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Retirement Planning Options
There are a variety of retirement planning options that can meet your needs. Your employer funds some; you fund some. Bear in mind that in most cases, withdrawals made before age 59 1/2 are subject to a 10 percent penalty, and withdrawals usually must begin by April 1 of the year after you turn age 701/2. Income taxes are also due upon withdrawal in most cases. This list describes 10 of the most common options.
defined benefit pension - normally provides a specific monthly benefit from the time you retire until you die. This monthly benefit is usually a percentage of your final salary multiplied by the number of years youıve been with the company. Defined benefit pensions are usually funded completely by your employer.
money purchase pension - provides either a lump-sum payment or a series of monthly payments. The size of this benefit depends on the size of the contributions to the plan. Your employer normally funds money purchase pension plans, although some will allow employee contributions.
profit-sharing plan - employee contributions are usually optional. Upon your retirement, you will normally receive your benefit as a lump sum. The company's contributions ı and thus your retirement benefit may depend on the company's profits. If a profit-sharing plan is set up as a 401(k) plan, employee contributions may be tax deductible.
savings plan - provides a lump-sum payment upon your retirement. The employee funds savings plans, although employers may also contribute. Employees may be permitted to borrow a portion of vested benefits. If a savings plan is set up as a 401(k) plan, employee contributions may be tax deductible.
employee stock ownership plan (ESOP) - an employer periodically contributes company stock toward an employee's retirement plan. Upon retirement, employee stock ownership plans may provide a single payment of stock shares. Upon reaching age 55, with 10 or more years of plan participation, you must be given the option of diversifying your ESOP account up to 25 percent of the value. This option continues until age 60, at which time you have a one-time option to diversify up to 50 percent of the account.
Tax-sheltered annuities or 403(b) plans - offered by tax-exempt and educational organizations for the benefit of their employees. Upon retirement, employees have a choice of a lump sum or a series of monthly payments. These plans are funded by employee contributions, and these contributions are tax deductible.
Individual retirement accounts - are available to virtually any wage earner at any salary. They are funded completely by individual contributions. IRAs are usually held in an account with a bank, brokerage firm, insurance company, mutual fund company, credit union, or savings association. They provide either a lump-sum payment or periodic withdrawals upon retirement.
There are two basic types of IRAs: traditional and Roth. Contributions to traditional IRAs may be tax deductible and are taxed upon withdrawal, whereas contributions to Roth IRAs are not tax deductible but qualified withdrawals are tax-free.
For Regular and Spousal IRAs
Your contribution is fully tax-deductible if:
Neither you nor your spouse participated in a company-sponsored retirement plan.
You contributed to a company-sponsored retirement plan: are single and earned less than $45,000 in 2004 ($50,000 in 2005), or married and filing jointly, and had a joint income of less than $65,000 in 2004 ($70,000 in 2005).
Your contribution is partially tax-deductible if:
You contributed to a company-sponsored retirement plan: are single and earned $45,000-$55,000 in 2004 ($50,000-$60,000 in 2005), or married and, filing jointly, and had a joint income of $65,000-$75,000 in 2004 ($70,000-$80,000 in 2005).
Your contribution is not tax-deductible if:
You contributed to a company-sponsored retirement plan: either single and earned more than $55,000 in 2004 ($60,000 in 2005) or married, filing jointly, and had a joint income of more than $75,000 in 2004 ($80,000 in 2005).
Keogh plans - were specifically designed for self-employed people. They are funded completely by wage-earner contributions and provide either a lump-sum payment or periodic withdrawals upon retirement. Keogh plans have the same investment opportunities as IRAs. Contributions to Keogh plans are tax deductible within certain generous limitations.
Simplified employee pensions, or SEPs - were designed for small businesses. Like IRAs, they can provide either a lump-sum payment or periodic withdrawals upon retirement. Unlike an IRA, the employer primarily funds them, although some simplified employee pensions do allow employee contributions. SEPs are usually held in the same types of accounts that hold IRAs. Employee contributions ı in those SEPs that allow them ı may be tax deductible.
Savings Incentive Match Plans for Employees, or SIMPLE plans, - were designed for small businesses. They can be set up either as IRAs or as deferred arrangements - 401(k)s. The employee funds them on a pre-tax basis, and employers are required to make matching contributions. Principal and interest grow tax deferred.
