What to Do If Your Company Doesn’t Offer a Retirement Plan

Working for a company with no retirement plans doesn't mean you can't create your own.

The ability to divert part of your paycheck to an investment account and build a nest egg is a huge advantage in the grand scheme of life. In fact, much of the American workforce relies on employer-sponsored retirement plans to do so.

But while we think of retirement accounts as part of a standard workplace benefits package, the reality is that not every employer offers a tax-advantaged retirement plan. The good news is that it’s possible to save for retirement on your own. Here’s how:

Start with an Individual Retirement Account (IRA)

If you have earned income, you are eligible to open an IRA. It’s possible to contribute up to $5,500 to an IRA in 2017. Individuals over the age of 50 can contribute an extra $1,000 each year to “catch up” on their retirement savings. There are two main types of IRAs to choose from:

Traditional IRA

When you contribute to a traditional IRA, you receive a tax deduction. Your investment broker will send you a statement at the end of the year so you know how much to deduct.

Because you receive a tax deduction now, you will have to pay taxes later when you withdraw money from your retirement account. You can start withdrawing money at age 59 and a half, and pay taxes on it at your marginal rate.

Note that if you or your spouse has a retirement plan through work, or if you have a higher income, your deduction eligibility phases out with a traditional IRA.

Roth IRA

With a Roth IRA, you make contributions with after-tax money, and the investments grow tax-free. So, you don’t get a tax advantage today, but you don’t have to worry about paying taxes on your future withdrawals.

Although this sounds pretty great, it’s important to note the income restrictions on the Roth IRA. Your ability to contribute phases out starting at $118,000 a year as a single filer in 2017. Once you reach $133,000 in income for the year, you can’t contribute to a Roth IRA at all. Instead, you might need to switch to a traditional IRA.

Choosing Between a Traditional & Roth IRA

Making this decision mainly focuses on your expected tax situation. If you think your taxes will be higher in the future, you can save money by paying taxes now at a lower rate and using a Roth IRA. However, if you think your tax bill will decrease later, try to avoid paying taxes today with the help of a traditional IRA contribution tax deduction.

Other IRA Options

Do you have a side gig on top of your full-time job? If so, use that as a reason to access some of the self-employed IRA options, such as SIMPLE IRA and SEP IRA accounts.

These IRA accounts often allow a higher yearly contribution than a traditional or Roth IRA. For 2017, the SIMPLE allows up to $12,500 in contributions each year with a $3,000 potential catch-up contribution. The SEP IRA has a limit of the lesser of 25 percent of your compensation or $54,000 for 2017.

Open Your IRA

Opening an IRA is relatively simple. You can open an IRA account with most online brokers and investors. Some even allow you to open an account with no minimum or opening balance. Other brokers might require a regular monthly contribution of $100 to create an account.

Many brokers offer access to low-cost index funds and ETFs for instant diversity and a reduction in fees. Set up an automatic transfer from your checking account into your investment account.

Consider talking to your human resources department to see if you can have part of your paycheck diverted to your IRA. Even if you don’t have an employee retirement plan, you can still passively generate savings for your future self.

See how debt affects your ability to save with a free credit report snapshot on Credit.com.

Consider the myRA

A few years ago, the government started an IRA alternative called the myRA. If you have a small amount to contribute, this can be ideal. You contribute as little as $5 per paycheck. Your tax-deductible contribution is invested in the Government Securities Fund. Your annual contribution limit and tax benefit is in line with a traditional IRA.

Once your account balance reaches $15,000, or after 30 years, you have to move the money into a private IRA. Plus, you don’t have as many choices for investing with the myRA. Your money has to go into the specified fund. Because the barrier to entry is so low, it’s a good starter retirement account as long as you plan to upgrade later.

Open a Health Savings Account (HSA)

Health care costs can present a challenge during retirement. One way to address this issue, especially if your employer doesn’t offer a retirement plan, is with the HSA.

Not only do you receive a tax deduction for your contributions, but also the money grows tax-free as long as you use it for qualified health-related costs. While you can use the money now, it’s a good strategy to let the money grow. Plan to use the HSA for health care costs during retirement to capitalize on long-term, tax-free growth.

Once you reach 65, you can treat your HSA like a traditional IRA (with most of the same rules). However, integrating the HSA into your overall plan by using it in conjunction with an IRA can help you maximize your assets during retirement.

Are You Eligible for a Solo 401(k)?

Another option for those with side gigs is the solo 401(k). If you have a side business on top of your work, and you don’t have any employees, you can take advantage of higher 401(k) limits by opening a solo 401(k). One advantage to the Roth solo 401(k) is that it doesn’t come with the income restrictions you see with a Roth.

A solo 401(k) comes with a very generous contribution limit. On the employee side, you can contribute up to $18,000 for 2017. Your business can also contribute a percentage of income (20% or 25%, depending on your type of business). For those 50 and over, contributions to a participant’s account, not counting catch-up contributions, can’t exceed $54,000

These accounts are harder to find than IRAs. You might need to speak with a specialty brokerage or your bank to open a solo 401(k).

Taxable Investment Accounts

Finally, you don’t have to limit yourself to tax-advantaged retirement accounts. Any regular brokerage account can help you save for retirement. Brokers such as Acorns and Robinhood can help you invest pocket change for the future.

