• Kale

Retirement Investing Strategy for 20-somethings

401k, Roth, IRA, etc - what is the ACTUAL best strategy that I should implement in my 20's?

This has been a topic that consistently riddles the Reddit Personal Finance forums.

And, rightly so.


Figuring out the mess that is the United States retirement system is a task that even most financial professionals have yet to do.


Stated differently, the fucks that you are paying to manage your wealth are probably getting it wrong and you should be doing it yourself.


And now you can after the advice to come.


So you're a 20-something who just started caring about your money.


Hopefully, your reason is not that you are in massive personal debt and are looking for a way to cash out your retirement.


If it is - this is not the place for you.


If you are here because you are doing well but think you could be doing better if you just had sound advice - welcome home.


Most of us have heard the numerous retirement account related acronyms for many years but do not have a clue what they actually mean (your nod & smile technique during the convos with your crazy uncle were on point but didn't actually help you learn anything).


So let's go over them quickly and talk about the rules associated with each.

Links to the IRS descriptions are included.


**If you only care about the results - scroll to the bottom.


Individual Retirement Arrangements (IRAs)

Roth IRAs

401(k) Plans

403(b) Plans

SIMPLE IRA Plans (Savings Incentive Match Plans for Employees)

SEP Plans (Simplified Employee Pension)

SARSEP Plans (Salary Reduction Simplified Employee Pension)

Payroll Deduction IRAs

Profit-Sharing Plans

Defined Benefit Plans

Money Purchase Plans

Employee Stock Ownership Plans (ESOPs)


Individual Retirement Arrangments (IRAs)


Best for: Individuals without a work-sponsored retirement vehicle

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Invested in stocks/bonds/mutual funds (opened through a brokerage)

Other: Contributions up to $6,000 are tax-deductible, you cannot make deductions if you have a work-sponsored plan & earn more than $75,000/year - if you make less than $65,000 and have a work-plan you can deduct the contribution in full


For additional information, reference.


Roth IRAs


Best for: Individuals without a work-sponsored retirement vehicle

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Invested in stocks/bonds/mutual funds (opened through a brokerage)

Other: Cannot deduct contributions, qualified distributions are TAX-FREE, for the personal finance nuts out there - check out the self-directed Roth IRA (this unlocks things such as investing in commercial real estate and private equity).


For additional information, reference.


401(k) Plans


Best for: Employees with employers who offer this plan (and hopefully include a contribution matching benefit!)

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Investment options limited to those chosen by the employer (typically more options that available in a 403(b) plan - see below)

Other: Deferrals/contributions are much higher than IRA alternatives ($19,500 - includes employer matching)


For additional information, reference.


403(b) Plans


This is essentially the equivalent of a 401(k) - the primary difference being is that it used by tax-exempt or public school employers.


Best for: Employees with public school/tax-exempt employers who offer this plan (and hopefully include a contribution matching benefit!)

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Investment options limited to those chosen by the employer

Other: Deferrals/contributions are much higher than IRA alternatives ($19,500 - includes employer matching)


For additional information, reference.


Simple IRA Plans


This is essentially a retirement plan used by small businesses/startups that are not currently sponsoring a plan.


Best for: Employees in small companies (less than 100 people) without any other employer-offered retirement programs

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: More investment options that 401ks

Other: Employees are always 100% vested in these plans from day 1


For additional information, reference.


SEP Plans


This is a type of retirement plan that can be offered by employers with volatile cash flows that is less costly deploy and allows for employer contributions of up to 25% of each employee's pay. Best used by self-employed entreprenuers.


Best for: Employees in companies that do not over conventional retirement plans

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Investment options selected by SEP provider

Other: Participant loans are not permitted, employee must be 21 years old to participate and must have worked for employer 3 of the last 5 years, requires equal contributions to all employees. Can be combined with a Roth IRA.


For additional information, reference.


SARSEP Plans


A really long acronym for "salary reduction simplified employee pension plan".


This type of plan was typically established before 1997 (not useful to most of us) and was used by small firms (less than 25 employees). This plan has all the same eligibility requirements as a SEP plan.


Best for: Only employees of employers who offered a SARSEP plan prior to 1997 (as they were discontinued)

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Investment options selected by provider

Other: Same as SEP. Unlike SEP, does not appear to have required 100% employer contributions matching.


For additional information, reference.


Payroll Deductions IRAs


This type of plan was involves the employee setting up an individual or Roth IRA and allowing the employer to directly add contributions from each paycheck.


