According to the Department of Labor Bureau of Labor Statistics, nearly 80 percent of full-time workers have access to employer-sponsored retirement plans, and more than 80 percent of those with access participate in a plan. If you are not part of this group, don’t fret—you have other options. Here is an overview of some of the most common retirement plans: 401(k), Traditional Individual Retirement Account (IRA), and Roth IRA.
A 401(k) is an employer-sponsored retirement savings plan that lets workers save and invest a piece of their paycheck before taxes are taken out. You, as the employee, have complete control over how your money is invested. Most plans offer a spread of mutual funds composed of stocks, bonds, and money market investments.
Bonus tip: If your employer offers a matching program, it is wise to invest enough to get the full matching amount. Otherwise, you’re basically walking away from free money.
Employers usually hire an administrator to oversee 401(k) accounts. That person will likely send you updates about your plan and its performance, manage the paperwork, and assist you with any requests. You should also have online access to your account, so you can keep an eye on it, as well as shift your money around.
A Traditional IRA is held at a financial institution such as a bank, and is available to individuals under age 70½ during the entire year who have income from wages. Earned income must be equal to or greater than your contribution. NVE Bank has competitive IRA rates.
Roth IRAs are available to anyone—at any age—whose modified adjusted gross income does not exceed Roth limits, to set aside after-tax income up to a specified amount each year. Earned income must be equal to or greater than your contribution. Other income-eligibility restrictions apply.
When it comes to any retirement plan, the big question is, how much of your paycheck should your contribute to your retirement account? The simple answer is, as much as possible. That is, of course, after ensuring you have enough to manage normal living expenses like shelter, food, and paying down debt. That detail aside, it is important to note the main distinctions between these plans—namely, how contributions are taxed and the rules for withdrawal. Here is a simple breakdown to help you keep them straight:
401(k) tax rules: Wages are contributed before taxes from each paycheck, like a deferred salary. Taxable income drops by the amount you contribute. You pay income taxes on contributions and earnings upon withdrawal.
Roth IRA tax rules: Contributions are made with money that’s already been taxed. Withdrawals of earnings are tax-free if you are age 59 ½ or older and have held the account for at least five years.
Traditional IRA tax rules: Contributions may be tax deductible for the year you make the contribution, depending on income, filing status, and whether you are covered by an employer retirement plan. Withdrawals in retirement are then taxed at ordinary income tax rates.
401(k) withdrawal rules: No access to your funds before age 59 ½ or if you leave your employer at age 55 or older. Any premature withdrawals will result in a penalty of 10% additional tax. There are several exceptions where the IRS will waive the 10% 401k early withdrawal penalty.
Roth IRA withdrawal rules: No required minimum distributions during the owner’s lifetime. There is a 10% federal penalty tax on withdrawals of earnings before age 59 ½ unless an exception applies. Bank penalties and/or fees may apply.
Traditional IRA withdrawal rules: You are required to start taking required minimum distributions (RMDs) at age 70 ½. There is a 10% federal penalty tax on withdrawals of deductible contributions or earnings before age 59 ½ unless an exception applies. Bank penalties and/or fees may apply.
If you leave a company, or if the company you’re working for goes under, your 401(k) stays with you. If your plan is terminated, consider rolling the money over into an IRA to avoid paying the 10% withdrawal penalty and income taxes. All plans allow rollovers to an established IRA account (non-taxable).
If you are self-employed, another retirement plan option is a Simplified Employee Pension (SEP). This plan allows an employer—and only an employer—to make a contribution to each eligible employee’s Traditional IRA (including his or her own Traditional IRA if self-employed). Any tax deductions apply to the employer.
Note that there are limits on annual contributions for all retirement plans. For the year 2014, the maximum contribution for Traditional and Roth IRAs is $5,500. However, individuals age 50 or older in 2014 are allowed an additional $1000 catch-up contribution beyond the maximum annual contribution. Ask your employer or plan administrator for details.
For a quick reference guide on Roth and Traditional IRA rules, including eligibility, contributions and withdrawals, click on the chart below:
You can open an IRA at NVE Bank for as little as $10. Our IRA specialist can provide expert advice on what IRA options make the most sense for your retirement needs. For more information, e-mail email@example.com. You can also visit the NVE website, stop by your neighborhood branch in Bergen County, or call 1-866-NVE BANK.