RETIREMENT PLANS

A retirement plan is a way to set aside money for the future. Regular contributions to a retirement plan can help you save more money and save more often. Start saving now, with even small amounts, to give your money more time to possibly grow.

There are various types of retirement plans.

  • Some employers offer their employees a 401(k), and may also offer a designated Roth account) retirement plan which can make it simple for employees to save money for the future out of every paycheck.
  • Federal employees and some military members may contribute to a Thrift Savings Plan (TSP).
  • Anyone with earned income or their spouse if they file jointly can fund an Individual Retirement Account (IRA).   
  • If you have a business of your own, you may be able to set up your own Simplified Employee Pension Plan (SEP) IRA, 401(k), or other type of retirement plan.
  • A Simple IRA, which works much like a 401k plan, is designed for employers with less than 100 employees.

To learn more, consult with a tax or retirement planning expert.


TYPES OF RETIREMENT PLANS

A retirement savings account, or plan, is a way to set aside money for the future giving your money more time to grow.

There are various types of retirement plans that you may be able to participate in as an individual or employer. Some employers encourage their employees to save for the future and make it simple, and automatic, for employees to save money out of every paycheck they get. Strongly consider contributing, as much as you can as soon as you can. Typically, retirement accounts offer different investment options. Some employers even offer to match your contributions. If yours does, take full advantage of it. Set a goal to contribute at least enough to get the full match. Keep in mind that your employers’ contributions can vary year to year, so stay up to date on any changes.

A retirement planning expert may be able to help you come up with a retirement strategy based on your situation. The two common types of retirement plans are defined contribution, such as 401k, 403b, 457, and Simplified Employee Pension Individual Retirement Plan (SEP) and defined benefit such as a pensions.   

Defined contribution – Example: 401(k), 403(b), 457, Thrift Savings Plan (TSP)

One common type of a company-sponsored employee retirement plan, is a defined contribution. It may be called a 401(k) if you work for a corporation, a Thrift Savings Plan if you work for the federal government, including military members, a 403(b) for certain employees of public schools or tax-exempt organizations, or a 457(b) if you work for state and local government employees. These retirement savings accounts can help you increase your retirement savings. All four, the 401(k), the traditional TSP, the 403(b), and the 457(b) offer the same type of savings and tax benefits.

According to Internal Revenue Service (IRS) guidelines, for 2020, the maximum 401(k), 403(b), or TSP contribution is $19,500 if you’re younger than 50, and $26,000 if you are 50 or older. If you are age 50 or older, you can take advantage of the “catch up” provision or contribution to maximize the amount of money you contribute. Some 403(b)s even allow an additional catch up contribution on top of the normal catch up contribution.  While there are legal limits on how much you can contribute, you usually don’t have to pay income taxes on the money you contribute until you withdraw the money when you’re retired. The withdrawal may also be subject to an IRS 10% additional tax for early or pre-59 ½ distributions (10% additional tax).

Your employer may designate or offer a Roth account option for your company-sponsored plan. A designated Roth account allows you to save for retirement by contributing with after-tax dollars now so your distributions in retirement can be tax-free, if you meet certain conditions.

If your company offers a retirement plan, study the specifics and talk with a retirement plan expert. To learn more about the Thrift Savings Plan, visit the tsp.gov website.

older couple looking at a bill

Defined benefit – Example: Pension

A defined benefit plan provides a specific income for retired employees, either as a lump sum or as a pension (an annual lifetime payment). When employers offer pensions, they contribute to a common asset pool of funds set aside for employees’ future benefit. These funds are invested on the employees’ behalf. The employees receive the funds upon retirement, usually based on the employee’s age at retirement, final salary, and the number of years on the job. If your company offers a pension, you may also be eligible for other retirement savings accounts. Be sure to consult with a retirement planning expert and tax advisor for more information.

Simplified Employee Pension Individual Retirement Plan (SEP)

If you are self-employed or operating a small business with fewer than 100 employees, there are a range of plans that should be considered. One option is a Simplified Employee Pension Individual Retirement Plan (SEP) can be a good option for any company, including people who are self-employed, have few employees, or a company of just family members. Funds may be invested the same way as in an IRA. According to Internal Revenue Service (IRS) guidelines, for 2020, you can contribute up to 25 percent of your business compensation, up to a maximum of $57,000, into a SEP.

