Adulting 101: retirement plans

Feb 23, 2017 | Retirement

We want your finances to age like a fine wine, not disappear like Franzia. And retirement, like winter, is coming. There are several major types of retirement accounts that offer ways to maximize your retirement piggy bank (and Tommy Bahama t-shirt collection). They all have their different tax advantages, requisites and limits, so let’s talk options.

401(k)s plans.

401(k)s are retirement plans offered to employees of most major organizations and many smaller companies. The IRS allows annual 401(k) contributions up to $17,500.

In many cases, employers will match a certain percentage of the amount workers contribute to their 401(k) plan. If your employer matches, try to contribute as much as you can to maximize your future payout. When you factor in the compounding of that extra money over time, you could wind up being quite the happy camper as you approach your Golden-Girls years.

A sibling of the 401(k) plan is the 403(b), which is a retirement plan offered by charitable organizations or non-profits to their employees.

Individual Retirement Account (IRA).

An IRA is a retirement account for all Americans with earned income (read: you), but especially those who don’t have an employer-sponsored retirement plan or a self-employed retirement plan.

There are two basic types of IRAs (three if you count Gershwin) traditional and Roth. Both allow a qualified worker to contribute up to $5,500 annually. Both allow your money to grow like that mythical money tree, tax-free, while in the account. But these savings-friends-with-benefits differ when it comes to tax benefits.

An IRA can be opened at any time, but must be funded for a given tax year by the due date of that year’s tax return — generally April 15 of the following year.

Traditional IRA.

With a traditional IRA, each annual contribution is eligible as a deduction on that year’s income taxes. Basically, funds you put in are in a no-tax zone. However, money that you withdraw or that is distributed is taxable.

You can start withdrawing funds without any nasty penalties the year you turn 59 ½ (and you thought half-birthdays were passé).  Once you reach 70 ½, you are no longer allowed to feed the IRA piggy bank. Also at 70 ½, you must begin taking minimum (taxable) distributions (AKA withdrawals).

Roth IRA.

With a Roth IRA, there’s no mandatory age you must take distributions. You can leave the money in for as long as you want, letting your nest egg continue to grow. In order to qualify for the full $5,500 annual contribution, your modified adjusted gross income (AGI) must be:

  • $114,000 or less when you file your taxes as single
  • $181,000 or less as a married couple filing jointly

If your income is higher than those levels (a crisp high-five for you), contribution limits are reduced.

Contributions to a Roth IRA are not permitted if:

  • your filing status is married filing jointly or qualifying widow(er) and your modified AGI is $191,000 or more
  • your filing status is single, head of household, or married filing separately and you did not live with your spouse at any time during that tax year and your modified AGI is $129,000 or more

Like traditional IRAs, a Roth IRA can be opened at any time, but must be funded for a given tax year by the due date of that year’s tax return — generally the dreaded April 15 of the following year.

So, for most people, the basic question is: do you want your tax break now or later? You can avoid up-front taxes on contributions (with a traditional IRA), or withdraw your nest egg money tax-free (with a Roth IRA).

With both IRAs, if you take a distribution before age 59 ½ you may have to pay an additional 10% tax for early withdrawals, unless you qualify for an exception. Death and taxes, what can you do?

Are you hitting the Over-50 Club? Take advantage of it.

Workers age 50 and older can fatten their retirement piggy bank with additional catch-up contributions. Those with an employer-sponsored pension, such as a 401(k) plan, may contribute an extra $6,000 annually above the $18,000 limit. Workers without an employer-sponsored pension may contribute an extra $1,000 to their IRA, for a total maximum annual contribution of $6,500.

This nifty comparison chart from the federal government provides information on the basic similarities and differences between traditional and Roth IRAs. Gershwin’s been left out.

NOTE: All amounts on IRS income and contribution limits are current as of the 2017 tax year. Consult your tax adviser or regarding any possible changes.

Plans for the self-employed.

If you’re self-employed, there are additional options for you. These include SEP-IRAs (Simplified Employee Pension Individual Retirement Accounts) and Keogh plans. Both require a little more paperwork to set up than regular IRAs, but permit business owners to sock away much more tax-advantaged money each year. If you’re self-employed, it’s worth a look.

All these retirement plans sound great, right? Just don’t forget, you have to feed the piggy bank to bring home the bacon.

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