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What Is a Retirement Account and What Are The Different Types?

 

 

 

 

 

 

 

 

 

Let’s start with the obvious question: What is a retirement account?

A retirement account is a very important and tax-advantaged investment tool that can help you save for retirement. Whether you are saving through your work established retirement account, or an individually set up IRA, the sooner you begin contributing to your retirement, the more money you can have in your pocket once you decide to retire.

Now that you know what a retirement account is, let’s discuss what your different options are.

There are many different types of retirement accounts available, but below we break down the seven most common to help you decide which option will be the best for you.

1. Traditional IRA​

a. Who can contribute?

i. Anyone who has earned income during the year (or their spouse) and is under the age of 70 ½ at the end of the year. Contributions are normally tax deductible, meaning your taxable income will be reduced by your contribution. However, your deduction rate depends on a few factors, which can be explained by a qualified tax professional.

b. How much can I contribute?

i. $6,000, or $7,000 if you are 50 years old or older.

c. When do I need to begin taking distributions and what are the tax implications?

i. Beginning at 70 ½, Traditional IRA account holders must start taking their required minimum distribution (RMD), which is based on the size of the account, and the age of the account holder. Your distributions will be taxed at your tax bracket rate at the time of the distribution.

 

2. Roth IRA

a. Who can contribute?

i. Individuals (or their spouse) who have earned income for the year. There is no maximum age to contribute, so you can continue to contribute into your Roth IRA for as long as you have eligible earned income. However, not everyone qualifies to contribute to a Roth IRA due to income limitations (which are laid out below). Contributions are not tax deductible, but qualified distributions are tax free since you are contributing with after tax dollars, and you do not have to pay any taxes on your investment gains.

b. How much can I contribute?

i. The amount that you can contribute is dependent on yours, and your spouses, salary. If you are filing single and make $122,000 or less, you can contribute the full $6,000, or $7,000 if you are 50 years old or older. If you are filing jointly, you can contribute the full amount if you make a combined $193,000 or less. There are also options to contribute a reduced amount: filing single is a salary of up to $137,000, and married filing jointly is a combined salary of $203,000.

c. When do I need to begin taking distributions and what are the tax implications?

i. The Roth IRA account owner never has to withdraw money from their account. Distributions are not required until after the death of the Roth IRA owner, when the beneficiary of the account will need to begin taking the RMD. If you do decide to withdraw from your Roth IRA, your qualified distribution is non-taxable (nonqualified distributions will be taxed as ordinary income).

 

3. SEP IRA (Self-employed)

a. Who can establish a SEP IRA plan?

i. Anyone (regardless of age) with self-employment income.

b. Who can participate?

i. If contributions are made for a self-employed individual, they must also be made for eligible employees.

c. How much can I contribute?

i. The maximum contribution allowed is 25% of the net self-employed income, after the self-employed tax deduction, up to a maximum contribution of $56,000.

d. When do I need to begin taking distributions and what are the tax implications?

i. Beginning at 70 ½, SEP IRA account holders must begin taking their RMD, which is based on the size of the account, and the age of the account holder. Your distributions will be taxed at your tax bracket rate at the time of the distribution. However, contributions can still be made to your SEP IRA after 70 ½ if the individual has self-employed income from that tax year.

 

4. SEP IRA (Employee)

a. Who can establish a SEP IRA for an employee?

i. Any employer who has their own SEP IRA.

b. Who can participate?

i. Employees who are at least 21 years of age, have worked for the employer during three of the last five years, and received at least $600 in compensation in the given year.

c. How much can I contribute as an employee?

i. Unfortunately, an employee cannot contribute to a SEP IRA. However, your employer can contribute for you up to 25% of your wages, up to a maximum contribution of $56,000. Business owners can deduct the contributions from their reported business income.

d. When do I need to begin taking distributions and what are the tax implications?

i. Beginning at 70 ½, SEP IRA account holders must begin taking their RMD, which is based on the size of the account, and the age of the account holder. Your distributions will be taxed at your tax bracket rate at the time of the distribution. However, contributions can still be made to your SEP IRA after 70 ½ if the individual has earned income.

