9 Min Read | Updated: November 30, 2023
Originally Published: March 18, 2020
Explaining 5 Key Types of Retirement Plans
Want to know more about retirement planning? Discover the different types of retirement plans and their tax advantages that help you save.
At-A-Glance
Retirement plans provide tax advantages, encouraging you to save for retirement.
Different types of retirement plans vary in the kind of tax benefit they provide, as well as in contribution limits and withdrawal rules.
Some retirement plans are designed for employees, others for business owners or self-employed people—and some are available to anyone.
We all know we should save for retirement. To inspire us to do so, Uncle Sam provides tax incentives that encourage us to sock away money in a variety of different types of retirement plans. But here’s the catch: Understanding the different types of retirement plans can be challenging—particularly since they have confusing names, like 401(k) and SEP IRA.
To help you navigate your options, here’s a comparison of five of the most common types of retirement plans:
- 401(k)
- Traditional IRA
- Roth IRA
- SEP IRA
- Solo 401(k)
How These 5 Types of Retirement Plans Differ
These retirement plans differ in many ways, but most importantly in the following key aspects:
- Tax advantages: some plans offer tax benefits when you put money into the plan, others when you withdraw the money
- Contribution limits: the maximum amount you can save each year
- Withdrawal rules: when you can withdraw money from the plan without penalty, and applicable penalties for non-compliant withdrawals
401(k): The ‘Standard’ Employee Retirement Plan
401(k) pros:
- An easy option if you’re an employee
- Employer matching contributions
- High contribution limits
401(k) cons:
- Limited investment options
- It may take several years before you fully own your employer’s matching contributions
If you’re an employee, your employer’s 401(k) could be a very convenient retirement plan option since companies usually strive to make them easy to set up and manage. A 401(k) is a retirement plan offered by many for-profit companies as an employee benefit. Generally, you can contribute simply by diverting part of your paycheck into the retirement plan.
Like most other types of retirement plan, a 401(k) provides tax advantages by reducing your taxable income. For example, if you earn $60,000 in one year and contribute $5,000 to a 401(k), you won’t pay income tax on the portion you contributed.
Tax-free growth. The money in your 401(k) grows tax-free until you choose to withdraw it, at which time you’ll pay income tax on the money you take out.1 As with most other types of retirement plans, you have to be 59 ½ or older to withdraw money without penalty, and you’re required to start withdrawing money at age 72.2,3
Matching contributions. A big attraction of 401(k) plans is that many employers provide matching contributions when you put money into the plan. That’s potentially free money. The catch: you may only earn the employer-contributed portion over several years (a process called “vesting”). If you leave the company before becoming “fully vested,” you’ll keep all your contributions but may get only a portion of your employer’s contributions. If you switch employers or retire, you can “roll over” your contributions to another company’s 401(k) plan or another type of retirement plan.
High contribution limits. Another attraction of 401(k) plans is the relatively high contribution limit: you can contribute up to $22,500 in 2023, or $30,000 if you're 50 or older.4 The total contribution limit, including both employer and employee contributions, is $66,000 (or $73,000 for over-50s).5
Limited investment choices. A disadvantage of 401(k) plans is that you're limited to only the investment options offered within the plan, such as mutual funds.6
Traditional IRA: A Retirement Plan for Anyone
Traditional IRA pros:
- Available to anyone
- Many plan and investment choices
Traditional IRA cons:
- Low contribution limits
IRA stands for Individual Retirement Accounts. As the name suggests, traditional IRAs are tax-favored savings plans that are mostly opened and managed by people themselves. Almost anyone with taxable income can contribute to a traditional IRA, so an IRA may be appealing if you don’t have access to an employer’s 401(k).
Many aspects of a traditional IRA are similar to a 401(k), including the way the tax advantages work. Your contributions reduce your taxable income, the money grows tax-free until you withdraw it, and there are similar age restrictions for contributions and withdrawals.
However, there are also big differences between traditional IRAs and 401(k) plans. Contribution limits are much lower: $6,500 in 2023, or $7,500 if you're 50 or older.7 On the other hand, you can choose between many IRAs from different financial-services companies, and each plan may include a much wider range of investment options, including stocks as well as mutual funds.
