Saving For Retirement
Updated for Tax Years 2010-2011

The number and complexity of retirement plans can be overwhelming. Nevertheless, retirement is in the future for all of us, young or old. Recent tax law changes have made it easier than ever to plan for that inevitable day. This brief summary is a starting point for you to explore your retirement saving options. For further clarification, and if you have questions, please do not hesitate to email or call. Hopefully, I can help you decide on your best approach. Should you wish to do more of your own research, the IRS site contains a wealth of research materials.

As an added incentive, the Savers Credit (formerly known as the Retirement Savings Contributions Credit) provides a tax credit of up to $1,000 ($2,000 filing jointly) for those whose AGI is less than $27,750 ($55,500 filing jointly) and who contribute to an IRA, an eligible deferred compensation plan, or a qualified retirement plan.

In general, there are three types of retirement savings plans:

1. Individual Retirement Accounts (IRAs)
2. Employee benefit plans, such as Keogh, 401(k), SIMPLE, SEP, etc
3. Social security taxes

Individual Retirement Accounts

IRAs are the simplest and most accessible form of retirement savings plan. They are personal savings plans that you may set up and fund by the original due date of your tax return, which is usually April 15. IRAs are of two forms:

1. Traditional IRAs
2. Roth IRAs

Contributions may be made to either type of IRA provided that you have at least as much earned income as you are contributing. If contributing to a traditional IRA you must be under age 70-1/2. There is no age limit for contributing to a Roth IRA, but the amount that can be contributed starts to phase out when Adjusted Gross Income reaches $105,000 in 2010 ($107,000 in 2011). If married filing jointly, phase-outs start at $167,000 in 2010 (169,000 in 2011).

Contributions to traditional IRAs are fully deductible for those not already covered by another pension plan. If you and/or your spouse are covered by another plan at work, the deduction may be limited depending on your income. Earnings continue to grow tax-deferred until withdrawn. Qualified withdrawals are subject to tax.

Contributions to a Roth IRA cannot be deducted, but earnings accumulate tax-free and qualified withdrawals are tax-free.

The maximum contribution to either type of IRA is $5,000. Additional annual catch-up contributions of $1,000 will be allowed for taxpayers age 50 and older. Couples with a nonworking spouse can make a combined deductible contribution of up to $10,000 ($11,000 or $12,000 if one or both are over 50).

Qualified withdrawals are generally made after attaining age 59-1/2. In addition, Roth IRAs have a five-year holding period beginning with the first year of contribution. There are certain situations in which funds may be withdrawn to buy a first home or pay certain hardship expenses. Otherwise, withdrawals made before age 59-1/2 are generally subject to a 10% federal penalty (plus 2-1/2% penalty for California residents).

Distributions from traditional IRAs must start at age 701⁄2 and are subject to tax. If you turned 70 ½ in 2009, the distribution requirement is waived until 2010. Distributions from Roth IRAs have no mandatory age requirement and are not subject to tax.

You may convert an existing IRA to a Roth IRA as long as your AGI is below $100,000 in the year of conversion. The conversion distribution will be taxed, but it won’t be penalized for early withdrawal. Amounts rolled over or converted into a Roth IRA and then withdrawn within 5 years face a 10% early withdrawal tax.

New in 2010: All limits to income and filing status for converting a traditional IRA to a Roth IRA have been eliminated. For transfers occurring in 2010, taxpayers may elect to defer paying tax on the transfer by reporting half of the amount transferred on each of their 2011 and 2012 income tax returns.

Extensive information about IRAs is contained in Tax Topic 451, 428, and 309 and Publication 590, which may be viewed or downloaded from the IRS website.

Employee Benefit Plans

Company pension and profit sharing plans generally hold the plan assets of each employee (or self-employed individual) until the employee leaves the company or retires. No taxes are due until the employee receives the money, and the employer receives an immediate deduction when contributions are made to the plan. Detailed information about these plans is contained in Publication 560, which may be viewed or downloaded from the IRS website.