 

5. Simple IRA

a. Who can establish a Simple IRA plan?

i. Employers with 100 or fewer employees that do not have another retirement plan.

b. Who can participate?

i. Employees of any age who have earned at least $5,000 in any prior two years and are reasonably expected to do so in the current year.

c. How much can I contribute?

i. Employees can contribute up to $13,000, with an additional $3,000 if age 50 or older at the end of the year. These are pre-tax dollars directly from your paycheck in the form of a salary reduction contribution (which is an amount an employee elects to have contributed to their SIMPLE IRA, rather than paid in cash). In addition, your employer can either:

1) Match employee contributions dollar for dollar, up to 3% of wages or

2) Contribute 2% of wages (up to $270,000) for all employees (including nonparticipants).

d. When do I need to begin taking distributions and what are the tax implications?

i. Beginning at 70 ½, Simple IRA account holders must begin taking their RMD, which is based on the size of the account, and the age of the account holder. Your distributions will be taxed at your tax bracket rate at the time of the distribution. However, contributions can still be made to your Simple IRA after 70 ½ if the individual has earned income.

 

6. 401(k)

a. Who can establish a 401(k) plan?

i. Any employer

b. Who can participate?

i. Employees who are at least 21 years of age, with one year of service (1,000 hours).

c. How much can I contribute?

i. Employees can contribute up to $19,000 (additional $6,000 if age 50 or older at the end of the year). These are pre-tax dollars directly from your paycheck in the form of a salary reduction contribution (which is an amount an employee elects to have contributed to their 401(k), rather than paid in cash). In addition, your employer can:

1) Contribute a percentage of your salary in the form of a contribution match (Ex: they will match dollar for dollar your contribution up to 3%), up to (combined with your own contribution) $56,000, or 100% of employee compensation, whichever is lower ($62,000 for employees 50 and older). Make note: Your employer does not have to offer a match option.

d. When do I need to begin taking distributions and what are the tax implications?

i. Beginning at 70 ½, or retired, whichever is later, 401(k) account holders must begin taking their RMD, which is based on the size of the account, and the age of the account holder. Your distributions will be taxed at your tax bracket rate at the time of the distribution.

 

7. 403(b)

a. Who can establish a 403(b) plan?

i. Tax-exempt religious, charitable, or educational organizations.

b. Who can participate?

i. Employees who work 20 or more hours per week.

c. How much can I contribute?

i. Employees can contribute up to $19,000 (additional $6,000 if age 50 or older at the end of the year). These are pre-tax dollars directly from your paycheck in the form of a salary reduction contribution (which is an amount an employee elects to have contributed to their 403(b), rather than paid in cash). In addition, your employer can:

1) Contribute a percentage of your salary in the form of a contribution match (Ex: they will match dollar for dollar your contribution up to 3%), up to (combined with your own contribution) $56,000, or 100% of employee compensation, whichever is lower ($62,000 for employees 50 and older). Make note: Your employer does not have to offer a match option.

d. When do I need to begin taking distributions and what are the tax implications?

i. Beginning at 70 ½, or retired, whichever is later, 403(b) account holders must begin taking their RMD, which is based on the size of the account, and the age of the account holder. Your distributions will be taxed at your tax bracket rate at the time of the distribution.

Distribution penalty for retirement accounts

All retirement accounts, with the except of Roth IRA’s, require you to take distributions, but you do not need to wait until 70 ½ to begin these distributions. You can begin withdrawing from your account at 59 ½. However, if you withdraw from your retirement account before age 59 ½ (unless you have an exception, which a qualified tax professional can explain to you) you will be subjected to a 10% tax fee, which is in addition to your normal income tax.

While this information may seem overwhelming at first, saving for your retirement is relatively simple once you figure out which option works best for you. If you have any questions, or would like help reviewing your retirement options, please call

Westco Financial Group at (516) 593-5070 or email at clientsvc@westcofinancialgroup.com

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