Getting Your Financial Ducks In A Row Rotating Header Image

qualified retirement plan

Rolling Over a 401(k) into a New Employer’s Plan

Feb 20th, 2013
by jblankenship.
No comments yet
Beethoven

When you change jobs you have a choice to make regarding your retirement plan at former employer.  If the plan is a 401(k), 403(b), or other qualified plan of that nature, you may have the option to roll the old plan into a plan at your new employer.

The new employer’s plan must allow rollovers into the plan – this isn’t always automatic.  Most plans will allow rollover of former employer’s plans, but not all.  Once you’ve determined that the plan will accept a rollover, you should review the new plan to understand whether or not it makes sense to roll your old plan into it, or choose another option.  Other options may be: rollover the old plan into an IRA, convert the old plan to a Roth IRA, leave the old plan where it is, or take a distribution from the old plan in cash.

In this article we’ll just deal with rolling over the old plan to your new plan.

If the new plan has some compelling features, such as access to very low cost institutional investments or attractive closed investment options, or if the plan has very low overhead and great flexibility, you might want to rollover your old plan into it.  Other reasons that might compel you to rollover the old plan might be – to have access to loan features (IRAs don’t have this), access to your funds when leaving your employer after age 55 but before age 59½, and ERISA protection against creditors.

There may be reasons to leave your old plan at the old employer though.  The two that come to mind are NUA treatment of stock of the old employer, and if you think you’ll need access to the funds before you leave the new employer (especially if you’ve left that employer after age 55).

So after reviewing the options and features, you’ve decided to rollover the old plan to the new employer’s plan.  It’s a relatively straightforward process:  you contact the old plan’s administrator and request a rollover distribution form. You should have already contacted the new plan’s administrator to ensure that the new plan will accept a rollover.  Once you have the rollover distribution form from the old employer, get any pertinent information from the new employer, such as your employee id, or an account number for the new plan.

On the rollover distribution form, you’ll have the option to send the distribution directly to the new plan – called a trustee-to-trustee transfer.  In this manner, the funds never come into your possession.  This is important, because if you take distribution in cash from the old plan, the IRS requires that 20% is automatically withheld from the distribution.  You could still send the distribution to the new plan – but you’d have to come up with the 20% that was withheld in order to make the transfer “whole”.  It’s not required that you make a complete transfer, but if you take any of the funds in cash, including the withheld 20%, this money will be taxable as ordinary income, and if you’re under age 59½ it will likely also be subject to an additional 10% penalty.

After all of this has occurred, your new plan will have the additional old plan money rolled into the account.  Most likely this will be entirely in cash when it arrives in the account – so you will need to make investment allocation choices for the new addition to the account.

Enhanced by Zemanta

Defined Contribution vs. Defined Benefit Plans

Jan 28th, 2013
by jblankenship.
1 comment
Silage at Mount Pleasant: Define 'Pleasant'

Many employers have made retirement plans available for their employees, and sometimes there are multiple types of plans that the employee can participate in.  These retirement plans fall into two categories: Defined Contribution and Defined Benefit plans.  In this article we’ll cover the differences between the two types of plans.

Defined Benefit (DB) Plans

The older type of retirement plan is the Defined Benefit Plan. (We’ll refer to this as DB for the rest of the article.)  DB plans are generally the old standard pension-type of plan, and this category of plan is named as it is because the benefit is a defined amount in a pension plan.

By a defined amount, we mean that a formula is used to calculate the amount of pension that you’ll receive.  The formula typically uses factors such as your years of employment, your average salary (either over your entire career, or perhaps over the most recent five years, as an example), your age when you begin receiving the pension payments, and other factors.

Let’s look at an example. Your final five years of salary averaged $50,000 per year and you had 25 years of service with the company. Your defined benefit calculation might be something like 2% per year of service times the average salary during your final five years, or 50% of $50,000 – for a pension of $25,000.  Pension calculations can be very complicated, this was a very simple example.  A few of the variances include:

  • a flat amount formula unrelated to years of service or earnings;
  • a flat percentage of earnings, unrelated to years of service;
  • a flat amount per year of service, unrelated to earnings; or
  • a percentage of earnings per year of service, reflecting both earnings and service.