When investing through taxable investment accounts, though, you need the discipline to avoid withdrawing the money before you retire. Taxable investment accounts don’t restrict your access in the same way, so it can be tempting to raid your retirement fund for today’s expenses.

Get Started Now

Regardless of your employer’s involvement, you need to make room in your budget for retirement savings. No matter how you go about it, the important thing is to start investing with retirement in mind. The earlier you start, the more time your money has to grow.

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8 Ways to Avoid Early IRA Withdrawal Penalties

An early distribution penalty isn't always inevitable. These exceptions might just apply to you.

Qualified retirement plans are designed to be used solely for retirement income. Taxable withdrawals from these plans before age 59.5 are generally assessed an additional 10% “early distribution tax” by the IRS. (The additional tax for SIMPLE IRA plans is 25% in the first two years of participation, and 10% thereafter). However, there are exceptions to this tax. Most of the exceptions apply to both individual retirement accounts and employer sponsored qualified plans, while a few only apply to IRAs. It may be possible, however, to roll a portion of your company’s retirement plan to an IRA in order to take advantage of those exceptions that only apply to IRA plans.

1. Disability

If you become disabled you can access your retirement funds without penalty, but there’s a catch. To claim the exemption, the IRS requires a “total and permanent” disability. You are only considered disabled if “you cannot engage in any substantial gainful activity because of your physical or mental condition. Additionally, “a physician must certify that the condition has lasted or can be expected to last continuously for 12 months or more, or that the condition can be expected to result in death.”

2. Education (IRAs only)

Distributions to pay qualified expenses for higher education qualify for the exemption if the student is enrolled in at least half of a full-time academic work load at an eligible academic institution. Qualified expenses include tuition, fees, books, supplies and equipment required for the education. These expenses can be for you, your spouse, you or your spouse’s child or grandchild. It is important to note that any expenses paid for with other government program funds or tax benefits are generally not eligible for this exemption. To qualify, the education expenses must be paid in the same year as the withdrawal.

3. First-Time Homebuyers (IRAs only)

Qualified first-time homebuyers can exclude up to $10,000 of penalty-free distributions from the early withdrawal tax if the proceeds are used to buy or build a primary residence within 120 days. The home can be for you, your spouse or either of your descendants. The term “first-time homebuyer” is a little misleading. According to the IRS, you are a first-time home buyer if you or your spouse did not have any ownership in a primary residence during the previous two years. So even if you have owned a home in the past, you can be considered a “first-time” homebuyer if it has been at least two years since you sold it. While this exemption can only be used once in a lifetime, both you and your spouse could each withdraw $10,000 and apply it to the same residence.

4. Unreimbursed Medical Expenses

Any unreimbursed medical expenses that exceed 10% of your adjusted gross income (Line 37 of the Form 1040) can be paid with funds from your IRA or company retirement plan without incurring the early distribution tax. The medical expenses must be paid in the same calendar year as the withdrawal to qualify.

5. Medical Insurance During Unemployment (IRAs Only)

If you lose your job and receive unemployment compensation for at least 12 consecutive weeks you may qualify to pay your medical insurance premiums with amounts withdrawn from your IRA without the early distribution tax. IRA withdrawals can be used to pay medical insurance premiums for yourself, your spouse, or your dependents without the 10% penalty. The distributions must be received in either the year you received unemployment compensation or the next year and must be withdrawn no later than 60 days after you start a new job.

6. Active Duty Military Reservist

If you are a member of the military reserves and are called to active duty for at least 180 days (or for an indefinite period) you will not have to pay the excess tax on any withdrawals made during your period of active duty.

7. IRS Levy

If the IRS places a levy on your retirement plan and you withdraw funds to satisfy the levy, you will not be charged the excess tax. If, however, you withdraw funds to pay taxes owed in anticipation of a levy, the exemption does not apply.

8. Substantially Equal Periodic Payments

If you do not meet any of the aforementioned exceptions, but still want to access your retirement plan without penalty, you can take “Substantially Equal Periodic Payments” over a period that is the longer of five years or until you reach age 59.5. The “Substantially Equal Periodic Payment” must be calculated according to complicated IRS actuarial rules. (You should consult a certified public accountant to perform the calculations.) These payments cannot be stopped or changed once they start or the 10% early distribution tax will be applied retroactively applied and you will also be charged interest.

It is important to weigh the consequences of taking distributions from plans designed to provide retirement income for non-retirement expenses. You should try to find another means to pay these pre-retirement expenses when possible. (If you plan to take out a loan, a good credit score will lead to a better rate. See where you stand before applying. You can check two credit scores for free at Credit.com.) Otherwise, make certain that you seek the advice of a competent tax adviser before making this critical decision. Mistakes can be costly.

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What Should I Do With My Retirement Plan When I Change Jobs?

When you terminate employment, you need to make some critically important decisions regarding your retirement plan.

When you terminate employment, you need to make important decisions regarding your retirement plan. Generally, you have three choices that allow you to continue to defer income taxation: leave the investments with your current employer, move them to your new employer or transfer them to an Individual Retirement Account (IRA). Of course if you are permanently retiring, the new employer plan is not an option.

Another choice is to cash out your account and pay income taxes on the withdrawal. This is usually not a good alternative since taxes will reduce the amount available for retirement and withdrawals prior to age 59 ½ will generally incur an additional 10% penalty.

