Are you thinking of your retirement? If so, chances are you may be like may and are a bit confused by all of the choices, terms, and amounts involved with these accounts. Let us face it; the Internal Revenue Service sets up these types of accounts and nothing the IRS does is simple. So in this post, we will examine some retirement terms, account types and amounts involved with each. And we all want to retire with the most money we can so it is essential that you understand these terms if nothing else but in a basic way. So let us begin with the newest tool aimed at making our retirement easier.
First, we will examine the traditional versus ROTH accounts and some ways to decide which is the best fit for you. Traditional accounts are set up, so your contributions are tax-deductible in the year in which you made the contribution. That is to say, if you contributed $5,500 towards a traditional IRA, you would be able to deduct that amount from your taxable income, provided you qualify. Then, when you retire, you will pay taxes on the amount you withdrawal. In traditional accounts, you are required to make what are called Required Minimum Distributions starting at age 70 and a half.
Now a ROTH account works in a similar fashion, but you pay tax on the $5,500 in the year you made the money and the contribution. Then when you make your withdrawals in retirement, your proceeds are tax-free. And in ROTH accounts there are no Required Minimum Distributions as the taxes have already been paid.
If you are required to make a Required Minimum Distribution in either a traditional IRA or any IRA that you inherit the IRS publicizes what that amount is on an annual basis. It changes and if you fail to make the distribution you face stiff penalties that are 50% of the amount you should have taken out of the account. A good incentive to make that withdrawal if you ask me.
So how do you pick the right account? If you qualify for a ROTH account, I suggest that route as tax-free money is always better in the long run. And let us face it, in today’s political climate I do not see taxes going down in the years to come. At best they will remain constant or if we are lucky to go down slightly. But dramatic shifts I really do not see happening. So place that $5,500 into a ROTH IRA and let it grow over the years to say $60,000. When you retire that money is yours tax-free, and all you had to do was pay taxes on the initial $5,500.
Now with a traditional account, you get the tax deduction now but will pay ordinary taxes on the full $60,000 when you retire. Of course, I hope you do not make a single contribution but rather a series of them over your working career. Even so, I would wager that by paying the taxes now you will be better off than if you deducted the money over a period of years. This is especially true when you are younger, and your tax rate is lower.
But if you are not sure which is the right tool for your retirement Google one of the many on-line tools that are available to aid you in making these decisions. You can try a simple search for “ROTH vs. Traditional calculators”. Then plug in the numbers and see what works best under your set f criteria.
At many places of employment, they have switched away from pensions towards 401(k) plans. The name of the 401(k) is from the section of the IRS regulations that created their existence. In the 1980’s Congress created the 401(k) as a way for employees to take control of their own retirement plans. And as they grew in popularity the use of pensions began to wane. If you work for a non-profit or state government, your plans may be named 403(b) or 457(b) plans. Again, named after where they can be found in the IRS code.
In most instances, employers will match the employee’s contributions to a degree. As an example, I work for the Federal government and get a 4% match for every 5% I contribute. If your company offers something even similar, I suggest you always take full advantage of the match. Otherwise, you are leaving free money on the table and an instant return on your investment. Some companies have a vesting period which is simply an amount of time that you must work before the matched funds become yours to keep.
In 2016 you are allowed to contribute $18,000 into your 401(k) or similar account. And for those over the age of 50 you are allowed an extra $6,000 in savings for a total of $24,000 a year. These amounts are adjusted by the IRS from time to time so always check the IRS website at www.irs.gov for the most up to date information. If you work for a small business, you may have a SIMPLE plan that allows for savings of up to $12,500 with a catch-up of $3,000 for those over the age of 50.
Recently the IRS allowed for the creation of ROTH 401(k) accounts. These work similar to the ROTH accounts outlined above with the exception that there are Required Minimum Distributions at age 70 and a half the same as a traditional 401(k).
IRA’s or Individual Retirement Accounts are another tool available to people planning for their retirement. There are numerous IRS rules and regulations that accompany the use of IRA’s, so it is important to seek the advice of an accountant or financial planner when using these. If you decide to go it alone that is fine as well, just make sure you read the regulations of the IRS website for the most up to date information on IRA’s.
IRA’s are both traditional and ROTH in variety. Again, the use of either is up to you and your best judgement. But the limitations on contributing to both are the same dollar wise. If you are under the age of 50 you may contribute $5,500 and for those over the age of 50 you are allowed an extra $1,000 contribution. And the limits are not per IRA but rather an accumulation between all IRA accounts you may have.
It is best always to seek the advice of a financial planner when dealing with these types of accounts provided you can find a good fee-only planner. While not necessary they can assist you in making wise decisions now that can either earn you thousands or if you go into these things blindly cost you thousands. So a small fee early on may be worth it to you or not depending on how comfortable you are with finances.
As always, if you need additional information or need assistance, feel free to contact me directly or leave a comment here.
