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Which Type of Retirement Account Should You Open?


Unless you want to work until the day you die, planning for your retirement is a must. There are a number of ways to get ready to retire, but you’ll generally need to open a retirement account to save the money you need. That way you can spend your golden years traveling, relaxing and enjoying your family instead of stuck behind a desk or starting a second career as a retail greeter. Here are some of the retirement account options you may have the ability to use and why each of them may or may not make sense for you.

A financial advisor can help you put a financial plan together for all of your retirement needs and goals.

Workplace Retirement Accounts

Workplace retirement plans are the first bucket of retirement accounts we’ll cover. If your employer offers a workplace plan, you at least should contribute enough to get the free money the company offers in an employer match.

Many workers in the private sector have access to 401(k) plans, which employers often offer as part of a benefits package. Employees can choose whether or not to participate in the plan. The 401(k) itself is essentially a shell for pre-tax money, which you then decide how to invest. Exchange-traded funds (ETFs) and mutual funds are the most common investment choices.

The tax-deferred status of a 401(k) is one of the biggest advantages that this retirement account option offers. Instead of paying taxes now, you pay them in retirement. You’ll likely be in a lower income tax bracket then, resulting in a lower total tax bill. The other major advantage is that some companies offer employer matches. This means your employer matches your contributions up to a certain percentage, effectively giving you free money for your retirement.

A 403(b) plan operates very similarly to a 401(k) plan. You contribute pre-tax money and then choose how invest it. You also may get a match from your employer. The only real difference is that while 401(k) plans are generally for employees in the private sector, 403(b) plans are typically for government or non-profit employees.

Individual Retirement Accounts

An IRA (individual retirement account) is a good option if your employer does not offer a retirement plan or if you’ve already maxed out your 401(k) contributions. Notably, IRAs have much lower annual contribution limits than the typical workplace retirement account. While you can contribute up to $20,500 to a 401(k) in 2022, the maximum contribution you can make to an IRA is $6,000 per year.

There are several types of IRAs to consider depending on your needs. The first is a traditional IRA, which functions similarly to a 401(k). You contribute pre-tax dollars, which are then invested in various investments, including stocks, bonds and mutual funds. Unlike a 401(k) plan, your employer has nothing to do with your IRA. You can open one on your own with any financial institution that offers them. While your 401(k) contributions are taken out of your paycheck before taxes are withheld, you fund your IRA with a direct transfer from your bank account or with a check or cash. You’ll then deduct your contributions when you file your taxes each year.

Roth IRAs work in the same way as traditional IRAs, except when it comes to taxes. You fund a Roth IRA with after-tax dollars. This means you won’t have to pay taxes when you withdraw your money in retirement. The downside to this is that you may be in a higher tax bracket now than you would be in retirement. On the other hand, you will know exactly how much you’ve saved and won’t have to worry about how much taxes will eat into your retirement income, which can make planning a bit easier.

Retirement Accounts for the Self-Employed and Small Business Owners

SmartAsset: Which Type of Retirement Account Should You Open?

There is also a bucket of plans that make sense for the self-employed or for small business owners.

The SIMPLE IRA is a workplace account that’s only for small businesses. Though IRAs are traditionally for individuals, small business owners can set up a SIMPLE IRA for both themselves and their employees. It works similarly to other workplace plans, but it is not optional. If your boss sets up a SIMPLE IRA and you are eligible, you are automatically enrolled. The SEP-IRA is similar, but all contributions are made by the business owner, not by the employees themselves.

Those without employees can choose a solo 401(k). This plan mimics a 401(k) for the self-employed or business owners with no employees. A solo 401(k) maximizes your contribution amount, allowing you to contribute the maximum of $20,500 per year as an employee in addition to a maximum of 25% of your compensation as the employer.

Pension Plans

In a defined contribution plan, like those above, your contributions and investments determine your retirement payout. In a defined benefit plan like a pension, your payout is determined by how long you work at the company, your age and your compensation. Pensions are not particularly common anymore, but if you work at an older company or for the government there is still a chance you’ll get one.

You can’t really choose whether or not to use a pension, as it entirely depends on whether or not you work at a place that offers one.

Which Retirement Account Is Right for You?

The biggest factor in determining which type of retirement plan you use will be your own employment situation. Workplace plans and pensions are automatically out for those who don’t have access to one. In that case, you’ll have to choose between a Roth IRA or a traditional IRA. Make your choice based on whether you’d rather pay taxes now and know how much will be in your account when you retire, or if you’d prefer to defer tax payments and potentially pay a lower tax rate in retirement.

If you work at a big company, your job will likely offer a workplace retirement plan. You don’t have to use it, though. If there is no company match, you may prefer to open an IRA so that when you leave that job you don’t have to deal with a 401(k) rollover. If a match is available, though, you probably want to use the workplace plan so you get that extra money.

Self-employed people or small business owners have a number of choices. Consider taxes, your total number of employees and how much you personally want to contribute when you make your decision.

Bottom Line

SmartAsset: Which Type of Retirement Account Should You Open?

There are four main categories of retirement accounts to choose from: workplace retirement accounts, IRAs, accounts for the self-employed and small business owners and pensions. There are advantages and disadvantages to each, so you’ll need to think carefully about which option best suits your situation. Your employment status will determine a lot about your retirement account choices. If your company offers a match, you should definitely take advantage. And remember, you can always open more than one retirement account to maximize your savings.

Retirement Tips

  • If you need help saving up for retirement, consider working with a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • While you need a retirement plan, you’ll also get a check from the government each month. Check out how much you can expect to get with our free Social Security calculator.

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