Once the amount of your pension is defined, you will know how much benefit you’ll receive when you begin receiving it – and it’s a guarantee.  It is for this reason that DB plans are often considered to be more valuable than Defined Contribution (DC) plans.  As you’ll see in the next section, DC plans don’t have such a guarantee.

This guaranteed benefit comes at the cost of the employer.  Since the employer must provide that specific benefit, variables such as the rate of return on investments, inflation, and the like, can have a negative affect on the funds available to pay the benefit. This can cause the employer to have to purchase insurance products that will account for those variables, which can be quite costly.

Defined Contribution (DC) Plans

This type of retirement plan is the newer of the two types, but it’s also the one that requires more participation from the employee.  The DC plan is generally a savings plan, such as a 401(k) plan, and the employee and employer make contributions to the account.  The amounts that can be contributed to the plan are limited by IRS definitions, and that’s the reason that these plans are called Defined Contributions – since the Contribution amount is defined.

There are a couple of types of DC plans – profit-sharing plans and stock bonus plans.  These can also be mixed together to create a hybrid DC plan.  The profit-sharing type of plan is where the profits of the business are shared among the employees in cash, where the stock bonus plan is a distribution of company stock to the employees.

Since the contribution is the amount that is defined in a DC plan (rather than the benefit, as in DB plans), the benefit that the employee will receive during retirement is not known.  The amount that the employee may receive during retirement is based completely on the following factors:

  1. How much the employee and employer contribute to the plan;
  2. What rate of return the plan experiences; and
  3. How long the funds are allowed to grow in the plan.

The amount that the employee contributes to the plan is totally up to the employee – these plans are voluntary in nature.  Contributing more to the plan is the primary thing that you can change to improve your chances of increasing the amount of funds that your plan will eventually have upon your retirement.

Rates of return are completely variable – this depends solely on what happens with the various investment choices that you use for investing your DC account.  If the investments you choose increase in value over time (which we hope that they would) then you’ll see your investment nest egg increase in value.  Sometimes you’ll see the investments go up in value, sometimes the investments will go down.

This is the same for both DB and DC plans – but in the case of the DC plan you’re not guaranteed a specific benefit, so reductions to your investments are borne solely by you, the account holder.  On the other hand, if there is a reduction experienced by the investments in a DB plan, the employer (or the insurance company that owns the pension annuity) must make up the difference to ensure that you receive the benefit that has been defined for you.

Comparison

Below is a table which compares the two types of plans:

Defined Benefit Defined Contribution
Cost variability and Risk Borne by the employer Borne solely by the employee
Funding Employer Employer and employee
Most Beneficial to Longer-term employees; encourages longer tenure as benefits are often increased by years of service Shorter-term employees; may encourage changing jobs to provide access to the account’s funds.
Cost to Employer Higher cost due to variances in returns Lowest costs; administrative costs only
Access to Account Generally not accessible pre-retirement Loans may be available, as well as inservice distributions after a specific age
Tax Benefit Employer only Employer and employee both receive tax benefits
Enhanced by Zemanta

What is a 401(k)?

Jan 23rd, 2013
by jblankenship.
No comments yet
Highway 401

Many of us have access to a 401(k) plan at our workplace – have you ever wondered exactly what a 401(k) is?

The 401(k) plan is named for a specific section in the Internal Revenue Code – Section 401, subsection k, to be exact.  This code section lays out the rules for these retirement plans, which are employer-sponsored plans providing a method for the worker or employee to defer a certain amount of income into a savings plan on a pre-tax basis.

Often the employer also includes a matching contribution to the employee’s account.  These matches are typically based upon the amount of contribution that the employee makes to the plan – such as a dollar-for-dollar match for contributions made by the employee up to certain percentage of the employee’s income.  The deferred income is not subject to ordinary income tax, but it is still subject to FICA (Social Security) and Medicare taxes.  The employer match is not subject to any of these taxes.