There are several factors to consider when making this important decision, including investment options, investment costs, simplicity and the ability to borrow from the plan. Here are four things to keep in mind.

1. Investment Options

Most employer retirement plans have a limited number of investment choices. This can be good and bad. Plans with an abundance of choices can overwhelm the participant with difficult decisions. However, too few choices can limit the participant’s ability to properly diversify assets or select options that reflect their goals and objectives.

It is important to evaluate the options available in the previous plan as well as the new plan. Moving the assets to an IRA allows the participant to invest in a nearly unlimited number of options.

2. Investment Costs

One of the advantages of large employer plans is that investment costs may be lower than those charged in a smaller IRA account. Large employers have more leverage to offer investment classes with lower management fees than an individual can access. However, some larger plans may actually have higher fees than those charged in IRA accounts due to plan administrative expenses.

One way to evaluate the investment costs is to visit the Financial Industry Regulatory Authority Fund Analyzer. This free tool can illustrate the total fees paid over several years and can be accessed online.

3. Simplicity

If you are like most Americans, you will probably change jobs several times over your lifetime. (Here’s what to leave off your resume when that happens.) Each new employment stop creates a new plan to monitor after you move on. Companies merge, change investment options and change plan administrators.

Each of these changes requires you to set up new investment choices and website logins. Keeping up with all of these changes among several retirement plans can be burdensome. Transferring the assets to a new employer or to a single IRA account can simplify your life since your retirement investments will be situated in one central location.

4. Plan Loans

Employer retirement plans may offer the ability for the participants to borrow from their account (loans are legally available to most employer plans, but not all plan sponsors elect to offer them, and some plan types cannot offer them). Retirement plan loans are limited to less than 50% of the account value or $50,000. While there may be an administrative fee charged for the loan, the interest paid by the participant goes directly into the account, rather than to the plan.

Tax regulations do not allow loans from IRA accounts, so retirement plan loans can be a reason to move assets to your new employer. It is important to recognize that plan loans normally must be repaid upon separation from the employer. Any unpaid balance is considered a taxable distribution, subject to taxation and the early withdrawal penalties previously discussed.

Financial decisions vary for each individual and there is not a one-size-fits-all answer that is right for everybody. You should weigh each of the four aspects of this question to determine the best option for you. (Get a look at your financial health by checking your free credit report snapshot on Credit.com.) Retirement plans and taxation are complex, so we recommend seeking the advice of a certified financial planner and a certified public accountant before making your elections. (Disclosure: I am a financial planner.)

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Here’s What You Need to Know Before Withdrawing Money From Your IRA

Before you take money out of your IRA, make sure you understand what’s expected of you.

One of the key pieces to retirement planning is understanding when and how much you can withdraw from your account.

Your individual retirement account comes with rules about when you can withdraw money and how much you must withdraw each year. Understanding IRA withdrawal rules is vital if you want to avoid paying penalties.

Why Are There IRA Withdrawal Rules?

It’s your money, so why are there rules about withdrawing from an IRA?

The government offers you a tax benefit when you invest using an IRA. As a result, the government expects you to use this tax-advantaged money for its intended purpose — retirement — and sets rules accordingly.

When you break the IRA withdrawal rules, you are subject to a penalty. This penalty can be hefty, depending on the circumstances. Additionally, the penalty depends on the type of IRA you have. There are slightly different rules for traditional and Roth IRA accounts. (You can learn about the differences between traditional and Roth IRAs here.)

Before you take money out of your IRA, make sure you understand what’s expected of you.

Traditional IRA Withdrawal Rules

The rules for withdrawing from a traditional IRA are more stringent than those for a Roth IRA. When you contribute to a traditional IRA, the money is pre-tax, meaning you get a tax deduction for your contributions. (Here’s a quick guide to common tax deductions.)

As a result — except for specific circumstances — the IRS expects you to keep your money in the account for a long period of time.

Withdrawing From an IRA Before Age 59½

If you take money out of your traditional IRA before you reach age 59½, you are subject to a 10% penalty. That penalty is on top of the federal and state income taxes you owe on the withdrawal.

There are exceptions to this rule. You can avoid the penalty if you withdraw the money for the following reasons:

  • Buying a home for the first time
  • Disability
  • Qualified education expenses
  • Health insurance (if you are unemployed)
  • Medical expenses that weren’t reimbursed

If you go this route, talk to a tax professional and use IRS Form 5329 to ensure you aren’t penalized.

Regular Retirement Withdrawals

During your “regular” retirement years, which start at age 59½, you can take money from your retirement account to cover any expenses you have. Though you won’t face penalties, you will be taxed at your marginal rate for withdrawals since they are considered part of your income.

Withdrawing From an IRA at Age 70½

Once you reach age 70½, you must take withdrawals from your traditional IRA. Up until this age, you aren’t required to take money out of your IRA if you don’t want to. However, at age 70½, you must take the required minimum distribution (RMD).

Your RMDs are based on a formula that takes into account the amount in your IRA and your life expectancy. If you don’t take the required amount, you will face a penalty of 50% of the amount you should have withdrawn.

Consult with a financial professional to help you figure out the best way to withdraw money from your IRA between age 59½ and 70½ to reduce the pain caused by RMD. A financial professional can help you create a plan that also takes into account the impact of Social Security benefits. Coordinate your benefits and plan withdrawals for best results.

