Nearly two-thirds of Americans can’t pass a rudimentary financial literacy test. This illiteracy extends to retirement: when quizzed on their retirement income knowledge, 80% of Americans ages 60-75 failed.
Fortunately, in our increasingly digital age, the information needed to educate oneself is readily available. When it comes to learning about retirement planning, we’ve made it even easier. We’ve broken down the most common types of retirement plans for you, beginning with our personal favorite:
Pensions
- Defined benefit group retirement plans sponsored by an employer. Provides a guaranteed monthly benefit for life in retirement, hence the term ‘defined benefit’.
- Benefits are determined using a formula that calculates 3 factors: length of employment, final average salary and a benefit multiplier.
- A portion of an employee’s pay is contributed to the pension fund, as well as a contribution from the employer. This money is pooled and professionally invested.
- Investment risk is collectively shared, shielding individuals from the whims of the market.
401(k)s
- Defined contribution retirement savings plans sponsored by an employer. Retirement income is determined by the contributions made to the account, hence the term ‘defined contribution’.
- Named for the section of tax code that regulates them, 401(k)s allow participants to save a portion of their paycheck into the account pre-tax.
- Employers may or may not contribute. For those who do contribute, the average employer match is 3.5% of the employee’s salary.
- Total annual contributions, from the employer and employee combined, are capped at the lesser of 100% of the employee’s earnings or $54,000.
- One can begin withdrawing money from their 401(k) when they reach age 59.5, experience financial hardship or have a ‘severance from employment’. Withdrawals become mandatory at age 70.5.
- The median defined contribution 401(k) account balance in the U.S. is $18,433.
IRAs
- Individual Retirement Arrangement. There are 2 types of IRAs: Traditional and Roth.
- Traditional IRAs allow you to make tax-deductible contributions until the age of 70.5, at which point you must make regular withdrawals that are subject to tax.
- Contributions to Roth IRAs are taxed but withdrawals are not. Participants can continue contributing to their Roth IRA as long as they’d like.
- Anyone under the age of 70.5 who receives taxable income can contribute to a traditional IRA savings plan. Individuals earning less than $132,000 annually also have the option of opening a Roth IRA.
- Contributions are capped at $5,500 per year, $6,500 per year for participants age 50+.
- Investment options vary widely.
Social Security
- Federal social insurance program developed by the U.S. government in 1935. Benefits include retirement income, disability income and health care services like Medicare and Medicaid.
- Roughly 167 million working Americans pay Social Security taxes. The program provides monthly benefits to over 59 million people.
- Retirement benefits are determined by calculating one’s ‘average indexed monthly earnings’ during their 35 highest-paid working years.
- Benefits can be drawn when one reaches full retirement age. This varies depending on birth year, ranging from age 62 to 67. Delaying retirement until after reaching this age can result in an increase in benefits.
- Not all Americans are eligible for Social Security. Nearly 30% of state and municipal employees are not covered by the system.
- Never intended to be a sole source of retirement income, Social Security replaces only about 40% of average income in retirement.
