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Times have changed for the ordinary workingman.
Our fathers counted on their pension plan and Social Security to give them comfort in their golden years. Today, private pension plans are an oddity and Social Security isn’t exactly the windfall that it once was.
Difficult But Must
This is why, once again, Uncle Sam is counting on you – this time to save for your retirement. The government is dangling a delicious carrot for you in the form of tax breaks for your retirement plans.
Here’s how to wade through the acronym creek that so permeates the world of retirement plans. Find which one among the options – IRAs, SEPs, 401(k)s, 403(b) and more letters – is the right one for you.
Retirement Savings Accounts To Consider
A 401(k) is a workplace retirement account that companies offer as a benefit to their employees. In this account, you can contribute a portion of your pre-tax paycheck into a tax-deferred investment account.
Contributing a pre-tax fund lowers your income tax base. For example, if you earn $80,000 and contribute $10,000, the IRS will only tax you for $70,000. So, aside from increasing your investment to your retirement fund, you also lessen your tax. Also, in a 401(k), the gains from your investments will grow tax-deferred until your retirement. However, if you withdraw funds from your plan before your retirement age, you could pay a 10% penalty. The government can also require you to pay federal, state or local income taxes.
If you need a quick loan, some employers allow employees to borrow from their 401(k) account.
Many employers match the contributions to a 401(k), usually up to 6%. Some gradually increase up to the full amount over a period of many years. If your employer matches your contributions to a 401(k), then you have a great employee benefit. If not, you are missing a great deal.
There are several variations of this type of account. There’s the 403(b), which is a retirement account for educators and nonprofit workers. There’s also the 457(b) plan, which is the retirement plan for government employees.
A Solo 401(k) sometimes goes by the names Uni-k or One-participant 401(k).
It’s similar to a traditional 401(k) but is applicable to a business owner and a spouse who has no employees. Several examples of holders of this type of account are novelists, photographers, and freelance artists. The business owner makes a contribution both as employer and employee since they will be acting in both personalities.
Up to $18,000
As an employee, you can contribute 100% of your earned business income up to $18,000. If you are 50 years old or older, you may contribute up to $24,000. As the employer, you may contribute up to 25% of your salary. However, for 2017 your contribution should not exceed $54,000 per year. If you are 50 or older, the limit is $60,000 per year.
If your business is just a side income, like teaching piano in your spare time, you can still participate.
This means that you can contribute to a 401(k) in another company. The total contributions you can make to both plans must not exceed the $18,000/$24,000 limits.
A 403(b) is a retirement plan for public school employees, ministers or those who are working for tax-exempt organizations. Eligible employees must establish and maintain these retirement plans.
Here are the three types of plans under 403(b):
- Annuity contracts provide an insurance company. They also call these 403(b) annuity plans as tax-sheltered annuities (TSAs) and tax-deferred annuities (TDAs).
- Custodial accounts provided through a retirement account custodian. In these accounts, they limit the investments to regulated investment companies such as mutual funds.
- Retirement income accounts. Here, they only consider investment options of annuities and mutual funds.
The employer selects the financial institution(s) where the individual employees may keep their 403(b) accounts. The financial institutions will determine what type of 403(b) accounts the different employees may establish and maintain.
State and government employees mainly benefit from these types of account. While still working for the not-for-profit agency, an employee enjoys a tax-deferred status for his 457. Should he leave the agency, he cannot roll his 457 Plan to an IRA. If the employee takes it before he turns 59 ½, he doesn’t have to pay any penalty. The employee has to pay the corresponding tax though.
There are two major things that a 457 Plan, 401(k) and 403(b) have in common:
First, the employees do not pay taxes when they contribute but will have to when they withdraw money during retirement. Second, they can have the contributions automatically taken from their paycheck making savings more convenient.
State and government workers have the benefit of contributing to both the 403(b) and 457 plans simultaneously. This provides an opportunity for them to save up to $36K annually in pre-tax accounts.
The 457 plan is attractive in a sense. It is a good investment vehicle for those who are planning to retire early. Employees can access their money without having to pay penalties.
For a husband and wife team, it is possible to contribute to all three retirement accounts. If the husband works for a private employer, he can contribute to a 401(k). If the wife is a public school teacher, she can contribute to a 403(b) and a 457 Plan. This way, they can maximize the benefits that the 3 plans provide.
Anyone can contribute a maximum of $6,000 to an IRA account up to 2019.
For those over 50 years old, the maximum limit is $7,000. The money they put in grows tax-free. An employee can have both an IRA and a 401(k) and a separate retirement plan at work. However, he cannot deduct his IRA contributions for income tax purposes if his income bracket falls within a certain range.