Roth IRA Withdrawal Rules

Roth IRA withdrawal rules are a little different. Because you contribute after-tax dollars to this account, reaping no immediate benefit, some of the rules are more flexible. However, you still need to be aware of potential pitfalls and penalties.

Withdrawing From Your Roth IRA

With this type of account, it’s important to make the distinction between your contributions and your earnings.

Say you invest $5,000 in your Roth IRA each year for two years. During that time, your account grows to $16,000. In this case, your contributions total $10,000 and your earnings come to $6,000.

You can withdraw your original contributions anytime without tax or penalty. This is the money you put in after-tax, and you can use it to pay for anything.

Once you start dipping into your earnings, however, you’ll face extra charges. Tap into the earnings from your Roth IRA before you reach age 59½ and you’ll pay a 10% penalty. Plus, an early withdrawal could be subject to tax — something you normally don’t pay on Roth IRA earnings if you withdraw after age 59½.

One nice bonus of a Roth IRA? There are no RMDs associated with this account type. It doesn’t matter how old you are — you will never be forced to take money out of your Roth.

The Five-Year Rule

You need to be aware of the five-year rule with your Roth IRA. This regulation states that initial contributions to your Roth IRA must be made at least five years before you start withdrawing earnings.

Say you’re 57 when you start contributing to a Roth IRA. In that case, you can’t actually start withdrawing your earnings at age 59½ without triggering a penalty — since the five years hasn’t been met. You need to wait until you are at least 62 to satisfy the rule.

In the end, IRA withdrawal rules are fairly straightforward. If you have questions, consult a tax professional before you take money from your IRA. That way, you have a plan in place.

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5 Ways to Catch Up on Retirement Savings

Whether you haven’t started or life got in the way and you needed to dip into your nest egg, don’t stress because it’s not too late to catch up!

Worried about your retirement nest egg? It’s normal for someone nearing retirement to question how much they have saved — and wonder if their savings will last. Whether you haven’t started or life got in the way and you dipped into your nest egg, don’t stress, because it’s not too late to catch up. Here are a few tips for topping up your retirement fund.

1. Maximize Contributions

If you have access to a company retirement plan, such as a 401K, consider contributing enough to capitalize on a company match. Losing out on a company match can mean missing extra money over the span of one’s working career. On top of taking advantage of the company match, you may want to consider maximizing your contributions. Increasing your contributions may seem intimidating, but putting away a little more each year can boost your nest egg when you factor in the effects of compound interest.

2. Invest Found Money

Of course, not everyone can contribute more to their retirement funds on a regular basis, which makes investing found money a great opportunity. If you’re lucky enough to come into some money, whether from a tax refund, a bonus or money from your wedding, consider directly depositing this money into your retirement account. This way it will never touch your hands or be spent on personal items. For example, if you’re getting by comfortably on your income and receive a bonus, you may want to deposit the difference to help you catch up on saving for retirement.

3. Open an IRA

If you do not have an individual retirement account, opening one can be a great vehicle for stashing away money. Used along with a company plan, a traditional or Roth IRA can mean more income in retirement when the day to hang up your hat finally comes. With both accounts, an individual can contribute up to $5,500 annually, and an extra $1,000 for those over 50. (The extra allowance can help those who are a bit older catch up on saving.) While both savings accounts offer tax incentives at different times, it’s important to understand these tax breaks, along with their income limits, before you decide which account to open.

4. Work Longer

While delaying your retirement may not sound appealing, it can mean more time to build up your retirement funds — and a shorter retirement for which to save. It can also mean delaying Social Security and receiving a bigger monthly check in the future. If you wish to continue working but want to take on fewer hours, consider picking up a part-time job or starting a side hustle. While this may affect your Social Security, it can also mean extra money in your pocket during retirement, less stress and more time to do what you want. Keep in mind, unless otherwise specified, there may be a required minimum retirement distribution, which requires you to withdraw money at a certain age.

5. Pay off Debts

While saving and maxing out your retirement fund is ideal, it will do you no good if you have high-interest debt that continues to build. (See how debt is affecting your finances with a free credit report snapshot on Credit.com.) Your debts can feel like chains tied to your ankles if you don’t get rid of them before you retire. You may want to continue saving for retirement as well, but consider paying down high-interest debt first. Taking debt into retirement can mean less money for your golden years. So if you’re nearing retirement and worried about debt, consider speaking to a debt attorney to see how they can help.

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Can I Still Contribute to an IRA & Get a Tax Break for 2016?

Can you contribute to your IRA and still get a tax break? Here's what you need to know.

Individual Retirement Accounts (IRAs) are an excellent means to save for retirement. You have until the tax-filing deadline (generally April 15) to make a contribution to your IRA for the previous tax year.

There are two types of IRAs: Traditional IRA and Roth IRA. The maximum contribution is the lesser of $5,500 ($6,500 for those aged 50 and over) or your earned income. This is a combined limit for all IRA contributions in a year (in either or both types). In order to contribute to a Traditional IRA, you must be under age 70½, but you can contribute to a Roth IRA at any age. You can learn more about IRAs here.

Whether you can contribute to an IRA and how much you can contribute depends primarily upon two factors: 1) your Modified Adjusted Gross Income and 2) whether you (or your spouse) participate in an employer-sponsored retirement plan.

