We’ve been talking lately about college costs and how to plan to those. This week, we’re going to jump to the other end of the spectrum — retirement savings.
Almost everyone realizes the importance of saving for their retirement, yet many get confused or overwhelmed by the many choices available for those retirement dollars. While this list is not all inclusive, it will give you a good base of knowledge.
Individual Retirement Arrangement (IRA)
Anyone who isn’t an active participant in a retirement plan at their employment can contribute and deduct on their tax return up to $5,500 (for 2015). Folks who turn 50 before the end of the year can contribute and deduct an additional $1,000 for a total of $6,500. If your earned income is less than the maximum allowable contribution, you can only contribute up to the amount of your earned income. Non-working spouses can contribute to their own IRA, even though they don’t have income, as long as their spouse’s earned income is great enough to cover both of their IRA contributions.
The IRA must be set up with a bank, savings and loan association, credit union, or other qualified person. Most investment houses are qualified to set up IRAs for individuals.
Characteristics of IRAs:
- Tax deduction in the year of the contribution, subject to income limits.
- Maximum contribution for 2015 is $5,500 ($6,500 if over age 50).
- No tax paid on earnings as long as the funds remain in the IRA.
- All distributions from the IRA are taxed as ordinary income in the year of the distribution.
- Any distributions taken before age 59½ are subject to a 10% early withdrawal penalty.
- At age 70½, required minimum distributions kick in.
Roth IRA
Roth IRAs have the same basic characteristics of the traditional IRA, but do have a few exceptions — as you will notice in the list of characteristics.
Characteristics of Roth IRAs:
- No tax deduction allowed for the contribution.
- Contributions are subject to income limitations.
- Maximum contribution for 2015 is $5,500 ($6,500 if over age 50).
- No tax paid on earnings.
- All distributions from the Roth IRA are not taxed (under current tax law) as long at the Roth IRA has been in existence for at least five years.
- Any distributions taken before age 59½ are subject to a 10% early withdrawal penalty.
- No required minimum distributions at age 70½.
401(k) plan
Also referred to as cash or deferred arrangements (CODAs), these plans are set up by the employer for the employees’ benefit. The employee owns all voluntary contributions he/she makes to the plan. Employer matches may or may not be immediately owned by the employee, depending on the plan.
Characteristics of 401(k) plans:
- Employee can defer up to $18,000 (for 2015) of his/her income into the 401(k).
- Amount deferred is not included in the employee’s taxable income.
- Employer matches are not included in employee’s current taxable income.
- No tax is paid on earnings as long the funds remain in the 401(k).
- All distributions from the IRA are taxed as ordinary income.
- Any distributions taken before age 59½ are subject to a 10% early withdrawal penalty.
- Required minimum distributions kick in at age 70½.
- The employer’s creditors cannot touch the funds in the 401(k).
- If the employee declares bankruptcy, the funds in the 401(k) are protected and cannot be taken by creditors.
Roth 401(k) Plan
Like the Roth IRA, the Roth 401(k) has the same basic characteristics as the regular 401(k) with these differences:
- Contributions to the Roth 401(k) are included in the employee’s income.
- All distributions from the Roth 401(k) are non-taxable (under current tax law) as long as it has been at least five years since the employee made his/her first contribution to the Roth 401(k).
Please note that the Roth 401(k) is subject to required minimum distributions at age 70½.
For more information on these plans or other retirement vehicles, please consult your tax professional.
Disclaimer: Please be advised that the information contained herein is not intended to be used, nor can it be used, for the avoidance of tax penalty that the taxing authorities might assess related to this matter.
Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.
