What Is A Retirement Plan? Different Plan Types Explained

Planning for retirement often starts with a simple question: how do you build savings in a way that supports you later in life? Many people look to retirement plans because they offer tax advantages that can help your savings grow over time. These plans may reduce your taxable income today or potentially provide tax-free withdrawals in the future, depending on the type you choose.

There are several plan options, and each one operates differently. Some are set up by employers. Others are designed for people who run their own businesses. A few are available to almost anyone with earned income.

Read on to see how these plans generally work, why they play an important role in long-term planning, and what makes each type of retirement plan unique.

Who Can Open a Retirement Plan?

Retirement plans generally fall into two groups. Some are tied to an employer. Others are available to individuals, including business owners and people who work for themselves.

Here is how the main options typically work:

Employer-Sponsored Plans

Employees depend on their workplace to offer these plans.

✅ 401k: You need to work for a company that sponsors a 401k. Employees cannot open these plans on their own.

Individual Retirement Accounts

IRAs give people with earned income an option to save outside of an employer plan.

✅ Traditional IRA: Anyone with earned income may open and fund a Traditional IRA. There are no income limits for eligibility.

✅ Roth IRA: Anyone with earned income may also open a Roth IRA. Roth IRA contributions are subject to income phase-outs.

✏️ Hypothetical  Example:

For 2025, single filers start to lose the ability to contribute when their modified adjusted gross income falls between $150,000 and $165,000. Contributions stop at $165,000.

📝 Note: Eligibility to contribute is separate from eligibility to open the account. Most people can open a Roth IRA, but income limits may restrict how much they can contribute directly.

Plans for Business Owners and the Self-Employed

These plans broaden your options if you run a business, freelance, or operate as a sole proprietor.

✅ Solo 401k: Available to business owners or self-employed individuals with business activity and zero full-time employees who work more than 1,000 hours per year, other than a spouse.
✅ SEP IRA: Any business owner may open a SEP IRA. Employee count does not affect eligibility.
✅ SIMPLE IRA: Business owners with fewer than 100 employees may open a SIMPLE IRA.

Types of tax-advantages

Most retirement plans offer tax-free compounding. This means the earnings stay in the account without immediate tax consequences. Regular taxable accounts work differently. Capital gains tax generally applies when you sell an investment for more than you paid.

✏️ Hypothetical Example: 

You invest $10,000 in a stock. It grows to $100,000. A taxable account would trigger capital gains tax on the $90,000 in earnings. A retirement plan would not. The earnings stay in the account, which may allow more of your money to stay invested over time.

📝 Note: Growth in retirement plans is never guaranteed. Investment risk still applies, and outcomes depend on market performance.

Traditional vs. Roth Options

Several retirement plans offer two versions: Traditional and Roth. The key difference is when the tax benefit applies.

Traditional Accounts

Traditional accounts give you a potential tax deduction for contributions. This may lower your taxable income for the year.

Withdrawals in retirement are treated as ordinary income.

Roth Accounts

Roth accounts do not give you a tax break when you contribute. Qualified withdrawals in retirement are tax-free.

Here is a quick overview:

✅ Traditional: Tax benefit at contribution
❌ Taxes due on withdrawals

✅ Roth: No tax benefit at contribution
❌ Taxes not due on qualified withdrawals

Your choice depends on whether you prefer a potential deduction today or potentially tax-free income later in retirement. Different plans offer different combinations, so the right fit generally depends on your income, your timeline, and how you expect your tax situation to change over time.

Types of Retirement Plans

Two of the most common retirement plan types are the IRA and 401k. As a business owner or freelancer, you also have a few additional options, the main ones being the Solo 401k, SEP IRA, and the SIMPLE IRA.

Let’s go through each of the accounts in more detail below.

401k

A 401k is an employer-sponsored retirement plan. Employees only have access to a 401k if their company offers one. Many employers also choose to make matching contributions, which can be a meaningful way to increase retirement savings.

✏️ Hypothetical Example:

Your employer offers a 5% match. If you earn $100,000, the maximum match could be $5,000 when you contribute at least 5% of your salary.

How It Works

Employees contribute a portion of their wages into their accounts. Employers may add matching contributions, but the specific terms depend on each workplace plan. The contributions grow tax-deferred. Many companies also offer a Roth 401k feature.

Here is how the tax treatment generally works:

✅ Traditional 401k:

✅ Roth 401k:

📝 Note: Tax-free growth does not guarantee investment gains. All investing involves risk.

Investment Options

Most 401k plans offer a limited menu of mutual funds. A typical lineup includes approximately 8 to 12 funds. Employees usually cannot invest in individual stocks or alternative assets such as private funds, real estate, or other nontraditional investments.

Contribution Limits for 2025

Remember that income required to max out these limits varies based on how your compensation is defined.

Withdrawal Rules

Required Minimum Distributions (RMDs)

Traditional 401k accounts have RMDs beginning the year you turn age 73, unless earlier rules already apply. The first RMD is due by April 1 of the following year. Later RMDs are due each December 31.

You may refer to this RMD table to calculate your RMD amounts.

IRA (Traditional and Roth)

An IRA is available to almost anyone with earned income. Unlike a workplace plan, you open an IRA on your own through a financial institution. You may choose a Traditional IRA, a Roth IRA, or both, as long as your total yearly contributions stay within IRS limits.

How It Works

A Traditional IRA and Roth IRA follow separate tax rules.

