Congress offers myriad choices to help make saving for your retirement more attractive. So how do you determine which option works best for you?
Here’s a brief look at the most common retirement savings strategies you may want to consider.
Understanding IRA options
Individual Retirement Accounts (IRAs) are available to virtually any individual (or spouse) with earned income. Because IRAs are sponsored by individuals, they are not subject to an employer relationship.
Upon retirement, the IRA owner can choose to take a lump sum benefit payment or a series of benefit payments. There are four kinds of IRAs — deductible, nondeductible, Roth and rollover IRAs. Each has its own unique advantages that vary with an individual’s situation.
Individuals under the age of 70 who earn an income may contribute to a deductible IRA straight out of their paycheck, provided they follow certain rules. Investment earnings within this account grow tax-deferred. Withdrawals are taxed at current ordinary income tax rates, but withdrawals taken prior to age 59 are subject to an additional 10 percent excise tax.
A nondeductible IRA is funded with contributions that have not been deducted from an individual’s current income. These contributions are not taxed when withdrawn because they have already been taxed. (Account earnings are taxable, however.)
Roth IRAs are similar to nondeductible IRAs, but earnings and eventual benefit payments attributable to these accounts are not taxed. Roth IRAs are attractive to individuals who expect to be in the same or higher marginal tax bracket in retirement.
Certain tax penalties do apply if benefits are paid out within five years from account inception or prior to age 59. Another major advantage of Roth IRAs is that they are exempt from minimum required distribution rules. This means that Roth IRA accounts can be conserved and left to heirs, who then must begin to take tax-free distributions over their remaining life expectancies.
Rollover IRAs are another option when you retire or change jobs. By moving eligible rollover distribution assets to an IRA, you can defer paying some or all taxes and penalties
Adding benefits with employer-sponsored retirement plans
If you are eligible for an employer-sponsored retirement plan, several alternatives can substantially increase the annual contribution you make.
Some small businesses use Employer Sponsored Simplified Employer Plans (SEP IRAs) as a funding vehicle. Unlike a traditional IRA, the employer funds these SEP IRAs, although some “grandfathered” plans do allow employee contributions.
SEP IRAs are usually held in the same types of accounts that hold IRAs. SEP IRAs provide either a lump sum payment or periodic withdrawals upon retirement.
Other small businesses establish Savings Incentive Match Plans for Employees (SIMPLE) plans using IRAs as the funding vehicle. SIMPLEs include employee deferral arrangements similar to those of 401(k)s. The employee funds these on a pre-tax basis. Employers are required to make matching contributions or a guaranteed base contribution. Principal and interest grow tax deferred.
Employees fund 401(k) Profit Sharing Plans through before-tax salary deferrals. Employers may also contribute through discretionary matching or profit sharing contributions. Unlike IRA-based programs, employees may borrow a portion of the vested benefits or take “in-service” distributions if permitted by the plan. Because contribution limits are higher, these plans are the most regulated.
Planning ahead
In most cases, withdrawals from pension plans made before age 59 1/2 are subject to a 10 percent penalty. Withdrawals usually must begin by April 1 of the year after you turn the age of 70 1/2. Income taxes are also due upon withdrawals in most cases.
Many pension plan limits are set to change. By contacting The Ohio Society of CPAs’ free Ohio CPA Referral Service, you can find a CPA in your area who can explain these changes and help you plan for a secure retirement. Jeffrey H. Tucker, CPA is chair-elect of The Ohio Society of CPAs Executive Board and a partner at Rea & Associates Inc. in New Philadelphia. For more information about The Ohio Society of CPAs’ free CPA Referral Service, call (800) 686-2727.
