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Retirement Plans: Types, Contributions, and Tax Benefits

Posted by Admin Posted on Nov 20 2015

When it comes to planning for retirement, the sooner you start, the better. But many of our clients who are just beginning their retirement planning are unsure of what plans are best for them, much less the details about the different available plans, such as maximum contributions and the tax implications of those contributions. At The Jones CPA Group, we are committed to helping you prepare for your future, so we’d like to provide you with some basic information regarding the different retirement plans available.

Traditional IRA

A traditional IRA can be set up through your financial institution, life insurance company, mutual fund, or a stockbroker. Like a 401(k), this type of retirement account allows you to make pre-tax (tax-deductible) contributions towards your retirement.

A traditional IRA has a contribution limit of $5,500 or your taxable compensation for the year, whichever is less. If you’re 50 or older, your maximum allowed contribution is $6,500 or your taxable compensation for the year, whichever is less. However, you can only make contributions up to the age of 70 ½. After this point, you are no longer allowed to contribute to a traditional IRA.

Though you can withdraw money from a traditional IRA at any time, any deductible contributions you withdraw are taxable. If you are under the age of 59 ½, you may have to pay an additional 10% tax for early withdrawals, unless you qualify for an exception, which can include situations such as qualified education expenses, first-time homebuyers, or permanent disability. To find out if you qualify for an exception, speak to a financial advisor or CPA.

With a traditional IRA, you are also required to begin taking minimum distributions after you turn 70 ½. The required amount of your distribution is calculated based on your year-end IRA balance, divided by a specified distribution period. Calculators are available online, but to ensure you are taking the correct amount, you should speak to a qualified financial advisor.

Roth IRA

A Roth IRA is subject to many of the same rules as a traditional IRA, including maximum contributions. It is important to note that the maximum contribution for traditional and Roth IRAs is the total amount that you are allowed to contribute to all of your IRA accounts. So if you have both types of IRA accounts, you may only contribute a total of $5,500 ($6,500 if over 50) between both accounts.

Despite their many similarities, there are some important differences to note between the two types of IRAs. Perhaps the most notable difference is that Roth IRA contributions are not tax deductible, so they do not offer you an immediate tax break like a traditional IRA does. However, this means that you can make qualified distributions without having to pay tax on the withdrawal. Contact one of our CPAs to learn more about qualified distributions from your Roth IRA.

Another key difference with this type of IRA is that there are no required minimum distributions, and you can continue contributing to your IRA throughout your life, no matter what your age.

401(k)s

A 401(k) plan is usually established through your employer, and it allows you to make elective deferrals from your paycheck directly into your retirement account. Additionally, your employer can make their own contributions to your 401(k), and many companies offer a contribution matching plan for their employees.

Like a traditional IRA, a 401(k) allows you to deduct your elective deferrals from your taxable income, giving you a tax break for every contribution you make. Of course, that also means that any distributions received at retirement, including any earnings the account has garnered, are counted as taxable income at the time of distribution.

Just as IRAs have contribution limits, 401(k)s do as well. The limit on employee elective deferrals is $18,000 for 2015 and 2016; this may be increased in future years to account for cost of living. There is also a limit placed on the total contributions made to your plan, including your elective deferrals and your employer’s contributions; we can help you figure out the limits on your accounts. 401(k)s also permit catch-up contributions; for 2015 and 2016, you can contribute an additional $6,000 into your 401(k) if you are over 50.

You are required to begin receiving distributions from your 401(k) either after you turn 70 ½, or after you retire, whichever is later. However, you are allowed to begin receiving your distributions at the age of 59 1/2, and you may receive your payments either as a lump sum of your full 401(k) balance, or as periodic distributions throughout your life.

Choosing the right retirement plan and maximizing the financial and tax benefits of these plans is a complex matter. It is not something you should attempt to puzzle out on your own. If you need help planning for your retirement or want to learn more about using your retirement accounts for tax-deduction purposes, contact our CPA firm in Orem.