The income that the employee voluntarily defers into the 401(k) plan is immediately vested with the employee, meaning that the contributions that the employee makes belongs exclusively to the employee.  Employer-matching funds are usually subject to a schedule for vesting. An example would be that the employee must remain employed for a specific period of time (say, five years) before the employer-matching funds are vested with the employee.  Leaving employment prior to meeting that vesting schedule could result in the employee relinquishing a portion or all of the employer-matching funds in the account.

The income that is diverted into the 401(k) plan can be allocated to a variety of investment choices.  The choices are generally limited to a defined group of stocks and mutual funds by the plan administrator.  Lately many plans also offer an option to use a regular brokerage account to provide investment in virtually any domestic holding.

Restrictions

In addition to the restricted group of investments that you may have available to choose from, there are many other restrictions on your 401(k) account.  For example, once you divert your income into a 401(k) plan, you generally cannot withdraw the funds from the account while you’re still employed with that employer.  Some plans do have in-service distributions available after the employee has reached a particular age (generally 59½), but this is relatively rare.

After you leave employment you have the option of withdrawing the funds from the account.  There are a few ways that this can be done -

  1. A direct rollover to another retirement plan (another 401(k) or an IRA), which is a non-taxable event; or
  2. A cash distribution to you, which will be subject to a mandatory 20% withholding, since this is potentially a taxable event (even if you rollover the distribution to another plan within 60 days); or
  3. A distribution of the securities that you own in the plan.  Part of this distribution may be taxable (see this article on NUA, Net Unrealized Appreciation, for more details).  The portion of the distribution that is taxable will be subject to the mandatory 20% withholding mentioned above.

If any of these distributions occurs before you reach age 59½ you may be subject to an early distribution penalty of 10% unless you meet one of the exceptions, which includes purchase of a first home and payment of certain medical expenses, among other exceptions.

Loans can be available to access the funds in your account while still employed.  The loans are limited to 50% of your total vested account balance, with a maximum loan amount of $50,000.  The loan must be paid back over the course of five years, at a prescribed rate of interest.  If you leave employment while your loan is still outstanding (at whatever amount), the loan must be paid back immediately, either from outside funds or from funds in the 401(k) account.  If the funds are paid back from within the 401(k), what happens is that you will be considered to have withdrawn the amount of the loan from the account, and the withdrawal will be subject to ordinary income tax and possibly a penalty if you are under age 59½ at the time you leave employment.

Contribution Limits

There are certain limits to the amount of contributions (income deferrals) that can be made into a 401(k) account.  For 2013, the annual limit for deferral of income is $17,500.  There is an additional “catch-up” contribution amount that folks over age 50 can make – up to $5,500.

There is also a maximum amount that can be contributed in total – including the employer match.  For 2013 this limit is $51,000, or $56,500 when the catch-up contribution is used.

All of these limits are based upon the employee’s salary, as well. If the employee’s salary is less than the annual maximum contribution limit, then the contributions are limited to 100% of the employee’s salary for the year.

Roth 401(k)

Briefly, there is another type of account that can be included in an employer’s 401(k) plan: the Roth 401(k), which is also known as a Designated Roth Account, or DRAC.  The DRAC allows the employee to divert income into the account on an after-tax basis – meaning that money contributed to the DRAC is taxed as if the employee received it in cash.  The funds in the DRAC account are subject to the same limitations of withdrawal (while employed) as the “regular” 401(k) account.  In return for the pre-payment of tax on these restricted funds, when the employee leaves employment he or she can access these funds tax-free once the employee reaches age 59½.

Wrap up

This article was not intended to cover every nuance of 401(k) plans; rather, it was intended to provide a brief overview of this important part of your retirement plan.  We’ll cover more specifics on the 401(k) plan in future articles.

Enhanced by Zemanta

History of the 401(k)

Jan 9th, 2013
by jblankenship.
11 comments
President George W. Bush signs into law the Pension Protection Act of 2006

Back in 1978, the year of 3 popes, Congress passed the Revenue Act of 1978 which included a provision that became Internal Revenue Code section 401(k).

The 401(k) has roots going back several decades earlier, with many different rulings (Hicks v. US, Revenue Ruling 56-497, and Revenue Ruling 63-180, among others), providing the groundwork for the specialized tax treatment of salary deferrals that Section 401(k) enabled.