Some of the more common retirement plans, in order of complexity, are:

1. Simplified Employee Pension Plan (SEP)
2. Savings Incentive Matching Plan (SIMPLE)
3. Complex qualified plans: 401k, 403b, KEOGH, and others

Preserving Retirement Funds

Most retirement plans let you take vested benefits with you if you change jobs before you retire. However, unless your old employer’s retirement benefit is paid directly to your IRA or to your new employer’s plan, 20% of your funds can be withheld for federal taxes. As a result, you may not have enough cash on hand to perform a tax-free rollover of the amount withdrawn from the plan. You want to consider your options for handling retirement benefits when you change jobs.

SEP-IRAs

SEPs provide a simplified method for employers to contribute to a retirement plan for their employees, or for you to contribute to your own retirement if self-employed. The rules are very similar to those of a traditional IRA, but the maximum deductible contribution may be much greater: up to the lesser of 20% (25% for owners) of a participant’s compensation or $49,000.

SIMPLE Programs

Under a SIMPLE plan, employees can elect to make salary reduction contributions (up to $11,500) rather than receiving these amounts in their regular pay. Participants age 50 or older may make additional contributions of $2,500.

The employer must match the contribution dollar for dollar up to 3% of the employee’s compensation or make an overall 2% contribution to every eligible participant. All contributions to a SIMPLE account are fully vested immediately.

SIMPLE programs can be designed as either an IRA plan or as a simplified 401(k) plan. The difference is that 401(k) plans pool investment assets. The difference between regular and SIMPLE 401(k) plans is that the SIMPLE plans treat all employees alike and any number of employees may choose to participate or not. SIMPLEs can be adopted by companies having 100 or fewer employees.

SIMPLEs must be set up by September 30 of the year when contributions will be made. Many banks, brokerages, and mutual funds will help you set up a plan. If you prefer to do it yourself, an employer can use Form 5304-SIMPLE (if you allow each participant to pick a financial institution to handle their contributions) or 5305-SIMPLE (if you require all contributions be deposited initially at a particular financial institution) to establish plans.

Complex Qualified Plans

Rules for setting up and administering these plans are more complex that SEP and SIMPLE plans. The advantages are increased flexibility in defining plans and, in some cases, increased contribution limits. There are two basic kinds of plan: defined benefit plans and defined contribution plans. A defined contribution plan may be either a profit-sharing plan or a money purchase plan. Under a money purchase plan, contributions are based on a fixed percentage, whereas contributions under a profit-sharing plan are more flexible. Determining contributions under a defined contribution plan is the most complicated of all and is based on actuarial assumptions and computations.

Some of the more popular plans are summarized below:

401(k) & 403(b) Plans

401(k) plans are stock bonus or profit sharing plans created by employers, including tax-exempt organizations. 403(b) plans are tax-sheltered annuity plans created by educational institutions and other tax-exempt organizations. As an employee, you can make a deductible contribution of a certain percentage of your salary, which is defined by the plan, or up to the contribution dollar limit, whichever is less. The contribution dollar limit is $16,500. People 50 and older can contribute $22,000.

Some companies match a portion of employee contributions and may also make additional contributions on behalf of the employees. These company contributions may be distributed according to the plan’s vesting schedule. So, if you leave employment before you are fully vested, you may not receive all of the company’s contribution. However, you will always be 100% vested in the funds you have contributed and their earnings.

Roth 401(k) Plans

Beginning in 2006, employers with 401(k) plans may also offer the new Roth 401(k) plan. Contributions to a Roth 401(k) are made with after-tax dollars, but investment gains are tax-free, and there is no minimum annual distribution.

Keogh Plans

Keogh plans are qualified plans for self-employed individuals. A sole proprietor or partnership can set up a Keogh plan. They are of two types: profit-sharing plans or defined benefit pension plans. Participants in a profit-sharing plan may make deductible contributions up to $49,000. Contributions to a defined benefit plan must be calculated each year by an actuary.

Social Security Benefits

Will you be eligible for social security benefits when you need them? Should you delay receiving social security benefits? Should you continue working when you become eligible? Will your benefits be subject to tax?

The Social Security Administration website contains a wealth of information to help you learn all about your social security benefits. In addition, they have three online calculators to help you plan your retirement sources of income.