Maximizing Your Retirement Savings

There are so many different kinds of plans that can be used to invest in for retirement that is can be very confusing. While many may know about Roth and traditional IRAs,  there are also many other types of IRAs and company sponsored plans available. To help get you on the right track and ensure that you are maximizing your retirement saving’s potential, these are some of the key programs that you may want to focus on.

Individual Plans

Traditional IRA – (2015/2016 contribution limit of $5,500, $6,500 if you are 50 or older)
A traditional IRA (or deductible IRA) is an individual savings plan for anyone who receives taxable compensation. IRA assets may be invested in any number of vehicles, and contributions may be tax-deductible depending on your adjusted gross income. Earnings in a traditional IRA grow tax-deferred until withdrawal, but they will be taxed when withdrawal begins – and withdrawals must begin by the time the IRA owner reaches age 70½. If these Required Minimum Distributions (RMDs) are not taken at that age, a 50% penalty will be assessed on the amount not distributed. You cannot contribute to a traditional IRA after age 70½. The IRS considers all IRAs other than Roth and SIMPLE IRAs as traditional IRAs.

Roth IRA – (2015/2016 contribution limit of $5,500, $6,500 if you are 50 or older)
A Roth IRA offers you a) tax-free compounding, b) tax-free withdrawals if you are older than age 59½ and have owned your account for at least five years, c) the potential to make contributions to your IRA after age 70½ without having to take RMDs. While contributions to a Roth IRA are not tax-deductible, a Roth IRA has an advantage on the back end, with fewer requirements and limitations regarding withdrawals.

Since 2010, anyone with a traditional IRA may convert it to a Roth IRA. Before 2010, you had to meet an eligibility test to do so.

Spousal IRA – (2015/2016 contribution limit of $5,500, $6,500 if you are 50 or older)
This is actually a rule that lets a working spouse make traditional or Roth IRA contributions on behalf of a non-working or retired spouse. The working spouse’s income is the determining factor as to whether or not a “Spousal IRA” contribution can be made. Contribution limits and eligibility requirements are the same as those for a regular IRA.

Inherited IRA – (No contributions allowed in some cases)
A Roth or traditional IRA inherited by a non-spousal beneficiary. You cannot treat this IRA as your own. (If you inherit your spouse’s IRA, you can name yourself as the new owner and sole beneficiary and make contributions and withdrawals from it.) Distributions from inherited IRAs are subject to the minimum distribution rules; they must be taken over your lifetime, and the inherited IRA assets cannot be rolled over into an IRA you own.

Rollover IRA – (2015/2016 contribution limit of $5,500, $6,500 if you are 50 or older)
Assets distributed from a qualified retirement plan may be rolled over into a traditional IRA, which may be converted later to a Roth IRA. Assets can be commingled within the IRA and rolled into another employer plan in the future.

myRA – The myRA is basically a government-sponsored Roth IRA with the same contribution limits ($5,500 a year, or $6,500 for those 50-and-older 2015/2016).  Like the Roth IRA, all myRA contributions will be made after-tax (in other words, no deductions for the contributions), but the money will come out tax-free when the taxpayer reaches age 59 1/2.  However, unlike the Roth, where the money can be invested in various investment vehicles, the myRA participant has exactly one investment option: the government’s Securities Fund for federal employers, which earned 2.31% in 2014.

There are however limitations on who can participate in the myRA program.  Only people without a 401(k) or 403(b) retirement plans at work can make myRA contributions, and only those with an adjusted gross income less than $131,000 a year ($193,000 for couples).  Additionally, once you’ve accumulated the maximum myRA balance of $15,000, you have to move the money over to a private-sector Roth IRA. The benefit to myRA is that it does not contain any custodial or account fees in order to setup or maintain.

Company Sponsored Plans

The Traditional 401(k) – Most people have such a retirement savings plan, and it works like this. The plan is funded with pre-tax dollars taken out of your paycheck (through payroll deductions). If you’re lucky, your company will match your level of contribution or even make contributions on your behalf – after all, the employer contributions are tax-deductible.

