Retirement Plans

It all seems like alphabet soup. What does it mean and why is it important to you? The first thing to understand about all these numbers and letters is that they represent different ways to save for retirement. The only differences between them are how they’re taxed and who is eligible for each of them. These traits are determined by the IRS who, shockingly, has also named them.

Each of the plans allows for either tax deferred or tax exempt growth of the money you deposit into the account. If the money is tax deferred, it has likely been taken out of your paycheck by your employer and deposited for you before you’ve been taxed on it. At the end of the year, if you earned $50,000 but contributed $10,000 in this manner to the retirement plan, you will only pay taxes on the $40,000 you actually took home. This money will be available for your use at age 59 1/2 and will only be taxed once you begin taking withdrawals. Only the withdrawals you take are taxed. The principle remains in the account growing tax deferred.

If you’re involved with a Roth IRA, then you will make contributions to the fund which are still taxed in the current year as though you took the money home, but the growth of that money will be tax exempt. When you reach age 59 1/2 you will be able to withdraw from the account and it will be a tax free source of income for you. In fact, there are only three ways to generate tax free income. Municipal bonds, cash value life insurance, and the Roth retirement plans.

The 401(k) is a qualified retirement plan that allows the participant to deposit up to $17,500 in years 2013 and 2014. 

The 403(b) Tax Sheltered Annuity (TSA) is available to employees of hospitals, schools, tax exempt entities, churches, and public school systems setup by indian tribal governments. These types of plans can be invested in either mutual funds or annuity contracts through an insurance company. The maximum contribution for years 2013 and 2014 is also $17,500.

The 457(b) Deferred Compensation plan is very special. It’s only available to employees of a state or local government or to those of a tax exempt entity. The plan allows for the same contribution limits as a 401(k) or 403(b) but can be accessed prior to age 59 1/2. Normally, if you take withdrawals before that age, the member would be hit with a 10% early withdrawal penalty, but the 457 isn’t hindered by the penalty which makes it an incredibly flexible retirement planning vehicle.

"In general, an eligible state or local government section 457 deferred compensation plan is not a qualified retirement plan and any distribution from such plan is not subject to the 10% additional tax on early distributions. However, any distribution attributable to amounts the section 457 plan received in a direct transfer or rollover from one of the qualified retirement plans listed above would be subject to the 10% additional tax."

An IRA or Individual Retirement Account is not a qualified retirement plan as defined by the IRS. The contribution limits to these plans are capped at $5,500 for 2013 and 2014, but everyone over the age of 18 is eligible to participate. These accounts are tax deferred retirement plans.

For those who own and operate a separate business, the SEP IRA and Solo 401(k) are available options which allow the participant to save $51,000 in 2013 and $52,000 in 2014 tax deferred. 

The Roth IRA annual limit is $5,500 per year in 2013 and 2014 and as mentioned previously, grows tax exempt. The new phaseout limits begin at $181,000 and end at $191,000 for couples filing jointly. What this means is that once the adjusted gross income reaches $181,000 you may not be able to contribute the full $5,500 and after your AGI has reached $191,000 you may not be able to contribute at all. For single people and those filing as head of household, the phaseout range is between $114,000 and $129,000. 

Those age 50 or greater may be able to make Catch Up Contributions. The limit to the contribution varies with the plan, but allows those nearing retirement to increase their savings. Give us a call and we can help you determine how much extra you might be able to put away.