More groundwork for the 401(k) as we know it was laid with the passage of the Employee Retirement Income Security Act (ERISA) of 1974, in that the Treasury Department was restricted from putting forth a particular set of regulations that would have reduced or eliminated the tax-deferral benefits of deferred compensation plans. After the Treasury Department withdrew the proposed regulations in 1978, the way was cleared to introduce the 401(k) plan with the Revenue Act.

This particular section of the Code enabled profit-sharing plans to adopt “cash or deferred arrangements”, or CODAs, funded via pre-tax salary deferral contributions. When the 401(k) code section became effective in January 1980, and the IRS proposed the regulations for Section 401(k) in late 1981, the idea came forth to replace existing bonus arrangements with the new tax-deferred alternative.  The real “kicker” that caused the 401(k) plan to garner interest by employers was the ability to save on taxes while still maintaining competitiveness with the earlier bonus plans – and the employer matching arrangement of 401(k) plans did just that.

Several large corporations very quickly began replacing after-tax thrift plans with the new 401(k) plan, and adding 401(k) options to existing profit-sharing and stock bonus plans.  The new 401(k)-type of plan provided the employee with deferred taxation on funds diverted into the plans, and provided the employers with the ability to make significant matching contributions on a tax-favored basis.

In 1984, the Tax Reform Act of ‘84 enacted rules for “non-discrimination” testing in the 401(k) plans – meaning that highly-compensated employees couldn’t receive benefit from the plans if non-highly-compensated employees weren’t participating in the plans to an allowable degree.

Then the 1986 Tax Reform Act further tightened the non-discrimination restrictions and set the maximum annual allowable amount of deferral of compensation by employees at $7,000.  Up to this point, there was only an annual limit on all contributions by both the employer and employee, which was set at $30,000 from 1982 through 2003.  These amounts have gradually increased to today’s levels, of $17,500 for regular deferral by employees and a total annual limit of $51,000.

The 20% mandatory withholding requirement for distributions from 401(k) plans was added with the 1992 Unemployment Compensation Amendments.  This requirement applies to distributions that are not rolled over into another retirement plan.

In 1996, the passage of the Small Business Job Protection Act provided an additional boost to participation in 401(k) plans with the release of limits on the contributions that could be made to a retirement plan by an employee that is also participating in a regular pension, or defined benefit, plan.

One more piece of legislation that had a great impact on 401(k) plans was the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which bumped up the annual maximum contribution by employers and employees (it had been frozen at $30,000 since 1987), as well as adding the “catch-up” contribution provision.  The catch-up contribution provision allows participants who are age 50 or older an additional amount to defer into 401(k) plans annually, not limited by the annual maximum contribution amount.  This was set at $3,000 initially and has been indexed by COLA to the 2013 limit of $5,500.

EGTRRA also introduced the Roth 401(k) feature, which allows participants to elect a designated separate account within the 401(k) plan that accepts salary deferrals on an after-tax basis, and then provides for a Roth-IRA-type of treatment for qualified distributions.

After EGTRRA, the Pension Protection Act of 2006 came along, which made permanent the provisions of EGTRRA (originally these were set to expire in 2010), as well as providing methods for employers to automatically enroll employees in the plans and choose default investments.  The purpose of these provisions was to bolster participation in 401(k) plans and facilitate the best used of these plans.

Most recently, the 2013 American Taxpayer Relief Act (ATRA) provided a method for converting “regular” 401(k) account funds to Roth 401(k) accounts – previously, a participant in a 401(k) plan could only convert funds from a regular account to a Roth account if he or she was in a position to otherwise distributed funds from the account.  Generally this means that the employee/participant has left the job associated with the 401(k) or has reached a retirement age set by the plan administrator.  With the new rules provided by ATRA, these conversions could be undertaken by a currently-employed participant of any age.

Enhanced by Zemanta

Receive a Tax Credit For Saving

Dec 19th, 2012
by jblankenship.
No comments yet
Life Saver's & Tent, Atlantic City, N. J.