✅ Traditional IRA

✅ Roth IRA

Investment Options

IRAs generally offer a wider range of investments than most workplace plans. You can choose:

You may also open a self-directed IRA, which typically expands investment choices to include certain alternative assets. Rules on prohibited transactions and disqualified persons still apply.

Contribution Limits for 2025

Your combined contributions to Traditional and Roth IRAs cannot exceed the yearly limit.

Roth IRA Income Limits for 2025

For single filers:

Traditional IRAs do not have income limits for making contributions.

Withdrawal Rules

Roth IRA Withdrawal Rules

Required Minimum Distributions (RMDs)

Solo 401k

A Solo 401k is designed for business owners and self-employed individuals with no full-time employees other than a spouse. It is known for its high contribution limits and flexible investment options, although the actual features depend on the provider and plan structure.

How It Works

You contribute as both the employee and the employer. Many Solo 401k plans allow Roth contributions, rollovers, loans, and strategies such as the Mega Backdoor Roth, depending on the Solo 401k plan provider.

Investment Options

Solo 401k plans may provide broader investment choices than corporate 401k plans. Many allow:

Some Solo 401k setups provide direct account control, which may include having direct check-writing authority over your Solo 401k. IRS rules still limit prohibited transactions and restrict investments such as collectibles and certain dealings with disqualified persons.

Contribution Limits for 2025

The Solo 401k has the highest contribution potential of any mainstream retirement plan.

Breakdown:

Employee Contributions

Employer Contributions

Your combined contributions must not exceed the annual limit.

Withdrawal Rules

The Solo 401k follows the same withdrawal rules as a standard 401k.

Roth Solo 401k Withdrawal Rules

Earnings require both:

RMDs

Traditional Solo 401k accounts have RMDs starting at age 73 for most owners. Designated Roth Solo 401k accounts are not subject to lifetime RMDs beginning in 2024.

SEP IRA

A SEP IRA is a retirement plan for business owners who want a simpler option for making employer-only contributions. It is often used by small businesses, especially when the owner has few employees.

How It Works

Only employers contribute to SEP IRAs. Employees cannot make their own contributions. Employers must contribute the same percentage of compensation for every eligible employee.

✏️ Hypothetical Example:

If you contribute 10% of your compensation to your own SEP IRA, you must also contribute 10% of compensation for each eligible employee.

This rule can make SEP IRAs costly for businesses with many employees, but employers may reduce contributions or skip them in lower-profit years.

Employee Eligibility

An employee is generally eligible if they:

Contribution Limits for 2025

Investment Options

SEP IRAs follow the same investment options as IRAs. These include mutual funds, ETFs, stocks, and bonds.

Withdrawal Rules

RMDs

RMDs begin at age 73 under current rules.

SIMPLE IRA

A SIMPLE IRA is designed for small businesses with 100 or fewer employees. It offers a lower-cost alternative to a full employer-sponsored plan.

Who It’s Designed For

SIMPLE IRAs work well for employers seeking a straightforward retirement plan. Business owners who want to save more for themselves may find a Solo 401k or SEP IRA more suitable.

How It Works

Employers choose one of two contribution methods:

Employees receive contributions based on the method the employer selects. All employer contributions are deductible.

Contribution Limits for 2025

Investment Options

Similar to SEP IRAs and standard IRAs, SIMPLE IRAs typically allow traditional investments such as stocks, mutual funds, bonds, and ETFs.

Withdrawal Rules

Additional SIMPLE IRA Withdrawal Rule

Withdrawals within the first two years of participation face a 25% penalty. The two-year rule also applies to rollovers.

✏️ Hypothetical Example:

You open a SIMPLE IRA and take a distribution in your first year. The IRS may impose a 25% penalty on the taxable amount, plus income taxes.

RMDs

RMDs generally begin at age 73.

Wrapping Up

Retirement plans come in many forms, and each one follows its own rules for taxes, contributions, withdrawals, and investment choices. A key difference across these plans is whether they use a Traditional structure, a Roth structure, or both. Traditional accounts may offer a potential deduction when you contribute, and withdrawals in retirement are treated as ordinary income. Roth accounts use after-tax contributions, and qualified withdrawals in retirement are tax-free when the timing rules are met.

The plans most people encounter first are the employer-sponsored 401k and the Traditional and Roth IRA. A 401k is only available if your employer offers it. An IRA is open to anyone with earned income, although high incomes can limit Roth IRA contributions.

Business owners and self-employed individuals have additional choices, including the Solo 401k, SEP IRA, and SIMPLE IRA. A Solo 401k may offer higher contribution potential, but it is limited to businesses with no full-time employees other than a spouse. A SEP IRA is simpler and works well for many small businesses, though contributions must follow employer-only funding rules. A SIMPLE IRA generally serves employers who want a lower-cost way to offer retirement benefits to their teams.

These options give you several paths to build long-term savings. The right plan depends on how you earn income, whether you run a business, and how you prefer your tax benefits to apply.

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The Carry Learning Center is operated by The Vibes Company Inc. (“Vibes”) and contains generalized educational content about personal finance topics. While Vibes provides educational content and technology services, all investment advisory services discussed on this website are provided exclusively through its wholly-owned subsidiary, Carry Advisors LLC (“Carry Advisors”), an SEC registered investment adviser. The information contained on the Carry Learning Center should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security or engage in a particular investment, accounting, tax or legal strategy. Vibes is not providing tax, legal, accounting, or investment advice. You should consult with qualified tax, legal, accounting, and investment professionals regarding your specific situation.

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