), and were designed to encourage people to save for their retirements.
401(k)s are popular with employers because the majority (or all) of the contribution comes from the employee. Traditional plans are extremely expensive, so using a 401(k) allows an employer to still provide employers with a retirement with far less cost. "Matched" 401(k)s are retirement accounts where an employer agrees to match the employee contribution up to a set amount (e.g., if the employee contributes $1,000, then the employer also contributes $1,000).
Employees like 401(k)s because the contribution they make from their salary is income tax free. Assuming an employee makes $50,000, if he makes $5,000 worth of contributions in a tax year to his 401(k), his actual income for income tax purposes will only be $45,000. The more an employee contributes, the lower his tax bracket can be.
Q: What are IRAs?
IRA stands for Individual Retirement Account and unlike a 401(k) is not a "qualified" plan. This does not mean it doesn't have favorable tax treatment, but rather the distinction to the IRS is that 401(k)s are created by employers, whereas an IRA is established by an individual.
There are a few different types of IRAs, such as Simple and Roth IRAs, which have different attributes and qualities, so investigate which type of IRA makes sense for you.
Q: What are Keogh plans?
Keogh plans are retirement plans intended for self-employed people. They are a "qualified" plan like a 401(k), and since you are self-employed, you the employer are setting it up. They function somewhat like a 401(k), but are generally more limited in terms of the contributions the individual can make. This is largely because the definition of "compensation" differs for general employees versus the self-employed.
Q: I hear the term "vested" used in retirement plans. What does it mean?
"Vested" essentially generally refers to whether you can actually claim a benefit. If you are 50% vested, then you can only take 50% of a benefit. In terms of a retirement account, if you are only 50% vested in your account when you leave the company, then you can only take 50% of it when you go.
Q: Can creditors reach my retirement accounts?
It depends on which type of retirement account you have. Many plans, including most "qualified" plans, are exempt from creditors under the Employee Retirement Income Security Act (" ERISA") and are also protected in bankruptcy.
IRAs of any variety, and Keogh plans are not necessarily protected and are not covered by ERISA. Many states, however, protect some of these plans or limit creditor's access to these plans, so check to see whether your state offers any protection.
Q: I work for a company offering a retirement account, but also own my own business. Can I set up multiple accounts?
Yes you can. However, there are overall contribution limits, which means that if you are contributing to your 401(k), it may reduce how much you can contribute to your own business retirement account. You have to coordinate the accounts to make sure you are complying with contribution limits.
Q: What other some other typical retirement accounts?
Other common retirement accounts include:
If you have additional questions about retirement plans, see FindLaw's Retirement Planning section.