Adjusted Gross Income (AGI) is the number listed on line 37 at the bottom of the first page of your Form 1040. In order to determine IRA contribution limits, AGI must be adjusted by adding back certain items that were deducted to arrive at AGI. Items added back to AGI include deductions taken for traditional IRA contributions, student loan interest, college tuition and fees, and some other less common items. The final result is Modified Adjusted Gross Income (MAGI).

Here’s how to know if you can deduct your IRA contributions this year.

Traditional IRA

While anyone under age 70½ with earned income can make non-deductible contributions to a Traditional IRA, deductible contributions are not as certain. If you are single and not covered by a plan at work or you are married and neither you (nor your spouse) have a plan at work, then your full contribution up to the annual limit is deductible.

However, if either you (or your spouse) participate in an employer retirement plan, your deductible IRA contributions may be limited or even completely eliminated. To determine if you are covered by work, you can look at your W-2. If there is a check next to “Retirement Plan” in Box 13, then you are covered. This chart on the IRS website illustrates deduction limits for both single and married taxpayers covered under an employer’s plan at work.

Roth IRA

While there are no age restrictions on who can contribute to a Roth IRA, there are income constraints that must be observed. Unlike Traditional IRA rules, Roth IRA regulations do not consider whether you have an employer plan. The only factor is your MAGI. Again, you can find the chart showing the income levels that affect Roth IRA contribution limits on the IRS’ website.

Kay Bailey Hutchison Spousal IRA

A Spousal IRA is not a third type of IRA but a provision for spouses without enough earned income to fully fund a Traditional or Roth IRA on their own. Named for the former United States Senator from Texas, the Kay Bailey Hutchison Spousal IRA allows a spouse with little or no earned income to have his or her own IRA account by qualifying with the working spouse’s income.

The Spousal IRA limits are the same as the Traditional and Roth limits ($5,500 or $6,500 if aged 50 or over). So the total combined contributions for both spouses are $11,000 or $13,000, if aged 50 or over. The working spouse must have earned enough money to fund both contributions.

Saving for retirement is more important than ever. (You can see if you have enough shored up here and keep tabs on your finances by viewing two of your credit scores, with updates every two weeks, on Credit.com.) If you don’t have a retirement plan, it’s never too late to start one. But knowing the rules is a critical step for a successful plan. Tax laws are complicated, and penalties for mistakes can be costly. Make sure you seek out the guidance of a tax professional before making important financial decisions.

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5 Things You Must Know About Lifetime IRA Distributions

ira-distributions-rules

Individual Retirement Accounts, or IRAs, are wonderful retirement accumulation vehicles. Contributions are generally tax-deductible (with limitations), and the assets in the accounts grow without the burden of taxation until withdrawn. Distributions are generally taxed the same as earned income. Roth IRAs are similar to Traditional IRAs in that the account also grows free of income taxation. However, contributions are not tax-deductible and qualified distributions are generally income-tax free. For the purpose of this discussion, I will primarily focus on lifetime traditional IRA distributions.

1. There Is a 10% Penalty Tax

Since Congress designed IRAs for retirement needs, and not for pre-retirement vacations or mid-life crisis Porsches, there is a 10% penalty tax imposed on the taxable portion of withdrawals taken prior to age 59½ (with a few limited exceptions). While the pre-59½ rule limits early distributions, there is also a rule that forces distributions to be taken later in life. This rule prevents the accountholder from overusing the tax deferral provided by the plan. Generally, April 1st of the year after the accountholder turns age 70½ is the Required Beginning Date (RBD) for withdrawals. This is when the first Required Minimum Distribution (RMD) from the plan is due. An individual reaches age 70½ six months following their 70th birthday. If you turn age 70 between January 1 and June 30, you will turn 70½ during that calendar year. If your birthday is between July 1 and December 31, you will turn 70½ in the following calendar year.

2. The RMD Must Be Taken Annually

The RMD must be taken annually by December 31 each year thereafter using the year-end value of the IRA of the previous year. It is important to note that the first RMD can be taken in the actual year that the participant turns 70½. The following year’s April 1st deadline is actually sort of a first-year grace period. If the first RMD is delayed until April 1st (as opposed to taken by December 31 of the 70½ year), another RMD is due by December 31 of that same year. So it may actually make sense to take the first RMD by December 31 of the year in which the participant actually turns 70½ instead of waiting to avoid two withdrawals in the same calendar year and possibly increase taxation by potentially pushing the participant into a higher tax bracket.

3. There Is a 50% Penalty If the Accountholder Doesn’t Take the RMD

If the accountholder does not take the required minimum amount, a 50% penalty is imposed on the portion of the required amount that was not taken. That is not a typographical error. The penalty is really 50%. This penalty is in addition to the normal income tax payable on the distribution. The purpose of this Required Minimum Distribution, at least theoretically, is to liquidate the entire balance of the retirement account by the end of the participant’s lifetime. In order to do this, the IRS has developed three Life Expectancy Tables (see below). Table I applies to RMDs after the death of the participant, while Tables II and III applies to required distributions during the participant’s lifetime.

