Your Retirement Plan Options

By Greenstein, Rogoff, Olsen & Co., LLP
3/3/2009

Traditional IRA

Features Invests your own money at financial institution or with mutual fund for retirement.
  1. Contributions: Tax deductible.
  2. Distributions: Taxed as ordinary income unless you make non-deductible contribution.
  3. Requirement Minimum Distribution:
    If required minimum distributions are not made at age 70 1/2, you may have to pay a 50% excise tax on the amount not distributed as required.

* Temporary waiver of required minimum distribution for 2009: you are not required to take a minimum distribution.

Distributions Early Distribution Penalty: If distributions are made before age 59 1/2, you must pay a 10% additional tax.

10% penalty will be waived if you are in one of the following situations:

  1. You have unreimbursed deductible medical expenses.
  2. You are disabled.
  3. Distributions are not more than your qualified higher education expenses.
  4. You use the distributions to buy or build a first home, but it is limited to $10,000 during individual's lifetime.
Maximum Annual Contribution The contribution limit is the smaller of $5,000 or your earned income for the year. People 50 or older at the end of the year can contribute up to $6,000.

Excess Contribution Penalty: If the excess contributions for a year are not withdrawn by the date your return for the year is due, you are subject to a 6% tax.
Income Limits or Phaseouts If you are covered by another retirement plan, you might not deduct all your contributions. Deductions are phased out depending on your modified AGI as follows:
  1. Single or Head of Household: $55,000 to $65,000
  2. Qualifying Widow(er): $89,000 to $109,000
  3. Married Filing Jointly
    a. Both are covered by another plan: $89,000 to $109,000
    b. Only one spouse is covered by another plan and the other doesn't participate in the active plan: $159,000 to $169,000
Advantages / Disadvantages / Strategies Advantages:
  1. Contributions are tax deductible.
  2. Taxpayer gets tax benefit immediately.

Disadvantages:

  1. Contribution limit is low.
  2. All distributions are taxable.
  3. Deduction amount is limited depending on your income.

Strategy:

  1. A taxpayer who expect lower tax bracket in retirement than during the working years.

 

Roth IRA

Features Makes nondeductible contributions to an individual retirement plan regardless of age.
  1. Contributions: Not tax deductible.
  2. Distributions: Not taxed as long as you meet certain criteria,
  3. No Minimum Distribution Requirement: If you are the original owner of a Roth IRA, you don't have to take distributions regardless of your age.
Distributions Early Distribution Penalty: If you receive a distribution that is not a qualified distribution, you may have to pay the 10% additional tax on early distributions.

A qualified distribution is a distribution received 5 years after the first contribution was made and meets the following requirements:

The payment or distribution is:

  1. Made on or after the date you reach age 59 1/2.
  2. Made because you are disabled.
  3. Made to a beneficiary or to your estate after your death.
  4. Used to buy and build a first home.
Maximum Annual Contribution Assuming it's your only IRA of any sort, your contribution limit is the lesser of your taxable compensation or $5,000 ($6,000 if you're 50 or older).

Excess contributions penalty:
A 6% excise tax applies to any excess contribution to a Roth IRA without withdrawal before due date.

Income Limits or Phaseouts Your contribution limit is reduced depending on your income as follows:
  1. Single or Head of Household: $105,000 to $120,000
  2. Married Filing Jointly or Qualifying Widow(er): $166,000 to $176,000
Advantages / Disadvantages / Strategies Advantages:
  1. Distributions/Earnings are tax free.
  2. Minimum distribution is not required at any age.
  3. A taxpayer can make contribution after age 70 1/2.

Disadvantages:

  1. Contribution limit is low.
  2. Contributions are not tax deductible.
  3. A taxpayer who is in a high tax bracket might not be eligible to contribute because of income limit.

Strategy:

  1. Young people with many years until retirement.

 

401(k) Plan

Features Elects to defer a portion of your compensation into your 401 (k) account.
  1. Contributions (elective deferral): Pre-Tax salary.
  2. Distributions: Taxable.
  3. Requirement Minimum Distribution: Minimum distribution is required at age 70 1/2. 50% penalty is charged if minimum distribution is not made.

* Temporary waiver of required minimum distribution for 2009: same as Traditional IRA
* Elective deferral is included in wages subject to social security and Medicare taxes.

Distributions Early Distribution Penalty: if the distributions are made before age 59 1/2, you must pay a 10% additional tax.

The exceptions to the 10% penalty include the followings:

  1. Death of the employee.
  2. Employee's disability.
  3. A series of substantially equal periodic payments made for the life of the employee.
  4. Separation from service after attainment of age 55.
Maximum Annual Contribution Employee annual limitation:
- Age 49 or less: $16,500
- Age 50 or more: $22,000

Excess contributions penalty:
If the excess contributions for a year are not withdrawn by April 15 of the following year, excess amount of distribution will be taxed twice.
Income Limits or Phaseouts Total employer and employee annual limitation:
- Lesser of 100% of the employee's compensation or $49,000.
Advantages / Disadvantages / Strategies Advantages:
  1. Tax on contributions are deferred.
  2. Contribution limit is high.
  3. Some employers make match contribution.

Disadvantages:

  1. Distributions are taxable.
  2. You are limited in what can be invested by what your employer offers.
  3. The plan can't discriminate in employee coverage.

Strategy:

  1. Higher income employee who can reduce his/her AGI.

 

Roth 401(k)

Features Combines features of the Roth IRA and a traditional 401 (k) plan.
  1. Contributions: After-tax salary.
  2. Distributions: Tax free.
  3. Minimum Distribution Requirement:
    Minimum distribution is required at age 70 1/2. 50% penalty is charged if minimum distribution is not made.

* Temporary waiver of required minimum distribution for 2009: Same as Traditional IRA.

Distributions Early Distribution Penalty: If you receive a distribution that is not a qualified distribution, you may have to pay the 10% additional tax on early distributions.

A qualified distribution is a distribution received 5 years after the first contribution and made on or after the date you reach age 59 1/2.

The exceptions to the 10% penalty is the same as explained above in 401(k) plan.

Maximum Annual Contribution Employee annual limitation:
- Age 49 or less: $16,500
- Age 50 or more: $22,000

Excess contributions penalty:
If the excess contributions for a year are not withdrawn by April 15 of the following year, excess amount of distribution will be taxed twice.
Income Limits or Phaseouts Total employer and employee annual limitation:
- Lesser of 100% of the employee's compensation or $49,000.
Advantages / Disadvantages / Strategies Advantages:
  1. If qualified distribution, entire earnings are not taxable.
  2. Compared to Roth IRA, contribution income limitation is high.

Disadvantages:

  1. Contributions are not tax deductible.
  2. Contributions are irrevocable. Once money is invested into the account, it can't be moved to a regular 401(k).

Strategies:

  1. Younger workers, in lower tax bracket now, expected to be taxed in a higher bracket upon retirement.
  2. Taxpayer who precludes from Roth IRA.
  3. Low-income employee.

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