Strictly speaking, annuity contracts are not qualified retirement plans. But they do provide tax-deferred growth like qualified retirement plans. They are also subject to withdrawal conditions very similar to qualified retirement plans, but there are no contribution limits. They can be used very effectively to supplement your employer-provided retirement plan.
401k Plan
Of all the retirement planning options that are available, 401(k) plans may be one of the best programs for accumulating retirement funds.
Unlike a taxable savings vehicle, a 401(k) plan allows you to make annual pre-tax contributions of up to $12,000 (in 2003). The contribution limit will increase an additional $1,000 per year until it reaches $15,000 in 2006. And pre-tax contributions are much better for savers than after-tax contributions. For example, if you are in the 27 percent federal marginal tax bracket, it effectively costs you only $73 of spendable income to save $100 for retirement. And it works out even better for those in higher tax brackets.
Like other qualified retirement plans, a 401(k) allows your money to grow tax deferred. This enables you to build capital significantly faster than similar investments outside the shelter of an employer-sponsored plan. Distributions from a 401(k) plan prior to age 591/2 may be subject to a 10 percent federal tax penalty and are included in gross income.
But that's not all. A 401(k) plan offers some additional benefits that make it particularly attractive.
Portability
A 401(k) plan is portable. Unlike some other employer-sponsored retirement plans, you can take your 401(k) plan with you when you change employers. Within certain limits, the accumulated funds in your 401(k) plan can be rolled over into your new employerıs retirement plan without penalty. If your new employerıs retirement plan doesnıt allow such transfers, you can roll over your funds into a traditional individual retirement account.
Considering that the average worker changes jobs five to seven times during his or her career, this can be an important advantage.
Employer Matching
Many employers offering 401(k) plans to their employees match contributions. For example, your employer may add an amount for each dollar you contribute, up to a certain percentage of your salary. Thatıs an automatic return on your investment.
Over the long term, matching contributions enable you to accumulate more retirement assets than plans based solely on employee contributions.
Investment Flexibility
A 401(k) plan can also provide a great deal of flexibility. Most 401(k) plans offer a number of investment options. This means youıre able to choose how your retirement fund will be invested. Most plans offer a stock fund, a bond fund, a money market fund, a guaranteed investment account, and company stock. You can be as aggressive or conservative as you wish.
"Catch-Up" Contributions
Special "catch-up" contribution provisions enable those nearing retirement to save at an accelerated rate. Those aged 50 and older before the end of the tax year will be eligible to contribute more than the regular limits. Eligible 401(k) plan participants may contribute an additional $2,000 in 2003, with that amount increasing by $1,000 per year until it reaches $5,000 in 2006.
If your employer offers a 401(k) plan, you should carefully weigh the benefits in light of your financial situation. A 401(k) plan can form the basis of a sound retirement planning strategy.
The Advantages of Saving Sooner
Most people have good intentions about saving for retirement. But few know when to start or how much is enough. Far too many people use credit cards as an additional income source and sink further into debt. This leaves precious few dollars to put aside for savings and retirement. And the interest on credit cards builds up much faster than interest on a savings account.
Of all workers, more than one-quarter have saved less than $10,000 for retirement. A better approach might be to allocate a certain amount for savings every month and pay yourself as though it were an expense.
Not only does it pay to save, but if you start sooner, you can take advantage of the power of compounding. For example, your deposits earn interest and so does your reinvested interest. This is a good example of letting your money work for you. The sooner you start saving for retirement, the more you will have when you retire. And the sooner you start saving for retirement, the sooner you will be able to retire.
If you have trouble saving money on a regular basis, you may try savings strategies that force you to save. Examples of forced savings strategies are whole life insurance, employer-sponsored retirement plans, and direct payroll deductions. These financial vehicles allow you to take your savings directly out of your paycheck as an expense. This means youıll be paying yourself even before your creditors. Some of these options, such as whole life insurance and employer-sponsored retirement plans, may also have deferred tax advantages that further increase the advantage of saving early.
Distributions from a tax-deferred retirement plan, such as a 401(k) plan, are taxed as ordinary income and may be subject to an additional 10 percent federal tax penalty if withdrawn prior to age 591/2.
