10 Most Frequently Asked Retirement Plan Questions

It’s never too early to start thinking about your retirement, no matter your age. Here are answers to 10 of the most frequently asked retirement plan questions.

1. What is a retirement plan?

A retirement plan is created to provide income during retirement. Employers, governments, insurance companies, and trade unions often sponsor retirement plans. In some cases, a person may need to set up their own retirement plan if they do not have access to an employer-sponsored or other organization-sponsored plan.

2. What types of retirement plans exist?

How many different types of plans are even out there is one of the most common retirement plan questions that people have. There are three types of retirement plans:

Defined benefit plans
Defined contribution plans
Hybrid plans (these combine aspects of the defined benefit plan and the defined contribution plan)

3. What is a defined benefit retirement plan?

Defined benefit plans provide a fixed amount at retirement. The amount is based on the number of years the participant has been a member of the plan and the amount contributed to the plan. See the Internal Revenue Service website for more information on these plans.

These types of plans are often referred to as pensions. Often, the employee has a choice of taking the retirement payment in a lump sum, or taking annuitized payments over time.

Defined benefit plans were once more common in the United States. As they have grown more expensive for employers to provide, the defined contribution retirement plan has become more prevalent.

4. What is a defined contribution retirement plan?

Defined contribution plans provide a payout at retirement based upon the amount of money the participant contributed to the plan and that investment’s performance.

Typical examples of defined contribution plans include:

Regular 401(k)
Roth 401(k)
Traditional IRA
Roth IRA
IRAs for self-employed people (SEPS, SIMPLE IRAs, etc.)

Employers typically sponsor 401(k) plans; individual retirement accounts (IRAs) are self-directed retirement plans.

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5. How are contributions invested in retirement plans?

The way contributions are invested depends upon the plan and how it is administered. With an employer-sponsored plan, you may have a choice of investments within a defined pool.

For self-directed retirement plans, many investment options are available. These include:

Mutual funds
Stocks
Bonds
Regular savings accounts or certificates of deposit (CDs)
Money market accounts
Insurance annuities

A number of factors will influence your choice of investments. These include:

The amount of comfort you have with risk
The length of time you have until retirement
The performance of particular investments
The pool of choices available (for example, if you are investing in an employer-sponsored plan and your choices are limited to certain investments)

6. Do different plans offer tax advantages?

Some have tax advantages, while others do not. In addition, some have different types of tax implications, which will affect you differently depending upon your tax situation.

For example, the traditional IRA allows you to make pre-tax contributions. Tax is not paid on contributions until withdrawn at retirement.

The Roth IRA contributions are made after you pay tax on them. However, earnings on your contributions are never taxed. Similar differences exist between the Roth 401(k) and the regular 401(k).

7. How much can I contribute annually to a retirement plan?

Retirement plans governed by the tax code (such as 401(k) programs and IRAs) have contribution limits. The limits on 401(k) accounts are higher than IRA plans, and you may be able to contribute more to some of these plans if you are 50 years of age or older.

Check out the retirement plan section of the IRS website for more information on contribution limits.

8. When can I withdraw from my plan?

Early withdrawals (prior to retirement) usually result in penalties and taxes. It is generally best not to tap into retirement funds early. Know when you can safely withdraw from your plan and consult your employer or the IRS (www.irs.gov) for information about withdrawal details, penalties, and taxes.

9. How do I know how much to save in my plan?

You will need to decide:

How much you want to live on per year during retirement
At what age you wish to retire

Many excellent retirement planning calculators can help you figure out how much you need to be saving for retirement. These programs will factor in your:

Current age
Rate of inflation
Projected yield of your investments

Check out the myOrangeMoney tool for an example of a retirement planning calculator.

10. What is the best advice regarding retirement plans?

Begin saving for retirement as early as possible. Even if you are 20 years of age, you are not too young to begin thinking about investing for retirement. Investments compounded over many years have the potential to grow exponentially.

Also save consistently. Make it a habit to pay yourself first, and contribute to a retirement plan weekly, monthly, or in a regular way that works for your budget.