The following is a guest post by Caroline Devoy
Okay, being able to retire in this economic climate is a little far fetched even if you are 85. But now is a good time, maybe even the best time, to reassess your retirement savings and what tax options are available to you.
You may know some retirement plan basics, but I'll review just in case. Retirement plans can be incredibly complicated, but I prefer to just ignore the complicated stuff. Seriously, if you are doing more sophisticated retirement planning than what is described here, you are going to need professional help anyway.1 And not just because of the mental agony.
A 401(k) plan is a retirement vehicle set up by an employer in which your salary can be invested pre-tax. (FYI, your 401(k) deductions are still subject to FICA and Medicare tax, aka payroll taxes.) Sometimes the employer will match a percentage of your contributions. Your money will be invested in a variety of vehicles (determined by you, but usually limited by the selections offered by the employer) and will earn money with no tax consequences until retirement or withdrawal.
You may contribute income (sometimes called a deferral) into the 401(k) as long as you are with that employer. Once you leave, you have a period of time to move it to another employer's 401(k) or IRA (Individual Retirement Account). In 2009, the maximum 401(k) deferral is $16,500, though your employer's plan can set a lower limit.
The tax code was modified in 1974 to allow IRAs (Individual Retirement Accounts), allowing individuals to save for retirement without relying on an employer or the government and still receive tax deferral.
Traditional IRAs allow you to deduct (with some limitations) contributions to your retirement account. The investment earnings in the account remain untaxed until withdrawal, usually at retirement. The annual limit on IRA contributions is the lesser of 100% of earned income (not interest or dividends) or $6,000 for 2009 ($5,000 for 2008).
You may contribute to an IRA and participate in an employer's 401(k) plan, though your deductible IRA contribution may be limited if you are covered by an employer's plan. The contributions must be made by the due date of your return, without extensions (that's April 15 this year and next).
The tax code allowing Roth IRAs was created in 1997 and was named for its sponsor, Delaware Senator William Roth. Roth IRAs are still retirement accounts for individuals, but are taxed differently. Contributions to Roth IRAs are NOT deductible. However, investment earnings in this account generally remain untaxed, even at withdrawal.
The limits on Roth IRA contributions are the same as a traditional IRA- 100% of earned income or $6,000. If you have both types of IRAs, you may only contribute a total of $6,000. However, if you earn above certain income levels, you may not be able to contribute to a Roth IRA. To contribute to a Roth IRA, your adjusted gross income (basically your income with some exceptions) must be less than $101,000 for single filers and less than $159,000 for married filers. Above those amounts, your contribution is reduced by a certain percentage until it is zero. Like a traditional IRA, you have until April 15 to make your Roth IRA contribution.
Your Retirement Account & Taxes
It depends on your tax philosophy whether you believe paying taxes now is better or worse than paying them later. I personally believe that tax rates will never go down, so I would rather pay now and get my retirement money tax-free. Also, with the stock market currently in the tank, the taxable investment earnings in your IRA or 401(k) are likely lower than they have ever been (and let's hope lower than next year). So if you haven't done so already, 2009 may be your year to convert from a 401(k) plan or traditional IRA to a Roth IRA. A few things to remember:
- you will be taxed on all untaxed moneys that are converted to the Roth in that tax year (Usually this would be all the money, except any non-deductible IRA contributions you may have made.)
- you can't rollover from a 401(k)until you no longer work for that employer
- you can't do a roth conversion if you file as Married, separate filers
- you can't do a roth conversion if your adjusted gross income is greater than $100,000
Fortunately in 2010, the income and married, filing separate limits are removed, so if you don't qualify this year, you will in 2010. You might want to contribute to a traditional IRA this year, then convert to a Roth in 2010. Or given the current market, you might want to put your money under a mattress and open a Roth next year.
To sum up!
A handy table for your reference- click pic to see larger version:
The IRS has an exhaustive publication on IRAs. I would not suggest reading it unless you are being forced to sit through a Max and Ruby cartoon. However, it could be helpful in answering questions about your particular circumstances.
Another good source of information about the rules regarding retirement plans is the custodian of your 401(k) or IRA. Many of their websites will walk you through limitations on contributions, when the money must be withdrawn, when it can be withdrawn and other tax consequences. The only thing they can't do for you is track the source of the money (401k rollover, non-deductible contributions, deductible contributions), so you need to keep that information yourself. That information is necessary to determine the taxability of withdrawals.
Of course, beyond the IRS limits, what should you be contributing to your retirement funds? It depends on your age, how much you are earning, your capacity for risk and how much you think you will need at retirement. A basic rule of thumb is 15% of your earnings, but that can be tricky if you are self-employed. Use the retirement calculator available on almost every investment site to determine if you are contributing enough to your retirement.
(1) For example, there are small-employer IRAs called SEP IRAs and SIMPLE IRAs. Consult a retirement advisor if you are interested in this type of plan. I'm also ignoring a new type of 401(k), the Roth 401(k), just because I haven't seen it show up at many employers yet.
(2) Traditional IRAs and 401(k) require you to start withdrawing money, usually at 70-1/2. Makes sense if your realize that none of that money has been taxed yet and the IRS wants to get some revenue. The taxes on the money in the Roth IRA have already been paid, so the IRS doesn't care if you keep it in there.
Caroline Devoy graduated with a B.S. in Accountancy some time in the 20th century. She worked as a CPA until the public accounting firm found her serious demeanor to be a problem in their fun-filled environment. In pursuit of further initials, she got her M.B.A. in Entrepreneurism and in her spare time, she runs jcaroline creative!, a website retailing fabric, ribbon, notions and a questionable hedge fund. Just kidding, we don't sell notions.