Choose wisely now to live well later.
There are many types of retirement plans available for taxpayers. In fact, there are so many, the President has considered reducing retirement accounts from the many types that exist today into one simplified retirement savings program.
Additionally, the amounts that can be contributed to the plans have changed radically. The following advisory discusses, in summary, the types of defined contribution retirement plans and contribution amounts.
Traditional 401(k) — The 401(k) retirement plan arises from Section 401(k) of the Internal Revenue Code. 401(k)’s are generally retirement plans sponsored by employers for their employees. However, specific sections of the code also make it advantageous for self-employed people to us e 401(k)’ s. These self-employed 401(k)’s are typically referred to as Solo (k)’s, Self-Employed (k)’ s, or even baby (k) ’s. 401(k) contributions are excludible from income.
Tax deductions occur when money is contributed to the plan. The annual deductible contribution limit to a 40 1(k) is $15,000. For those turning 50 and older this year, “a catch-up” or additional contribution of $5,000 is allowed annually. When distributed, the distribution is taxable as ordinary income.
Roth 401(k) — The Roth 401(k) is similar in all respects to the traditional 401(k). However, instead of contributions being deductible, contributions are taxed presently, but not taxed upon distribution. Roth 401(k) contribution limits are the same as traditional 401(k) limits. Income must generally be below $160,000 annually to take advantage of the Roth 401(k).
Simple 401(k) — The Simple 401(k) is also an employer plan, but tends to be easier to administer. The contribution limits are $10,000 annually, while allowing $2,500 catch-up contributions for those over 50 years of age annually.
Traditiona l 403(b) — This is generally a government employee retirement plan which is equivalent to the private sector 401(k) plans. The annual contribution limit is $1 5,0 00, while allowing a $5,000 annual “catch-up” contribution for those 50 and older.
Roth 403(b) — This retirement plan is the same as the traditional 403(b); however, it allows no deduction for contributions currently as it does not tax distributions when made, same as the Roth 401(k).
Traditional IRA — The traditional IRA is an individual retirement account. These can be set up by an individual at a bank. The annual contribution limit is $4,000, and the law allows $1,000 annual “catchup” contribution limits for those turning 50 years of age and older. Under the traditional IRA, contributions are deductible, but distributions are taxed when made.
Roth IRA — This is also an individual account. The contribution limits are the same as the traditional IRA; however, they are not deductible. Staying true to “Roth” form, the contributions are not deductible, but the distributions do not get taxed.
Simplified Employee Plan (SEP) — A SEP is a retirement plan where the employer contributes directly to an IRA of an employee. The employer contributions are excluded from the employee’s gross income and an annual contribution of up to $44,000 is allowed. The employee is also allowed to contribute to the plan. SEPs are set up by completing IRS form 5305-SEP and retaining the form as evidence of the plan. The 5305 -SEP form is not submitted to the IRS.
Simple IRA — This plan is established by an employer by completing forms 5304-SIMPLE (when the employee can choose the financial institution) or 5305-SIMPLE (when the employer chooses the financial institution that will receive the contributions). The annual limit of contributions is $10,000 annually, while allowing $2,500 in annual catch-up contributions.
|Meet the Author
Bart A. Basi, Ph.D. is the president of The Center for Financial, Legal and Tax Planning, Inc. in Marion, Illinois.