4. There’s a Specific Way to Determine the Lifetime RMD

The lifetime RMD is determined by dividing the account balance as of December 31 of the previous year by the factor on Table III of the IRS Publication 590 Life Expectancy Tables, corresponding to the age of the account owner. If, however, the sole beneficiary of the account for the entire year is a spouse who is more than 10 years younger than the participant, Table II must be used. For subsequent years, the new attained age for that year is used to determine a new RMD divisor in the same Table that was used in the first year. In other words, increase the age by one year and look up the corresponding new life expectancy factor each year.

5. Lifetime RMDs Do Not Apply to Roth IRAs

It is important to note that the lifetime RMDs generally apply to Traditional, SEP, and SIMPLE IRAs, but do not apply Roth IRAs. (The RMD rules vary somewhat for employer-sponsored retirement plans like 401Ks, 403Bs, pension plans, and government plans, which are not covered in this discussion.) If the participant owns multiple IRAs, the values must be combined to determine the correct RMD, but withdrawals can come from any or all of the accounts.

[Editor’s Note: Saving for retirement is an important part of any financial plan, and so is improving your credit. You can monitor your financial goals, like building a good credit score, each month on Credit.com.]

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What Should I Do if My 401K Stinks?

lousy-401-k-plans

Q. I don’t think I have good investment choices in my 401K plan, but I’ve always saved the max. Does it make sense to save to an IRA instead and put the rest in some other kind of account where I can choose the investments? — Analyzing

A. There’s a lot to consider here.

If your employer offers a 401K and will match a percentage of your contributions, you should definitely take advantage of it, said Lisa McKnight, a certified financial planner with Lassus Wherley in New Providence.

She said most employers offer a matching contribution up to a certain percentage of your salary.

“For example, if your employer will match your 401K contributions up to 6% of your salary, you should always contribute at least 6%,” McKnight said. “That’s equivalent to a 100% return on investment.”

It would take years in an IRA to achieve that same 100% return, she said.

Over time, those contributions compound, leading to far more growth over the long term.

Next, consider taxes.

All the money you contribute to a 401K is pre-tax, she said. You are not taxed on that money during the year that you earn it. Rather, it is taxed when you withdraw it in retirement.

McKnight said in 2016, you can contribute up to $18,000 of pre-tax money to a 401K and if you are over 50, you can contribute an additional catch up contribution of $6,000.

She said saving to a 401K is easy and disciplined with automatic payroll deductions.

As you noted, in a company-provided 401K, you are limited to choosing among the investment choices, typically mutual funds, that the plan offers.

“While your company may give you information about the funds, you’ll need to figure out which ones are best for you,” she said. “Since you’re bearing all the risk, it’s important that you choose wisely.”

McKnight said although you are limited to the funds within the plan, you do have control over which ones and the types of investments to use.

These should be based on your risk tolerance and investment horizon, she said.

She said your employer may offer tools to help you familiarize yourself with the risk/reward relationships. You will want to familiarize yourself with your choices.

“There should be a few target date funds, stock and bond funds and blended funds,” McKnight said. “Within each of these categories, there should be a number of funds to choose from, each with a different investment strategy and level of risk.”

If you do not feel comfortable choosing your own funds, then a target date fund may be the way to go.

“Target date funds will align with retirement dates such as Target 2020, Target 2025, etc.,” she said “These funds invest more conservatively as you near your retirement date.”

Target date funds are great options for people who want to invest in a fund that will automatically adjust the overall risk level as they near retirement, McKnight said.

Even if you end up investing in a target date fund, you may still want to invest in some other funds to further diversify your portfolio, she said.

There are funds that focus on a wide variety of different investments, all with differing levels of risk. You will likely have options that include funds that focus on international stocks, emerging markets or real estate.

If you are more of a do-it-yourselfer and want to choose your own funds, she recommends you look for index funds.

Most plans will have a handful of index funds.

“Index funds are style specific, low cost and track the performance of various indexes, such as the S&P 500, Russell 2000 or the EAFE,” McKnight said. “If your plan offers several low cost index fund choices, perhaps an S&P 500 or total stock market index fund, an international stock index fund and a bond index fund there is enough variety to serve as the core of a diversified portfolio — the division of your funds between stocks and bonds.”

If you are stuck with choosing from investment options consisting only of actively managed funds, she suggests you pick the ones in each asset class with the lowest expense ratio.

“Avoid all funds that hit you with a sales charge,” she said.

Additionally, you will want to avoid company stock, she said. Some companies encourage the purchase of company stock in 401K plans, and they may even make matching contributions in company stock.

McKnight said you should avoid purchasing company stock.

“You are already invested because you depend on your company for your paycheck. It would be a financial blow if your company went out of business and you lost your job,” she said. “Don’t compound that risk by adding company stock to your 401K plan.”

Now let’s look at IRAs.

McKnight said if you have a poor 401K plan and your employer does not make any matching contribution, you may want to consider participating in a self-directed plan such as an IRA or Roth IRA, or you can save to both.

She said you don’t have to choose between an IRA and a 401K as long as you are qualified and you heed contribution and income limits.

Be aware that there are restrictions with IRAs and Roth IRAs such as contribution and income limits.

“If you are able to participate in an employer-sponsored plan, then the deductibility of your IRA contributions will be subject to income limits,” McKnight said. If your income is too high, you cannot deduct contributions.

In 2016, your ability to deduct contributions to a traditional IRA begins to phase out if you earn more than $61,000 as a single tax filer or $98,000 if you’re part of a married couple filing jointly.