Traditional IRAs have long been popular with investors. For many people, they offer a substantial current income tax deduction. And the assets in an IRA grow tax deferred.
Unfortunately, there are some significant eligibility restrictions for traditional deductible IRAs. If youıre an active participant in a qualified retirement plan ı such as a simplified employee pension plan or a 401(k) plan your IRA deduction could be reduced or eliminated if your income is above certain levels.
Roth IRAs
Now Congress has stepped in to help fill the gap.
A tax-favored vehicle called the Roth IRA offers tax-free accumulation and withdrawals if certain conditions are met.
Unlike traditional deductible IRAs, taxpayers cannot deduct contributions made to Roth IRAs. However, unlike the case with traditional IRAs, qualified distributions from Roth IRAs arenıt included in a taxpayerıs gross income or subject to the additional 10 percent federal income tax penalty for early withdrawals. This means that qualified withdrawals from a Roth IRA will be free of federal income tax.
Qualifying Distributions
To qualify for a tax-free withdrawal at retirement (after age 591/2), a distribution must be made after a five-year holding period. In other words, you cannot make a withdrawal until five years from the first tax year you make a contribution to your Roth IRA.
After this initial holding period, you may also make withdrawals due to death or disability, or to purchase your first home (up to a $10,000 lifetime cap), without triggering federal income taxes or being subject to the 10 percent federal income tax penalty for early withdrawals. You may also withdraw funds from your Roth IRA for college expenses (after the initial five-year holding period) without incurring the 10 percent penalty, although regular income taxes would be due on withdrawn earnings.
Keep in mind that although qualified distributions are free of federal income taxes, state and/or local taxes may apply in some states.
Limits
For tax years 2002 to 2004, the Roth IRA contribution limit is $3,000, and it will gradually reach $5,000 in 2008. Eligibility to contribute to a Roth IRA phases out for taxpayers with higher incomes. Eligibility begins phasing out for single filers with adjusted gross income of $95,000, phasing out completely when adjusted gross income reaches $110,000. Similarly, eligibility begins phasing out for married taxpayers (filing jointly) with adjusted gross income of $150,000, phasing out completely when adjusted gross income reaches $160,000.
Catch-Up Contributions
Special "catch-up" contribution provisions enable those nearing retirement to save at an accelerated rate. Those aged 50 and older before the end of the taxable year will be eligible to contribute more than the regular limits. Eligible Roth IRA participants may contribute an additional $500 per year from 2002 through 2005, and an additional $1,000 per year thereafter. This is in addition to the otherwise maximum contribution limit (before application of adjusted gross income phaseout limits).
Unlike a traditional IRA, there are no penalties if you make contributions to (or fail to take minimum distributions from) a Roth IRA after you reach age 701/2.
If you're looking for a retirement savings vehicle with some distinct tax advantages, the Roth IRA could be right for you.
Retirement Plan: Obtain Benefits
When it comes to receiving the fruits of your labor (the money accumulated in your employer-sponsored retirement plan), you are faced with two broad options. Should you take the payout as a lump sum or as an annuity?
The Annuity Option
If your retirement plan is inflexible, you may be forced to take the annuity option. Many company pension plans pay out in the form of an annuity. An annuity is a fixed monthly payment for the duration of your life.
The advantages of receiving an annuity include avoiding the temptation to squander or the pressure to invest a large sum of money which must last you the rest of your life. Also, there is no initial tax on the entire value of your retirement fund each monthly payment is regarded as ordinary income and taxed accordingly.
If you are married, you may have the option to elect a joint and survivor annuity. With this option, you receive a lower monthly retirement payment, but in the event of your death, your spouse will continue to receive a portion of your retirement income. If you do not elect an annuity with a survivor option, your monthly payments end with your death.
The main disadvantage of the annuity option lies in the potential reduction of spending power over time. If we have annual inflation of 4 percent, the purchasing power of the fixed monthly payment would be halved in 18 years. Since the life expectancy of the average 65-year-old is now an additional 20 years, you can see the potential difficulties of relying primarily on an annuity in your retirement years.
Lump Sum Distribution
If you decide to take the money as a lump sum, you receive the value of your account in one single payment and invest it as you see fit. You retain control of the principal and can use it whenever necessary for your children, grandchildren, vacations, or anything you want. You retain the autonomy to make your own investment decisions.
