401(K) Plans

Creating a savings plan for retirement is essential in obtaining the desired retirement lifestyle that you want. Within a 401(K) savings plan, you as an employee allow to divert a portion of your salary to a long-term retirement investment. For this type of plan, your employer can match your contributions up to a particular limit which aids in your overall retirement fund. Being that a 401(k) is a “qualified” retirement plan, that means that the fund is possibly eligible for special tax benefits that are cleared through the IRS. These qualified plans are: defined-contribution or defined-benefit (pension plans), but a 401(k) plan is considered a defined-contribution plan. This means that the account amount after retirement is entirely in the hands of the employee, not the employer. Your employer may choose to match your contributions or they may not, regardless, the account is predominantly what you put in. This type of plan is pretty common and most employees have some sort of a 401(k) plan.

Another type of retirement savings plan is an Individual Retirement Account or an IRA. This type of plan is a tax-advantage investing tool that people can use to divert money to retirement savings. The different types of IRA plans are: Traditional IRA’s, Roth IRA’s, SEP IRA’s, and SIMPLE IRA’s. With IRA’s, your employment status matters and it can determine the type of plan you can pursue, often providing different tax liabilities. IRA’s also have rules regarding max contributions as well as income limits and these change every year. A benefit of having a self-directed IRA is that it allows for investors to make all decisions regarding investments. It also ives access to a larger selection of investments which include: tax liens, real estate, and private placements. An individual taxpayer will usually move forward with a traditional IRA or an Roth IRA. Small business owners or those who are self-employed, will usually establish a SEP or SIMPLE IRA’s. You can only establish an IRA plan if you earn the earned and approved income established by the IRA rules. For example, social security benefits or child support do not quality as earned income and can not be used within this plan. Since IRA’s are a retirement savings plan, if you choose to withdrawal your money early, before the age of 59 and a half, you will pay an early-withdrawal penalty of 10% of the account balance. Additionally, you may also have to pay income tax on an early withdrawal depending on the type or IRA plan that you have.

Next, we have Roth IRA’s. Not all employers offer this type of plan, but it is a great option. This type of IRA plan allows for you to pay income taxes immediately on whatever amount you put within your fund. Upon retirement, you can withdraw this money without having to pay further taxes on the total amount, nor taxes on your investment gains. Additionally, you can continue to contribute to your Roth IRA as long as you have earned income that is eligible, regardless of you age. In turn, you do not have to take all of the money out of the account if you don’t choose to. This type of plan is great for those who think their taxes may be higher during retirement than they are as of right now. Most banks and investment companies offer IRA plans so they are pretty easy to find. The only snag is, they do have limitations on contributions. For example, for 2020 the limit for singles is $139,000. For married couples, it is $206,000, so if you make too much money this plan is not for you. Also, the amount that you can contribute shifts periodically. For 2020, if you are under 50 years old, the limit you can contribute is $6,000/year. If you are over 50, you can contribute up to $7,000/year. Overall, the IRS limits the amounts of money that you can deposit, just like any type of IRA where the amounts adjust regularly.

Another extension of the IRA plan family is the Roth 401(k) plan. This basically mixes together the type of funds we discussed above. This type of plan is an employer-sponsored savings account where the money that is put in is after-tax dollars up to the contribution limit. If you believe that in retirement you’ll be in a higher tax bracket than you are now, this is an optimal plan for you being that you won’t be taxed on withdrawals. This plan also has no income limitations in order to get this plan. With this plan, your contribution limit will differ based on your age. For some, the limit is $19,500/year, but if you’re over 50 years old, you can contribute an additional $6,000/year in order to “catch-up”. In order to make withdrawals, there are some limitations. In order to not be taxed on withdrawals, you must have a qualified distribution plan as well as held the account for at least 5 years. You also can’t withdrawal on a frivolous basis; the account must be withdrawn from on the basis of disability, death of account owner, or after the account holder is 59 and a half years old. This type of plan is optimal for those who are currently in a low tax bracket and project to be within a higher tax bracket upon retirement. If you are an individual who is approaching retirement and expects a drop in income, this plan is not for you. I say this because when you are expecting a drop in income, you are most likely shifting to a lower tax bracket and that is basically the opposite of this plan’s purpose.

In regards to SIMPLE IRA, this pertains to Savings Incentive Match Plan for Employees (SIMPLE). Like I stated earlier, this type of IRA plan is really geared more towards small business owners and self-employed individuals. This type of plan allows for both employers and employees to contribute to an employees’ traditional IRA. This plan is usually used as a start-up retirement plan for small businesses and small employers to provide some sort of savings plan for their employees, even though they aren’t currently sponsoring retirement plans. The contributions are already pre-taxes so this will reduce the taxes you have to spend when you withdrawal for retirement. An employer can match your contributions as an employee, but up to a maximum of 3% of your compensation. What’s nice about this, though, is that even if you don’t participate in your SIMPLE IRA plan, your employer will still have to contribute a fixed 2% rate on your compensation. The contribution limit changes periodically but as for the 2016/2017 tax years, employees were allowed to contribute up to $12,500 to their SIMPLE IRA plan. If you were older than 50 at that time, you could add an additional $3,000 in order to play catch-up. This type of plan offers higher contribution limits than a Roth or traditional IRA plan. It also offers more investing options than many employer-sponsored plans and can be a great option if it suits your needs.

Lastly, we will cover SEP IRA. A SEP IRA stands for Simplified Employee Pension Individual Retirement Arrangement. With this type of plan, your employer is responsible for setting it up for their employees. If you are self-employed you can arrange for this type of plan and play the role of both the employer and employee. The contributions made to a SEP IRA are tax-deferred, which means that you won’t be responsible for paying taxes on any income or investment gains until you withdrawal your money. What is important to note about this plan is that SEP IRA’s don’t usually have limitations on which investments you want to make. Employers have the opportunity to contribute up to a quarter of an employee’s while wages. As of 2017, the max contribution amount was $54,000, which is much higher than say a SIMPLE IRA plan. The only snag to this type of plan is for those individuals who are business owners with employees. You as an employer can not make sizable contributions to your own SEP IRA account without doing the same for your employees. But, the isn’t always a bad plan, especially if the salary disparities are drastically different. SEP IRA’s make it really easy for employers to help their employees safe for a fruitful retirement under their company so this may be a great option if it suits your needs.

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