Roth IRAs do not provide a tax deduction for deposits, but allow you to withdraw money tax-free in retirement, McKnight said.

There are income eligibility limits starting at $116,000 for single taxpayers and $183,000 for married couples filing jointly. Those with earnings less than the income limits are eligible to deposit up to $5,500 into an IRA or Roth IRA in 2016. Those age 50 and older are able to deposit up to $6,500 in their account for the year.

Those above the income limits can still contribute up to the maximum to an IRA, but lose the ability to deduct the contribution, she said.

One drawback of an IRA is that it doesn’t offer the same level of creditor protection as a 401K plan, McKnight said.

Another downside of IRAs is that the onus is on you to vet investment options, she said.

“Most 401K plans offer a limited number of investment options, whereas with an IRA you are open to a much larger universe of investments,” she said. “It is your responsibility to vet and choose wisely.”

McKnight recommends you be aware of high fees and avoid higher-priced commissionable products. Your IRA may end up being more expensive than it needs to be.

Despite these restrictions, an IRA does offer more freedom of where you want your money to go, McKnight said.

Both are great tax-advantaged ways to save for retirement.

“Regularly contributing to either one is a great way to grow your investments for retirement. The more you contribute, the more your assets can compound over time,” she said. “You should strongly consider maxing out your contributions, especially if they are eligible for an employer match.”

McKnight suggests you consider the following:

1. If your employer offers a company match, then first fund your 401K up to the point where you get the maximum matching dollars.

2. Direct the next investing dollars to an IRA — a traditional IRA for upfront tax deductions or to a Roth IRA to get a tax break in retirement when you start making withdrawals.

3. After maxing out the IRA, return to your 401K plan to take advantage of the higher contribution limits and the higher current year income tax break.

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Retirement Accounts: What You Need to Understand

Finances

With mounting concerns over Social Security, and a languishing number pensions, it’s more important than ever to start investing for retirement. Tax advantaged retirement accounts offer investors the best opportunities to see their investments grow, but the accounts come with fine print. These are the things you need to know before you start investing.

What are employer sponsored retirement accounts?

Employee sponsored retirement accounts often allows you to invest pre-tax dollars in an account that grows tax-free until a person takes a distribution. In some cases, you may have access to a Roth retirement account which allows you to contribute post-tax dollars. Contributions to employer sponsored retirement accounts come directly from your paycheck.

The most common employee sponsored retirement accounts are defined contribution plans including a 401(k), 403(b), 457, and Government Thrift Savings Plan (TSP). Private sector companies operate 401(k)s, public schools and certain non-profit organizations offer 403(b)s, state and local governments offer 457 plans, and the Federal government offers a TSP. Despite the variety of names, these plans operate the same way.

According to the Bureau of Labor Statistics, 61% of people employed in the private sector had access to a retirement plan, but just 71% of eligible employees participated.

How much can I contribute? 

If you’re enrolled in a 401(k), 403(b), 457, or TSP, then you can invest up to $18,000 dollars to your employer sponsored retirement accounts per year in 2016. If you qualify for multiple employer sponsored plans, then you may invest a maximum of $18,000 across all your defined contribution plans. People over age 50 may contribute an additional $6,000 in “catch-up” contributions or $3,000 to a SIMPLE 401(k).

In addition to your contributions, some employers match contributions up to a certain percentage of an employee’s salary. Visit your human resources department to learn about your company’s plan details including whether or not they offer a match.

What are the benefits of investing in an employer sponsored retirement plan?

For employees that receive a matching contribution, investing enough to receive the full match offers unparalleled wealth building power, but even without a match, employer sponsored plans make it easy to build wealth through investing. The funds to invest come directly out of your paycheck, and the plan invests them right away.

However, there are fees associated with these accounts. Specific fees vary from plan to plan, so check your company’s fee structure to understand the details, especially if you aren’t receiving a match. If you don’t have an employer match, then it may make more sense to contribute to your own IRA in lieu of the employer-sponsored plan.

Investing in an employer sponsored means getting to defer taxes until you withdraw your investment. Selling investments in a retirement plan does not trigger a taxable event, nor does receiving dividends. These tax benefits provide an important boost for you to maximize your net worth.

In addition to tax deferred growth, low income investors qualify for a tax credit when they contribute to a retirement plan. Single filers who earn less than $41,625 or married couples who earn less than $61,500 qualify for a Saver’s Tax Credit worth 10-50% of elective contributions up to $2000 ($4000 for married filers).

What are the drawbacks to investing in an employer sponsored retirement plan?

Investing in an employer sponsored retirement plan reduces the accessibility of the invested money. The IRS punishes distributions before the age of 59 ½ with a 10% early withdrawal penalty. These penalties come on top of the income taxes that you must pay the year you take a distribution. In most cases, if you withdraw money early pay so much in penalties and increased income tax rates (during the year you take the distribution) that you would have been better off not investing in the first place.

Additionally, investing in an employee sponsored retirement plan reduces investment choices. You may not be able to find investment options that fit your investing style through their company’s plan.

Should I take a loan against my 401(k) balance?

Since money in 401(k) plans isn’t liquid, some companies allow you  to take a loan against your 401(k). These loans tend to be low interest and convenient to obtain, but the loans come with risks that traditional loans do not have. If your job is terminated, most plans offer just 60-90 days to pay off the loan balance, or the loan becomes a taxable distribution that is subject to the 10% early withdrawal penalty and income tax.