There are certain tax options available that may reduce or defer your tax bill should you decide on a lump sum. However, unless there are exceptional circumstances, there is a 10 percent penalty imposed by the IRS on lump sum distributions taken before age 591/2 that are not rolled over into an individual retirement account. This rollover must occur within 60 days of distribution.
In addition, lump sum distributions are subject to 20 percent withholding toward income taxes. This withholding can be avoided only by arranging for a direct trustee-to-trustee transfer of funds from your employer-sponsored plan into a traditional IRA or another qualified plan or kept in the former employer's plan, if allowed.
Before you take any action, it would be prudent to consult with a tax professional regarding your particular situation. Choose carefully, because your decision and the consequences will remain with you for life.
IRA Rollover
If you want to rollover an IRA, either Traditional or Roth, you need to request a check from the current custodian or institution that handles your IRA. As long as you put the money from the old IRA into a new IRA within 60 days, your IRA remains intact and you won't owe any federal income tax or tax penalties on the money. So, as you can see, it's important to make sure that the money is put back into your new IRA account within 60 days. The IRS allows you to "Rollover" your IRA in this fashion, once every 12 months.
Direct Transfer
In many cases you may wish to transfer your money directly from one IRA custodian to another. By doing a "Direct Transfer" you avoid the risk of owing any federal income tax or tax penalties and you don't have to worry about the 60-day requirement. Unlike a "Rollover", which can only be completed once every 12 months, the IRS does not limit the number of times you can "Transfer" your IRA.
1035 Exchange
1035 refers to a provision in the tax code which allows for the direct transfer of accumulated funds in a life insurance policy, endowment policy or annuity policy to another life insurance policy, endowment policy or annuity policy, without creating a taxable event.
Title 26, Subtitle A, Chapter 1, Sub chapter O, Part III, Section 1035
states that "no gain or no loss shall be recognized on the exchange" of a life insurance policy for another life insurance policy or endowment or annuity policy.
An ENDOWMENT for another endowment with maturity no later than the maturity date of the endowment being replaced.
An ANNUITY POLICY for that of another annuity policy.
The 1035 exchange is one of the few parts of the tax code that works in your favor. For example, when you sell shares of stock to buy shares of a different company, the profits on your investment are subject to taxes. With annuities, you can exchange one company's product for another's with the earnings from your original investment still tax-deferred until you take money out of annuities for good.
AVOID Losing 20-30% of Employer Retirement Account to IRS?
When you change jobs or retire, you face one of the most important financial decisions you'll ever need to make: What do I do with the Lump Sum Distribution from my company's retirement plan?
The amount saved in your company's retirement plan could represent the largest asset you own. The investment may represent years of hard-earned savings and be a sizable part of your financial support during retirement. If you are eligible to take a distribution from the plan, make sure you know your distribution options and the tax consequences involved before withdrawing money.
Consider These issues with retirement plan distribution
If you have your Lump Sum Distribution directly paid to you, 20 percent must be withheld automatically. Why? Because this payout is considered part of your income now and the 20 percent withholding is credited against federal income taxes you may owe. Note: You may owe additional federal and state income tax on this income, depending upon your tax bracket.
In certain situations, you must pay a 10 percent penalty for taking your retirement plan money. You pay this 10 percent in addition to any income taxes you pay on the money. Youıre subject to the penalty if you are under the age of 59.
You can avoid the 10 percent penalty if you open an IRA within the 60 days of your distribution and put the 80 percent you were paid plus 20 percent out of your own pocket to make up for the withholding. The 20 percent withheld counts toward your income tax liability when you file your federal return.
You can entirely avoid penalties and withholding and preserve 100 percent of your investment by establishing a Direct Rollover IRA. The key is to have the distribution check deposited directly into your new IRA, so you never even see it.
Your savings will continue to grow tax-deferred, and you can withdraw money as you need it.
A direct rollover IRA isn't your only option...But itıs your best option
The material presented on our web site may contain concepts that have legal, accounting and tax implications. It is not intended to provide legal, accounting or tax advice, you may wish to consult a competent attorney, tax advisor, or accountant.
Note: Any reference to the word guarantee is based on the claims paying ability of the underlying insurance company.
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