After the income reaches $61,000 and $98,000, respectively, the IRS only allows for a partial deduction. For those who do not have a retirement plan at work, they get the full deduction no matter what their income is. This doesn’t apply, however, for those whose spouses have a retirement plan at work. IRA and 401(k) are the most popular retirement account while there are a couple of significant differences between them.
A Roth IRA has two distinct qualities.
First, employees contribute after-tax dollars. Second, they get no tax deduction for their contributions. The money they earn will grow tax-free and they won’t have to pay tax for withdrawals after the employee has reached 59 ½. Unlike a regular IRA, there is no mandatory withdrawal at age 70. An employee can withdraw the amount he contributed (but not earnings) any time without any penalty or tax. They cannot do this with a traditional IRA.
Not For Everyone
To qualify for a Roth IRA, you must make less than $135,000 annually if you are single. If you are married and filing jointly, you must have an income of less than $199,000. If you have an income of more than $120,000 (single) or $189,000 (married, filing jointly), they have reduced your contribution.
You may contribute to both traditional IRA and Roth IRA but you must apply the limits to the total contribution.
Some individuals who make too much to contribute to a Roth IRA also contribute to a conventional IRA. Then, they convert it to a Roth IRA later.
As the name suggests, a Roth 401(k) combines the features of a Roth IRA and a 401(k).
Employers offer this type of account but since this is relatively new, not all employers offer them. Contributions come from the employee’s after-tax salary instead of the pre-tax wage.
As long as the employee meets certain regulations, he wouldn’t have to pay taxes for his contributions and earnings.
This retirement account is for people who are self-employed and has no other employees. You can contribute to your own retirement account and deduct these contributions from your income tax. The maximum annual contribution for a SEP IRA is also higher than other tax-favored retirement accounts.
As they become more successful in their careers, employees may accumulate a variety of retirement accounts. Eventually, they may end up with one or more of these plans. Employees with a Rollover IRA may consolidate their 401(k) accounts from other employers. They can also convert an existing 401(k) or IRA into a Roth IRA account. The good thing here is, they can pay the tax now and they won’t have to pay again.
Those who are starting to save can use the employer’s 401(k) as the springboard for tax-deferred growth. Later on, a Roth IRA is great for storing extra cash they are saving for retirement or other life events. Before retirement, they can withdraw contributions to a Roth IRA without penalty and they will not pay any tax for it. This is why a 401(k) and a Roth IRA make a great combination.
This is an inexpensive retirement account option for any type of business, especially for those with 100 or fewer employees.
There’s a little administrative hassle and minimal paperwork involved. SIMPLE stands for Savings Incentive Match Plan For Employees. Employers contribute to a traditional IRA but unlike SEP IRA, employees can also put money in their account. For 2017, employees can contribute up to $12,500 if they are under age 50 and $15,500 if they’re over 50.
Employers have two choices on how to contribute to a Simple IRA:
- Match the contributions. They can match, dollar-for-dollar, what the employee contributes up to 3% of the compensation. In this option, if the employee chooses not to contribute to his account, the employer won’t have to contribute either.
- Make non-elective contributions. Employers can choose to make a flat 2% contribution regardless of how much contribution the employee makes. In this option, if the employee chooses not to contribute to his account, the employer still gives the 2%.
In both options, the employee is vested 100% in all their Simple IRA money.
Health Savings Account
Employees with high-deductible health insurance plans can save tax-free money is a HAS.
For 2017, the contribution limit is $3,400 for individuals and $6,750 for a family. For individuals aged 55 or older, they can make a catch-up contribution of an additional $1,000. They will allow employees to withdraw money to pay allowable medical expenses. These also cover copays and other items such as eyeglasses and hearing aids. If an employee doesn’t spend the money, it automatically and indefinitely rolls over.
Youngers pay 20% penalty
Once the employee reaches 65, he can withdraw the money for any purpose without any penalty. However, the money is subject to income tax. The retiree can also use it for his medical expenses. In this scenario, it will be tax-free.
If the employee withdraws money before he is 65 and uses it for non-medical expenses, there’s a downside. There is a 20% penalty plus the money will be subject to income tax.
An employee can also withdraw money to reimburse his own medical expenses even if he has paid them years ago. Of course, he has to be able to show the corresponding receipts for them as proof. If an employee did not use the money for medical expenses and he turns 65, he can still use his account. He can use it tax-free to pay for out-of-pocket health expenses.