It is best to only consider a 401(k) loan for a short term liquidity need or to avoid them altogether.

What if I don’t qualify for an employer sponsored retirement plan?

If you’re an employee, and you don’t have access to an employer sponsored retirement plan you have to forgo the tax savings and other benefits associated with the accounts, but you may still qualify for an Individual Retirement Account (IRA).

However, if you pay self-employment taxes then you can create your own retirement plan. Self-employed people (including people who are both self-employed and traditionally employed) can start either a Solo 401(k) or a SEP-IRA.

A Solo 401(k) allows an elective contribution limit of 100% of self-employment income up to $18,000 (plus an additional $6000 in catch up contributions for people over age 50) plus if your self-employed, then you can contribute 20% of your operating income after deducting your elective contributions and half of your self-employment tax deductions (up to an additional $35,000).

If you qualify for both a Solo 401(k) and other employer sponsored retirement plan, then you cannot contribute more than $18,000 in elective contributions among your various plans.

A SEP-IRA allows you to contribute 25% of your self-employed operating income into a pre-tax account up to $53,000.

What are Individual Retirement Accounts?

Individual Retirement Accounts (IRAs) allow you to invest in tax advantaged accounts. Traditional IRAs allows you to deduct your investments from your income, and your investments grow tax free until they are withdrawn (at which point they are subject to income tax). You can contribute after-tax money to Roth IRAs, but investments grow tax free, and the investments are not subject to income tax when they are withdrawn in retirement. There are income restrictions on being eligible for deductions and these vary based on household income and if an employer-sponsored retirement plan is available to you (and/or your spouse).

What are the rules for contributing to an IRA?

In order to contribute to an individual retirement account, you must meet income thresholds in a given year, and you may not contribute more than you earn in a given year. The maximum contribution to an IRA is $5500 ($6500 for people over age 50).

A traditional IRA allows you to defer income taxes until you take a distribution. Single filers who earn less than $61,000 are eligible deduct one hundred percent of deductions, and single filers who earn between $61,000 and $71,00 may partially deduct the contributions. Couples who are married filing jointly may make contribute the maximum if they earn less than $98,000, and they may make partial contributions if they earn between $98,000 and $118,000.

Roth IRAs allow participants to invest after tax dollars that are not subject to taxes again. The tax free growth and distributions can be especially beneficial for those who expect to earn a high income (from investments, pensions or work) during retirement. Single filers who earn less than $117,000 can contribute the full $5,500, and those who earn between $117,000 and $132,000 can make partial contributions. Couples who are married filing jointly who earn less than $184,000 may contribute up to $5500 each to Roth IRAs, and couples who earn between $184,000 and $194,000 are eligible for partial contributions.

What are the benefits to investing in an IRA?

The primary benefits to investing in an IRA are tax related. Traditional IRAs allow you to avoid paying income taxes on your investments until you are retired. Most people fall into a lower income tax bracket in retirement than during their working years, so the tax savings can be significant.  Roth IRA contributions are subject to taxes the year they are contributed, but the IRS never taxes them again. Investments within an IRA grow tax free, and buying and selling investments within an IRA does not trigger a taxable event.

Additionally, low income investors also qualify for a tax credit when they contribute to a retirement plan. Single filers who earn less than $41,625 or married couples who earn less than $61,500 qualify for a Saver’s Tax Credit worth 10-50% of elective contributions up to $2000 ($4000 for married filers).

IRAs also allow individuals to choose any investments that fit their strategy.

What are the drawbacks to investing in an IRA? 

Investing in an IRA reduces the accessibility of money. Though it is possible to withdraw contribution money for some qualified expenses, many distributions are to be subject to a 10% early withdrawal tax penalty when a person takes a distribution before the age of 59 ½. In addition to the penalty, the IRS levies income tax on distributions the year that you take a distribution from a Traditional IRA.

Should I withdraw money from my IRA?

Taking a distribution from an IRA means less money growing for retirement, but many people use distributions from IRAs to meet medium term goals or to resolve short term financial crises. The IRS publishes a complete list of qualified exceptions to the early withdrawal penalty.

If you have to pay the penalty, withdrawing from an IRA is not likely to be the right choice. Once the money is withdrawn from an IRA it can’t be contributed again. For short term needs, taking out a loan usually comes out ahead.

What’s the smartest way to invest?

Investing between 15-20% of your gross income for 30 years often yields a reasonable retirement nest egg, but even if you can’t invest that much right now, it’s important to get started. The smartest place to invest for retirement is within a tax advantaged retirement account.

If you don’t have access to an employer sponsored plan the best place to start is by investing in an IRA. On the other hand, if you have access to both an employer sponsored plan and an IRA, the answer is not as clear. Anyone who has an employer with a matching policy should aim to invest enough to take full advantage of any matching plan that your company has in place.

After taking advantage of a match, the next best option depends on your personal situation.

Employer sponsored plans and Traditional IRAs offer immediate tax benefits that can be advantageous for high income earners. However, investing in a Roth IRA keeps money more liquid than either an employer sponsored plan or a traditional IRA.

Of course, the best possible scenario for your retirement is to maximize contributions to both an employer sponsored account and an individual retirement account, but you should carefully weigh how investing in these accounts affects your whole financial picture and not just your retirement goals.

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