A Beginner’s Guide to Choosing the Right Retirement Plan

Retirement plans are one of the last things we (i.e., young people) take into consideration while job hunting and reviewing the benefits packages offered by different employers. Therefore, saving for retirement has probably not crossed your mind, especially as someone who is self-employed and working as a freelancer or living the digital nomad lifestyle.

 
However, planning for your future retirement in this climate is a must. Times are tough as the Social Security fund used to pay out pensions is going broke. Once 2033 hits, the government is projected to only be able to pay out about 75% of participant benefits, which will leave beneficiaries scrambling to cover the rest.

 
There’s also the simple fact that the pension model our parents and grandparents once benefited from is dying out. Gone are the days where you would get a job straight out of high school or college, stay there for 30 to 40 years, then retire. It’s clear that as Millenials we’re open to leaving organizations in favor of new opportunities elsewhere. This fact makes old school pension models, which were built on a loyalty system that rewarded employees who stayed at the company in question long enough to invest in a retirement plan or even receive the matching employer contribution, not conducive to our generation’s employment behavior.

 

It’s clear that as times change we need to adapt accordingly. Furthermore, as freelancers, it’s important that we prioritize saving for retirement since we have to take it upon ourselves to build our own benefits package. As a matter of fact, you should be aiming contribute at least 15-20% of your earnings to a retirement plan of your choice. So, let’s talk plans.

Choosing a Retirement Plan

As a working professional, I’m sure you already have some idea of the different retirement plans out there. However, just for the sake of being extra thorough and really breaking down the advantages and disadvantages of different plans, listed below is a brief description of the most common retirement plans.

 

401(k)

This is the most well-known retirement plan, which has been around since the 80s and was developed by Congress. Essentially, it’s a fund where the money you contribute is invested into different stocks, bonds, etc. based on your age and career choices.

For example, when I was in my early 20s I worked for a women’s health non-profit where my most of my stock options consisted of various health funds. I also had the least conservative plan, which meant that my investment options featured mainly stock options over more conservative investments, such as bonds, because I was young enough to take the risks associated with working the market. If I lost a significant chunk of change on the stock market, I was still young enough to recoup the loss and maybe even see some serious investment growth in the long run.

One of the major advantages of this plan is that it’s comprised of pre-tax payroll deductions. This means that the money you put into the fund is not taxed until you retire and begin receiving disbursements. Also, this particular plan is a favorite among many companies that typically choose to match the contributions made by their employees up until a certain percentage, thereby allowing you to save even more money for retirement. Finally, you also get a lot of say in how your money is invested, as 401(k) plans tend to offer a wide array of investment options.

However, one of the major drawbacks for freelancers is that this plan mainly serves people who are full-time employees at  a company, and can take advantage of the employer’s matching contribution and investment managers. Nevertheless, it’s still important to know about it in case you do take on a full-time position with a company where this retirement plan is offered in their benefits package or you decide to keep this retirement plan after leaving your company (more on that later).

 

403(b)

This retirement plan is very similar to the 401(k) in terms of the investment options offered and the fact that it is typically employer-sponsored. The main difference is that 403(b)’s typically allow for higher matching limits than its 401(k) counterpart.

 

Traditional IRA

This individual retirement account is not employer-based and invests the funds you contribute into stocks, bonds, etc. While you’re only able contribute a certain amount of money to the fund annually (the cap is $5,500 per year), the money is tax-exempt until you enter retirement and begin receiving disbursements. This means that you can take a deduction on your taxes for however much money you contributed to your IRA during the year and you get to watch your investment grow without having to pay taxes on it!

If you’re like me and need a tax break now rather than latter, then this plan is definitely worth looking into. It is important to note that when you do retire and began receiving disbursements, these payments will be taxed as regular income. However, given that your tax rate will most likely decrease post-retirement, choosing this plan means that you won’t have to risk the government taking a huge chunk of change out of your disbursement for tax purposes.

 

Roth IRA

Similar to the Traditional IRA, the main difference between a Traditional IRA and a Roth IRA is that this retirement plan is not tax-exempt, which means you will have to pay Uncle Sam for any contributions you make to your plan annually until you retire. Therefore, this plan mainly benefits those who are looking at being locked into a higher tax bracket post-retirement. It’s also important to note that not everyone can open a Roth IRA. If you make more than $186,000 you’re shut out of the plan (I wish I had this problem).

 

What to Look for in a Provider

 

First, you should decide if you want to manage your investments yourself or if you want to have someone else manage them for you. If you’re investment savvy and want to avoid paying fees on your account, than the former might be more for you. However, if you want to adopt a “laissez-faire” approach to investing, then you should consider opting for a plan with a robo-advisor that creates and manages an investment portfolio for you.

After you’ve decided how much (or how little) you would like to be involved in the cultivation of your investment portfolio, you should look for retirement companies that provide plans that fit your ideal model and have a solid reputation. Keep in mind that you will be investing thousands of dollars into this fund during your lifetime. Therefore, you should choose a company that has proven itself to be client-oriented, in that they’re known to handle funds in a way that’s in their client’s best interest.

Also, picking a company that is known to provide great customer service is imperative. You want a company that’s willing to answer your questions, address any concerns you might have, and help you plan and work towards saving up for your retirement. Quality customer care is essential.

 

Cashing Out, Rolling Over, or Staying Put

 

If you have a 403(b) or a 401(k) from a former employer that you’re trying to figure out what to do with, there are a few options: (1) you can continue contributing to it on your own terms depending on the guidelines in place; (2) you can roll it over into an IRA account; (3) or you can cash it out.

I don’t recommend cashing out your plan unless you absolutely need the money and doing so is a last resort because your money will become subject to employer withholding, taxation, and fees.

Leaving your 401(k) alone is a pretty solid option if you don’t want to deal with the hassle of rolling the funds over, but would still like to contribute to a plan. The main downside of this option is that your former employer can switch up their investment options without you knowing until a bit later down the road because you no longer work for the company.

Choosing to transfer the funds from your former employer’s retirement plan into an IRA account (this is called a “direct rollover”) provides you with significant tax benefits since you do not have to pay any tax penalties on the money transferred. Furthermore, if you opt to rollover your funds into a Traditional IRA you can quickly take advantage of the tax benefits associated with contributing money to your plan.

It’s also important to note that while choosing to contribute to the retirement plan you had under your former employer is a painless process, rollovers can be equally as easy depending on the companies housing your former and future plans and how difficult they make the process.

Also, you do not have to rollover all of your funds. You can choose to keep your old retirement plan and transfer a set amount of funds from it into an IRA account. This is a good option for those of us who are looking to do freelance work, but remain open to picking up work from a company later on down the road who might offer us a benefits package that includes retirement planning. Already having a 401(k) or 403(b) could make rolling over your former retirement plan into your employer’s new plan a hassle-free process depending on the compatibility of the plans in question.

 

Next Steps

 

If you do decide to do a rollover, do your research and decide what type of account would work best for you and select a trustworthy, well-established entity to host your account. However, regardless of the type of retirement plan you choose, you should contribute to your plan on a monthly basis.

While dedicating 15-20% of every check you receive to your retirement fund is ideal, as a freelancer, I know that the occupation boasts both times of feast and times of famine. Therefore, even if you find yourself unable to invest that exact amount every time you get paid, just do your best by contributing however much you can for that month.

Lastly, while you’re planning for the future, don’t forget to take into account what’s happening in the present! I ended up going with a Traditional IRA and a robo-advisor to oversee my retirement planning, not only because I believe it will serve me the best when I do retire, but also because I could really use the tax breaks right now.

 

Happy investing!
BDB

Buppie

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