Best for: Employees of firms that do not offer ANY OTHER retirement plan

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Investment options selected by employee (essentially anything)

Other: Employer does not obtain any benefit from this plan. The onus of effort is entirely on the employee. Same contribution limits as traditional IRAs. No loans or collateral assignment permitted.


For additional information, reference.


Profit-Sharing Plans


This type of plan serves as an alternative to a traditional retirement plan and allows employers to contribute any portion of earnings to be divided amongst all qualifying employees. Employers sets contribution percentages and qualification criteria.


Best for: Employees of firms that do not offer ANY OTHER retirement plan

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Depends on whether profits are paid out in cash or placed intro managed trust

Other: Employer places excess earnings into a retirement account for employees BUT employees cannot make any contributions to the retirement account (unlike a 401k). Some of the "profit sharing" may also be distributed as cash (similar to a bonus) rather than placed into the retirement account.


For additional information, reference.


Defined Benefit Plans


This type of plan is best for employees who intend to stay at their employer for the long-haul (or at least until fully vested). Few companies offer these plans in 2020 due to the risks involved with promising to pay your employees a fixed amount until they die


Best for: Employees of firms that intend to stay for a long period of time (or, at a minimum, until fully vested)

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Set my employer but typically based on years of service & highest salary earned.

Other: A great option for employees at firms that offer BUT not the best option if you expect a short tenure (vs standard 401k alternatives where you control investments). Participant loans may be permitted.


For additional information, reference.


This category deserves a bit extra due to the risk the a company's pension (defined benefit plan) goes bankrupt - which has happened. Reference


Although most pension plans are insured by the Pension Benefit Guaranty Corporation (PBGC) - if a plan goes bankrupt, participant payouts can be dramatically reduced below the "promised amount".


The maximum annual payout allowed by the PBGC as of 11.23.2020 for someone retiring at the age of 60 is about $4,000/month or $48,000/year. This amount does increase if you retire later (because statistics say you will die earlier in the payoff period - thus less risk).


Lastly, it is projected the the PBGC multi-company plan will be completely insolvent by 2025 (right around the corner). Although a taxpayer bailout is inevitable, this could lead to an even more dramatic reduction in your expected pension benefits at retirement.


My point being - hope for the best, prepare fo the worst with pensions.


Money Purchase Plans


This one took a bit of digging to understand the current value.


This type of plan is better or at least equal to a 401k. Unlike a 401k, employees do not have add funds to be matched, rather, the employer selects a % of salary to be paid into this account each year regardless of employee contributions.


Best for: Employees of firms not offering a 401k or offering benefits for contributions that the 401k

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Based on employer select plan options

Other: Very similar to a 401k but without the required employee contributions.


For additional information, reference.


Employee Stock Ownership Plans


This type of plan provides employees with an equity stake in their employer. Employees should review vesting schedule of the equity before selecting.


Best for: Employees of any firm unless the stock is expected to be worthless (failing/struggling company) or the vesting schedule is far longer than you intend to stay with the employer

Age restrictions: 59.5 years old minimum age (without penalty)

Returns: Based on company performance

Other: This can be a very useful tool for employers/employees, HOWEVER, anyone participating in these plans should be sure to invest/diversfiy additional retirement holdings in addition to this stock. The biggest reason for this is if your company goes belly up (Enron), you could lose all every penny of your retirement savings.


For additional information, reference.

Your Plan of Action


1. Join Defined Benefit Plan (if you plan to stay until vested at a minimum)

If you will leave within 1-3 years (likely before vesting), elect for the 401k option


2. Max out matching on your 401k/403b/SIMPLE

Elect for all retirement funds to be placed into a US Total Market Stock Index Fund provided by your brokerage


2a. Join Money Purchase Plan if 401k is not offered


3. "Opt in" to an ESOP plan (if offered and the vesting period is within reason)

Same goes for any profit sharing agreements available


3. Max contributions to a Roth IRA (if income is below $66,000)

Elect for all retirement funds to be placed into a US Total Market Stock Index Fund provided by your brokerage


3a. If you earn more than $66,000 - use "backdoor" Roth IRA Strategy (reference)


$66,000 is for single (not married) filers

$6,000 is the current IRA (Roth and traditional) combined contribution limit per tax filer


4. Take this knowledge, tell your friends who care, and save tens of thousands (if not hundreds) on lifetime retirement taxes by playing the game prudently


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