The I.R.S. will currently let you put up to $18,000 (2015/2016) a year in a Traditional 401(k); cost of living adjustments may drive that limit higher in the future. The I.R.S. also allows catch-up contributions (additional contributions from those aged 50+), with a current annual limit of $6,000 (2015/2016). In 2015/2016, the total amount put into a 401(k) by you and your employer can’t exceed the lesser of 100% of your compensation or $53,000 ($59,000 including catch-up contributions).

There are also variations on the traditional 401(k) theme …

The Safe Harbor 401(k) –  A byproduct of the Small Business Job Protection Act of 1996, the Safe Harbor plan combines the best features of the traditional 401(k) and a SIMPLE IRA, making it very attractive to a business owner. With a Safe Harbor plan, an owner-operator can avoid the big administrative expenses of a traditional 401(k) and enjoy higher contribution limits. The Safe Harbor plan allows for employers to make matching or non-elective contributions. Typically, employers match contributions dollar-for-dollar up to 3% of an employee’s income.

The SIMPLE 401(k) – Designed for small business owners who don’t want to deal with retirement plan administration or non-discrimination tests, the SIMPLE 401(k) is available for businesses with less than 100 employees. Like a Safe Harbor plan, the business owner must make fully vested contributions (up to 3% of an employee’s income). But the maximum pretax employee contribution to a SIMPLE 401(k) is $12,500 and $3,000 catch-up for those aged 50+ (2015/2016), and employees with a SIMPLE 401(k) can’t have another retirement plan with that company.

The Solo 401(k) – Combine a profit-sharing plan with a regular 401(k), and you have the Solo 401(k) plan, a retirement savings vehicle designed for sole proprietors with no employees other than their spouses. These plans currently permit you to contribute both:

• Elective deferrals up to 100% of compensation limited to the annual contribution limit ($18,000 in 2015/2016 or $24,000 for those age 50 or over plus…
• Employer non-elective contributions up to 25% of compensation or a total amount of $53,000 annually plus $6,000 in catch-up contributions for a total of $59,000 if you are 50 or older.

The Roth 401(k) – Imagine a Traditional 401(k) fused with a Roth IRA. Here’s the big difference: you contribute after-tax income to a Roth 401(k), and when you reach age 59½, your withdrawals will be tax-free (provided you’ve had your plan for more than five years). The annual contribution limits are the same as those for a Traditional 401(k) plan.

You can roll Roth 401(k) assets into a Roth IRA when you retire – and you don’t have to make mandatory withdrawals from a Roth IRA when you turn 70½. With a standard 401(k), you have to roll over the assets to a traditional IRA and make the required withdrawals.

And then there are SEP-IRA and SIMPLE IRA plans …

SIMPLE IRA – (Contribution limit of $12,500 for 2015/2016; $3,000 catch-up contribution allowed if you are 50 or older)
SIMPLE IRAs are qualified retirement plans for businesses with 100 or fewer employees. They are much easier (and more affordable) to administrate than 401(k) or 403(b) plans. They are funded by “elective deferrals” (salary reduction contributions from employees), and generally the employer has to match employee contributions on a dollar-for-dollar basis up to 3% of an employee’s compensation.

SEP-IRA – (Contributions cannot exceed $53,000 for 2015/2016 or a maximum of 25% of employee compensation)
SEP stands for Simplified Employee Pension. These traditional IRAs are set up by an employer for employees, and like a pension plan, funded by employer contributions only. Contributions are tax-deductible, but qualified withdrawals taken after age 59½ are taxed at standard income tax rates. If an employer implements an SEP plan, allocations to all employees’ SEP-IRAs must be proportional to their salary/wages.

Retirement Planning – Basic Training Series

For some, retirement may be a long way off into the future and for others – right around the corner. Even if you are already retired it isn’t too late to do some planning to ensure that your future is secure. In this series we provide some of the important tips and tools for tax efficiency and financial longevity.

Next in this series: The Magic of Compounding

The effect of compounding is huge. Most people underestimate it, so it is worth illustrating. We will use reasonable annual return rates to do so – we will assume an investor can earn an average of 6-7% a year on his or her portfolio.