Starting (or staying with) a savings plan can be difficult to do.  After all, it’s often difficult enough to just get by on your earnings day-to-day, week-to-week, before reducing the take-home pay that you’ve worked so hard for by putting it into a savings plan.  The thing is though, once you start a savings plan, you’ll be surprised at how little it “hurts” to start putting small amounts aside.  After a while, you won’t even miss it.

In addition, the IRS has a way to help you get started – it’s called the Saver’s Credit.  This is a credit that you receive on your tax return, simply for putting money aside in a savings plan.  Pretty sweet deal, if you asked me!

The IRS recently released their Newswire IR-2012-101, which details how the plan works and how you can take advantage of it.  The full text of IR-2012-101 is below:

Plan Now to Get Full Benefit of Saver’s Credit; Tax Credit Helps Low- and Moderate-Income Workers Save for Retirement

WASHINGTON – Low- and moderate-income workers can take steps now to save for retirement and earn a special tax credit in 2012 and the years ahead, according to the Internal Revenue Service.

The saver’s credit helps offset part of the first $2,000 workers voluntarily contribute to IRAs and to 401(k) plans and similar workplace retirement programs.  Also known as the retirement savings contributions credit, the saver’s credit is available in addition to any other tax savings that apply.

Eligible workers still have time to make qualifying retirement contributions and get the saver’s credit on their 2012 tax return.  People have until April 15, 2013 to set up a new individual retirement arrangement or add money to an existing IRA and still get credit for 2012.  However, elective deferrals (contributions) must be made by the end of the year to a 401(k) plan or similar workplace program, such as a 403(b) plan for employees of public schools and certain tax-exempt organizations, a governmental 457 plan for state or local government employees, and the Thrift Savings Plan for federal employees.  Employees who are unable to set aside money for this year may want to schedule their 2013 contributions soon so their employer can begin withholding them in January.

The saver’s credit can be claimed by:

  • Married couples filing jointly with incomes up to $57,500 in 2012 or $59,000 in 2013;
  • Heads of Household with incomes up to $43,125 in 2012 or $44,250 in 2013; and
  • Married individuals filing separately and singles with incomes up to $28,750 in 2012 or $29,500 in 2013.

Like other tax credits, the saver’s credit can increase a taxpayer’s refund or reduce the tax owed.  Though the maximum saver’s credit is $1,000, $2,000 for married couples, the IRS cautioned that it is often much less and, due in part to the impact of other deductions and credits, may, in fact, be zero for some taxpayers.

A taxpayer’s credit amount is based on his or her filing status, adjusted gross income, tax liability and amount contributed to qualifying retirement programs.  Form 8880 is used to claim the saver’s credit, and its instructions have details on figuring the credit correctly.

In tax-year 2010, the most recent year for which complete figures are available, saver’s credits totaling just over $1 billion were claimed on more than 6.1 million individual income tax returns.  Saver’s credits claimed on these returns averaged $204 for joint filers, $165 for heads of household and $122 for single filers.

The saver’s credit supplements other tax benefits available to people who set money aside for retirement.  For example, most workers may deduct their contributions to a traditional IRA.  Though Roth IRA contributions are not tax deductible, qualifying withdrawals, usually after retirement, are tax-free.  Normally, contributions to 401(k) and similar workplace plans are not taxed until withdrawn.

Other special rules that apply to the saver’s credit include the following:

  • Eligible taxpayers must be at least 18 years of age.
  • Anyone claimed as a dependent on someone else’s return cannot take the credit.
  • A student cannot take the credit.  A person enrolled as a full-time student during any part of 5 calendar months during the year is considered a student.

Certain retirement plan distributions reduce the contribution amount used to figure the credit.  For 2012, this rule applies to distributions received after 2009 and before the due date, including extensions, of the 2012 return.  Form 8880 and its instructions have details on making this computation.

Begun in 2002 as a temporary provision, the saver’s credit was made a permanent part of the tax code in legislation enacted in 2006.  To help preserve the value of the credit, income limits are now adjusted annually to keep pace with inflation.  More information about the credit is on IRS.gov.

Enhanced by Zemanta

C’mon America! Add 1% More to Your Retirement Savings This Year!