In some cases, you may be able to contribute to both an IRA and a 401(k) in the same year. But be careful: your IRA contributions may not be tax-deductible if you or your spouse are covered by another retirement plan, unless your household income is below a threshold amount.7
Roth IRA: A Different Type of Retirement Plan Tax Advantage
Roth IRA pros:
- You could pay less tax overall
- You can withdraw retirement savings tax free
- More flexible contribution and withdrawal age limits
Roth IRA cons:
- No tax break for contributions
- Income restrictions
- Low contribution limits
The biggest difference between a Roth IRA and a traditional IRA is when you get the tax benefits. With a traditional IRA, you pay no income tax on your contributions, but you pay tax when you take the money out. With a Roth IRA, it’s the exact opposite: you pay taxes on the money that you contribute, but you can withdraw money tax-free at retirement—so every dollar in your account goes into your pocket.
Should you pick a traditional or Roth IRA? One big factor is whether you expect to be taxed at a higher or lower rate when you retire, experts say.8,9 Many people expect a lower tax rate after retirement because their income is lower. If you’re one of them, you might be better off with a traditional IRA; if not, you could pay less income tax overall with a Roth IRA.
There are other differences between a Roth IRA and a traditional IRA. For example, you don’t have to start withdrawing money at age 72, and you can withdraw some money early without penalties (although there are restrictions). Also, you can only contribute to a Roth IRA if your income is below a specific threshold, unlike with a traditional IRA. In other aspects, including contribution limits, Roth IRAs are similar to traditional IRAs. To explore the similarities and differences in more detail, see the IRS comparison table.10
SEP IRA: For Small Business Owners and the Self-Employed
SEP IRA pros:
- High contribution limits
- For employees, immediate vesting can be an advantage
SEP IRA cons:
- For employers, immediate employee vesting may be a disadvantage
A SEP IRA (SEP stands for simplified employee pension) is a specialized type of IRA used mainly by self-employed people or small business owners, though technically it can be used by any size company.11 For employers, these retirement plans may be easier and cheaper to operate than traditional 401(k) plans.12
In some respects, a SEP IRA operates similarly to a traditional IRA. But a big advantage of a SEP IRA is the ability to stash away much bigger retirement savings each year than with a traditional IRA. An employer can contribute up to 25% of each employee’s income up to a maximum of $66,000 in 2023.12 If you’re self-employed, you can contribute up to 25% of net income from self-employment, up to the same limit.13 Unlike with a 401(k), employees are always immediately 100% vested in employer contributions—which could be seen as an advantage if you’re an employee, or a disadvantage if you’re an employer trying to maximize employee loyalty.12
Solo 401(k): For Business Owners with No Employees
Solo 401(k) pros:
- You may be able to contribute more than with other individual retirement plans
- Some plans allow either traditional pre-tax or Roth (after tax) contributions
Solo 401(k) cons:
- Limited investment options, like regular 401(k) plans
- May be more complicated to set up than IRAs
Solo 401(k) plans, also known as individual or one-participant 401(k) plans, can help maximize retirement savings for self-employed people and business owners that don’t have employees. They work a bit like regular 401(k) plans, except that you can boost your savings by contributing as both employer and employee.
As an employee, you can contribute up to 100% of self-employment income, to a max of $22,500 in 2023 or $30,000 if you’re age 50 or over.14 Then you can put on your employer hat and chip in up to an additional 25% of your business’ income. Depending on your income level, this dual contribution formula may let you contribute more than with other retirement plans, such as SEP IRAs, although the maximum contribution limits are the same ($66,000 if 50 or under/$73,500 if older).3,14
The Takeaway
Retirement plans all provide tax advantages as incentives to save for retirement. The various types of retirement plan differ in aspects such as when you pay income tax, contribution limits and withdrawal rules. Some plans are designed for employees, some are for sole proprietors and business owners, and some are available to anyone. But any individual may or may not be eligible for these plans’ tax advantages, due to their many variables—so it’s important to consult a professional tax advisor about your specific circumstances.
1 “401(k) Plan Overview,” IRS
2 “Retirement Topics - Exceptions to Tax on Early Distributions,” IRS
3 “IRS reminds those over age 72 to start withdrawals from IRAs and retirement plans to avoid penalties,” IRS
4 “401(k) limit increases to $22,500 for 2023, IRA limit rises to $6,500,” IRS
5 “Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits,” IRS
6 “What Is a 401(k)?,” Experian
7 “IRA FAQs,” IRS
8 “Summary of the Thrift Savings Plan,” Veterans’ Administration
9 “Roth and traditional TSP contributions,” Thrift Savings Plan
10 “Traditional and Roth IRAs,” IRS
11 “Individual Retirement Accounts (IRAs),” Investor.gov, U.S. Securities and Exchange Commission
12 “Simplified Employee Pension Plan (SEP),” IRS
14 “One-Participant 401(k) Plans,” IRS
Mike Faden has covered business and technology issues for more than 30 years as a writer, consultant, and analyst for media brands, market-research firms, startups and established corporations.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
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