Considerations

  • Easy to setup and operate
  • Low administrative costs
  • Withdrawal restrictions
  • Flexible annual contributions – good plan if cash flow is an issue
  • Employer must contribute equally for all eligible employees
  • Available to any size business
  • No filing requirement for the employer
  • Only the employer contributes (maximum of up to 25 percent of each employee’s pay)
  • Employee is always 100% vested in (or, has ownership of) all SEP-IRA money
  • Participants (employees) cannot take loans from or use as collateral
  • Withdrawals subject to additional tax of 10% if under age 59 1/2

ABOUT INDIVIDUAL RETIREMENT ACCOUNTS

An Individual Retirement Account (IRA) is an account that holds investments you’ve selected (for example, CDs, mutual funds, or stocks) to help pay for your retirement. There are two main types of IRAs—Traditional and Roth. Both types of IRAs offer investment flexibility, tax advantages, and the same contribution limits.  For 2020, the maximum you can contribute to all of your Traditional and Roth IRAs is the smaller of:

  • Lesser of 100% of earned income or
  • $6,000 (if under age 50)
  • $7,000 if you’re age 50 or older (for the tax year the contribution is made)

The traditional IRA offers tax-deferred growth potential. You pay no taxes on any investment earnings until you withdraw or “distribute” the money from your account, presumably in retirement. Additionally, depending on your income, your contribution may be tax deductible. Deductible contributions and any earnings are subject to ordinary income tax and distributions before age 59 ½ may be subject to the 10% additional tax.

The Roth IRA offers tax-free growth potential. Investment earnings are distributed tax-free in retirement, if the account was funded for more than five years and you are at least age 59½, or as a result of your death, disability, or using the first-time homebuyer exception. Since contributions to a Roth IRA are not deductible, there is no tax deduction regardless of income. If your income exceeds the modified adjusted gross income (MAGI) limit, you are not eligible to contribute to a Roth IRA. Distributions before age 59 ½ may be subject to the 10% additional tax. 

To understand the differences between Traditional and Roth IRAs, and to set up an IRA, it’s important to work with a banker, a financial advisor, or a retirement specialist. Since laws frequently change, check with your banker, a financial advisor, or a retirement specialist for current limits, maximum contributions, and potential tax deductions.

To understand the differences between Traditional and Roth IRAs, and to set up an IRA, it’s important to work with a banker, a financial advisor, or a retirement specialist. Since laws frequently change, check with your banker, a financial advisor, or a retirement specialist for current limits, maximum contributions, and potential tax deductions.


COMPARING INDIVIDUAL RETIREMENT ACCOUNTS

This chart compares the traditional IRA and the Roth IRA. To learn more about the differences and to set up an IRA, it’s important to work with a banker, a financial advisor, or a retirement specialist.

Which Individual Retirement Account (IRA) is best for you?

Traditional IRARoth IRA
Account DescriptionYour earnings grow tax-deferred and, if eligible, your contributions may be tax-deductible as well. You can also roll over your IRAs  or employer-sponsored qualified retirement plan, such as a 401(k), to consolidate your retirement assets without having to pay taxes currently.You make after-tax contributions but the money you distribute in retirement may be free from federal taxes, if certain conditions are met.
Eligibility to contributeYou can contribute at any age as long as you or your spouse if filing jointly have earned income.You can contribute at any age as long as you or your spouse if filing jointly have earned income and meet the income limitations.
Maximum annual contributions$6,000 ($7,000 age 50 and older) for the 2020 tax year.$6,000 ($7,000 age 50 and older) for the 2020 tax year.
Tax-deductible contributionsYou can deduct your contributions if you meet the eligibility requirements.No tax deduction, contributions are made with after-tax dollars.
Taxation of earnings and distributionsTax-deductible contributions and earnings are taxed as ordinary income when distributed. After-tax contributions are distributed tax-free on a proportionate basis.• Contributions are always distributed tax-free • Qualified distributions, which are tax-free and not included in gross income, are when your account has been open for more than five years and you are at least age 59½, or as a result of your death, disability, or using the first-time homebuyer exception. • A non-qualified distribution may be subject to tax and a 10% additional tax, unless an exception applies.
Distribution tax10% additional tax on early or pre 59 ½ distributions, unless as exception applies.10% additional tax on early or pre 59 ½ distributions of convert amounts or earnings unless as exception applies.
Required withdrawalsMust begin at age 72.Owner have no RMDs.
The information contained herein is being provided as-is and without representation or warranty. The enclosed information is not intended as legal, tax or financial planning advice. Any discussion of tax or accounting matters herein (including any attachments) should not and may not be relied on by any recipient or reader. The recipient/reader should consult his/her tax adviser, legal consultant and/or accountant for a statement of tax and accounting rules applicable to his/her particular situation and for all other tax and accounting advice.

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