Nov 21st, 2012
by jblankenship.
No comments yet
ceramic piggy bank

My fellow financial bloggers and I have come together to encourage an increase in retirement savings this year.  Since many employees are going through annual benefit elections right about now, it’s also a very good time to consider increasing your annual contributions to your retirement savings plans.  Small steps are the easiest to take, and the least painful – so why not set aside an additional 1% in your retirement plan in the coming year?

The list below includes a boatload of ideas that you can use to help you with this increase to savings.  I’ve heard from several more bloggers who are going to put their posts up soon. If you’re a blogger, see the original post for details on how to join the action: Calling All Bloggers!

Listed below are the articles in our movement so far (newest are at the top):

From Dana Anspach: Can You Spare A Penny?

From Steve Doster: The Easy Way to Become a Millionaire

From Nancy Anderson: Save 1% More for Retirement in 2013

From Kathy Stearns: Do the 1% in 2013!

From Ken Weingarten: The 1% Challenge (Should you dare to accept)

From Richard Feight: The 1% Challenge!

From John Hunter: Save What You Can, Increase Savings as You Can Do So

From Emily Guy Birken: Increase your savings rate by 1%

From Jonathan White: Ways to increase your retirement contributions 1% in 2013

From Alan Moore: Financial Challenge – Should You Choose To Accept It

From Ann Minnium: Gifts That Matter

From Laura Scharr: In Crisis: Personal Savings- Here Are Six Steps to Improve Your Retirement Security

From yours truly: Add Your First 1% to Your 401(k)

From Steve Stewart: Seriously. What’s 1 percent gonna do?

From Theresa Chen Wan: Saving for Retirement: The 1% Challenge for 2013

From Mike Piper: Investing Blog Roundup: Saving 1% More

From Robert Wasilewski: Increase Savings Rate By 1%

From Sterling Raskie: A Nifty Little Trick to Increase Savings

From Roger Wohlner: Need Post-Election Financial Advice? Try the 1% Solution

From Michele Clark: Employer Retirement Accounts: 2013 Contribution Limits

Thanks to all who have participated so far – and keep those links coming!

Enhanced by Zemanta

The 403(b) and 457(b): A One-Two Punch for Retirement

Aug 6th, 2012
by sraskie.
3 comments
403 B's

Many non-profits, public schools, universities, state governments have access to either a 403(b) or a 457(b) retirement plan. Both the 403(b) and the 457(b) are retirement plans that these institutions can offer employees in addition to or in lieu of a defined-benefit pension. For ease of simplicity, think of these plans as a 401(k), but for non-profits. We won’t get into the minutia of exactly how they’re different here.

Like their 401(k) counterpart, the 403(b) and the 457(b) allow their owners to defer from their salaries up to $17,000 annually, on a pre-tax, tax-deferred basis. For those aged 50 and over, the IRS allows an additional $5,500 age-based catch-up contribution. These numbers are for 2012, they are indexed annually for inflation.

There is a select group of people that may have access to both the 403(b) and the 457(b). For these chosen few, there is an opportunity to save even more money. Here’s why: Let’s say you work for two employers, one is a for-profit that offers a 401(k) and one is a non-profit that offers a 403(b). By law, you are allowed to put in $17,000 total among both accounts – meaning $17,000 aggregated between the two accounts. So you could put in $9,000 in the 401(k) and $8,000 in the 403(b), and other different combination as long as your total between the two doesn’t exceed $17,000. For the age based catch-up, the aggregate between the accounts cannot exceed $22,500.

Now, let’s say you have access to both a 403(b) and a 457(b). Technically speaking, the 457(b) is considered a non-qualified plan – meaning it isn’t subject to certain ERISA requirements. One of those requirements it’s exempt from is the aggregation rule. What does this means for the chosen ones? It means that they can now contribute $17,000 to the 403(b) and another $17,000 to the 457(b) – for a total of $34,000, annually!

As you can see, these numbers can really add up especially if you’re nearing retirement and wanting to save all you can. It also comes in handy if you’re expecting a contract buy-out at retirement and or have unused vacation or sick time coming your way. No need to take that as a lump sum and have it taxed. Simply defer it to your 403(b), and once your 403(b) is full, move the remainder to your 457(b) or vice versa.

Talk to your employer to see what they offer and see if you’re one of the lucky ones!

Enhanced by Zemanta

The Difference Between IRA Contributions and Rollovers

Jul 18th, 2012
by jblankenship.
2 comments
Contribution Box

Often there is confusion about what constitutes a “contribution” and a “rollover” into an IRA.  This post is intended to clear up the difference.

While both activities are technically contributions, there’s a major difference between the two.  The most significant of the differences is that with a regular annual contribution there are several limits imposed that can be quite restrictive.

Annual Contribution Limits

For an annual contribution to a traditional IRA or a Roth IRA, you are limited to the lesser of $5,000 or your actual earned income for the year.  If you have no earned income, you’re not allowed to make an annual contribution to an IRA.  Above that amount, if you happen to be 50 years old or better, you can add $1,000 more to your annual contribution (2012 figures).

Astute readers will point out that there is the option for a spouse to make a spousal IRA contribution in the event that one member of the couple has low or no income for the year.  As long as the other spouse has earned income, IRA contributions are allowed on behalf of the other spouse up to the limits mentioned above.

In addition, if the taxpayer has a retirement plan available in his or her job, there are further income limits that impact deductibility of traditional IRA contributions.  For 2012, the limit is Modified Adjusted Gross Income above $92,000 (for married filing jointly) or $58,000 for single filers.  Above these limits, deductibility is gradually reduced to zero when the Modified Adjusted Gross Income (MAGI) is at $112,000 (or $68,000 for singles).

For Roth IRA contributions, if the MAGI is greater than $183,000, contributions are not allowed for those who are married filing jointly.  For Single filers, the limit is $125,000.

Rollovers

Rollover contributions don’t have an annual limit.  You can rollover literally as much as you like from a qualified retirement plan (QRP) or IRA into another IRA.  In addition, there is no requirement to have had earned income for the year when making a rollover.

In addition, rollovers have no impact on your annual contribution amounts and vice versa.  You can rollover any amount without having to worry about annual limits, and then you can make regular annual IRA contributions up to the limits mentioned above.

Conversions

You are further allowed to convert any amount that you wish from a traditional IRA or QRP into a Roth IRA without limits and without impact to annual contributions.  The problem is that you have to pay tax on pre-taxed amounts that you convert, and this can amount to a sizable tax burden – all pre-tax amounts converted to Roth IRA are subject to ordinary income tax.

Conclusion

So the major difference between annual contributions and rollover or conversion distributions is that annual contributions represent “new money” being contributed into the IRA or Roth IRA account.  Rollovers are simply the transfer of money that was already in a tax-deferred account, into another tax-deferred account.  Or in the case of a Conversion, this is the transfer of existing tax-deferred funds into a tax-free Roth IRA.

Limits on contributions do not apply to rollovers or conversions; the two types of money are not related in any way.

Enhanced by Zemanta

What If My Employer Doesn’t Match My 401(k) Contributions?

May 30th, 2012
by jblankenship.
2 comments
Lighting a match

Should I continue to make contributions to my 401(k)? Is there something else that I should make contributions to instead?

As you may recall, the recommended order for retirement savings contributions is normally as follows:

  • 401(k) contributions up to the amount that the company matches
  • max out your Roth or traditional IRA contributions for the year (as applicable)
  • max out the remainder of the available 401(k) contributions
  • make taxable investment contributions

In the situation where your employer doesn’t match your contributions to a 401(k) plan, the order of contributions is more appropriate if you bump up the Roth or traditional IRA contributions.  In other words, just eliminate the first bulletpoint.

Now, the choice of Roth IRA versus the traditional IRA for your contributions is dependent upon your income and the tax impacts.  For example, you would not be eligible to make a deductible traditional IRA contribution if your Modified Adjusted Gross Income (MAGI) is greater than $112,000 (if you’re married and filing jointly), or $68,000 if you’re single. (Contribution limits are for 2012 tax year.)

Since the deductible traditional IRA has the ability of being deducted from your income, making your contribution there could decrease taxes.  If you’re in a position to take advantage of this, you should probably go this route.  In the case where you’re married and your spouse isn’t covered by a retirement plan – either he doesn’t work outside the home or his employer doesn’t have a retirement plan – you can make a deductible IRA contribution for your spouse as well if your MAGI is less than $183,000.

On the other hand, if your MAGI is greater than $112,000 (MFJ) or $68,000 (Single), a Roth IRA contribution might be the best first option for retirement savings contributions.  The Roth IRA contribution is available to you if your MAGI is less than $183,000 (MFJ) or $125,000 (Single).  The Roth IRA contribution doesn’t reduce taxes for you currently – but in the future your distributions from the account can be tax-free if qualified.

If you don’t fit into those income categories, you still have the option of making non-deductible contributions to a traditional IRA for the tax year.  Again, there’s not a tax benefit in the current year, but there are benefits to making such a contribution – such as the ability to convert the funds from this traditional account to a Roth IRA later – that will make the contribution worthwhile.

The reason that the use of either a Roth IRA or a traditional IRA is the first choice (if available to you) over a non-matched 401(k) plan is because with the IRAs, you have much better control over your costs, investment choices, and fewer restrictions on non-qualified distributions.

The 401(k) still offers the greatest amount of tax-deferral – up to $22,500 if you’re over age 50, $17,000 otherwise – versus a maximum contribution of $6,000 ($5,000 if under age 50) for the IRAs.  This is the reason that the 401(k) account is still a good choice for making retirement savings contributions, even if your employer doesn’t match your contributions. So if you have more money to contribute to your retirement savings than the initial $5,000 (or $6,000 if over age 50), the 401(k) should definitely still be a part of your plan.

Enhanced by Zemanta

What is Meant by Half Years of Age?

May 21st, 2012
by jblankenship.
1 comment
fireworks

If you’ve paid much attention to the rules around retirement plans (IRAs, 401(k)s, and others), you’ve probably noticed that there are a couple of rules that refer to ages that include “½”.  So what does this mean??

Well, quite literally, this means 6 months after you reach a certain age.  The two primary ages with “½” included are 59½ and 70½.  So, to be age 59½, means that you reached your 59th birthday six months prior to that date.  Likewise, to be age 70½ means that you reached age 70 six months prior to that date.

These two ages are for different purposes and are (naturally) treated differently.

Age 59½

The rule using age 59½ is for one of the exceptions to the penalty for early withdrawals from your IRA or 401(k) plan: once you’ve reached that age (and not before that age) you can take withdrawals from your IRA or 401(k) plan without limits (401(k) plans may also require a separation from service).

Here is an important point: this rule is specifically applied ONCE YOU REACH AGE 59½, and not before.  In the year that you will reach this age, any withdrawals taken from the account before you reach age 59½ will be subject to the 10% penalty if no other exceptions apply.

Age 70½

The rule using age 70½ is regarding Required Minimum Distributions (RMD), as well as limiting contributions to an IRA.  For RMDs, the requirement is simply that you must begin taking the required distributions for the year in which you’ll reach age 70½.  (You can actually delay the first distribution until April 1 of the following year, but the distribution is based on the year when you reach age 70½.)

Note that this is different from the way the 59½ rule works: it’s simply the year in which you’ll reach age 70½, not the specific date that you reach age 70½.  So if your birthday is between January 1 and June 30, your age 70½ year is the year that you reach 70 years of age.  If your birthday is between July 1 and December 31, your age 70½ year is the year that you’ll be reach 71 years of age.

The same holds true for contributions to an IRA: in the year that you’ll reach 70½, you are not allowed to make contributions, and you are not allowed to make contributions thereafter.

You Don’t Have to Count Days

The good news is that you don’t have to count days.  For the purposes of these rules, the half year is the same date, six months later.  For a birthdate of May 11, the half year is reached on November 11 of that same year.  For odd circumstances, such as August 31, of course you’ve reached the half year on February 31 of the following year.  Actually, I believe the rule is that you reach that milestone on March 3 – I’d use this date if you are in this situation, just to be certain.

Enhanced by Zemanta
← Earlier Posts
%d bloggers like this: