Month: November 2006

IRA or the Individual Retirement Account provides double benefits to the customer. In the first instance it provides Compound Interest and the additional benefit is that there is no tax on this income. This mode of saving is really good if you have the money and can afford to keep it in the account for a longer period. The benefit of compound interest, without the additional burden of tax on this amount, is a powerful incentive to contribute in the Individual Retirement Account or IRA as it is commonly known.

 

The IRA account is for everyone who looks forward to some relaxation and enjoyment. At being able to do the things during their twilight years which they could not do during their earning years; things like, going on a cruise, spending some romantic moments with your loved ones,  in a place which you long dreamed off, playing golf or buying gifts for your near and dear ones. IRA contributions definitely play an important part in helping you to fulfil your long cherished dreams.

 

Then there is the Simple IRA Plan which is for employers employing one hundred or less workers. Here, the employee contributes a percentage from each salary cheque and the employer matches the amount with the company’s contribution up to three percent or makes a fixed contribution of two percent to each employee plan. The contribution of every eligible employee is deducted from his/her payroll. The amount so deducted is then contributed to the Simple IRA plan of the employee including the employer’s contribution which is then placed with a financial institution. The financial institution can be chosen by the employee or the employer. The employer can also choose to maintain the Simple IRA investments of all the eligible employees in a single financial institution. The Simple IRA plan is also beneficial because it involves minimum paper work and saves administrative costs.

 

Therefore this is one plan that has. : a) Salary reduction facility (the contributions to Simple IRA are directly deducted from the salary)         b) Little or no administrative costs involved for maintaining the Plan. c) Can be started by any employer who does not presently maintain any IRA related accounts and has on his payroll less than 100 workers e) the facility where the employee can not only decide how and where to invest the money but also can transfer his/her Simple IRA plan if and when he/she leaves the present workplace and joins another organisation.

 

If you are an eligible employee and are about to contribute to any of the IRA plans, it helps to know some of the terms and what they mean to any IRA account holder. Most IRA plans have Annual Contribution Limits which simply means that there is a limit to your annual contribution to your IRA account. Then there are the Withdrawals or Distributions which relate to the amounts withdrawn from the account. These amounts generally consist of your additional contributions or earnings in the IRA account.  The Simple IRA account helps you to take that first step, which of course is a step in the right direction.

The Simplified Employee Pension or SEP is a retirement plan meant to encourage savings for a secure and relaxed life after retirement. The SEP though different in structure, serves the same purpose as the Individual Retirement Account (IRA). The SEP is designed for persons who are self-employed, sole proprietors, independent contractors, partnership or owner-employees of an incorporated business or trade. This plan can be applicable to any business. SEP is easy to provide, plan and execute without having to incur a lot of expense and is does not involve any complex administration work like many of the qualified retirement plans. SEP, in fact, can be established only in case of the employer having no other qualified retirement plan in force at the time.

 

The contributions from the employer to the Simplified Employee Pension or SEP are made at the employer’s discretion. These contributions should amount to $30,000 or 15% whichever is less and are must be deposited in the IRA account established in each and every eligible employee’s name. This is the reason why the arrangement is known as a SEP – IRA.  The employee now has the right to use the funds as these contributions are now owned by him or her. These funds can now be transferred or withdrawn by the employee at any time at his discretion. However as the SEP accounts are IRAs they are subject to all existing IRA rules and regulations governing the withdrawal, transfer and taxation.

 

In the traditional IRAs money can be withdrawn at any time but the withdrawals, either part or whole, will be taxed at the prevailing income tax rates. These withdrawals may also be penalized. If the withdrawals are made before attaining the age of 59 1/2 years they may attract an excise duty of 10% in addition to the income tax.  However, there are exceptions where the 10% penalty does not apply to IRA withdrawals. Those are:  A) the withdrawals made in case of the IRA owners death.   B) Due to the owners disability.     C) Medical expenses that are not reimbursed and which exceed 7 1/2% of adjusted gross income (AGI).   D)  “Substantially equal periodic payments” that are made over the life expectancy of the owner.   E) Payments made as costs of first time home purchase. These of course, are subject to a limit of $10,000.  F) Payments made as medical insurance premiums. This exception is only applicable to persons who have received unemployment compensations for over 12 weeks.  G) Payments made as back taxes in case of a levy placed against the IRA by the Internal Revenue Service and  H) Qualified expenses incurred for higher education for the IRA owner or the eligible members of the family.

 

It is compulsory in case of traditional IRAs, for the distributions to begin before the owner reaches the age of 70 1/2. In case the minimum required distributions are not made before this period, the balance undistributed amount will attract an excise tax of 50%. This however is not applicable to Roth (IRAs) as this IRA plan does not have any mandatory distribution requirement.

The Roth 401(k) plan is a combination of Roth IRAs and the traditional 401(k) plan. Commonly known as Roth 401(k) the plan also differs in some respect from the originals. The employer can offer the Roth 401(k) as well as the traditional plan 401(k) and the employee can contribute to both the plans but the total combined contributions to both plans are limited and should not exceed the limits set by the Internal Revenue Service for individual plans. For 2006 the limit set by the IRS is $ 15000 ($ 20,000 in case the employee is 50 years or older). However once you have decided to take part in both plans the decision will have to be final because you will not be able to switch money from one plan to another. But you have the option of choosing the amount that you want to contribute to each of your accounts. The Roth 401(k) provides you the roll over option to Roth IRA in case you move to another organisation. 

 

The employer is also entitled to provide a matching contribution to the Roth 401(k) plan and in case he does then two accounts have to be set up. One will contain the employee’s contribution which is deposited after deducting the relevant tax. The withdrawals from this account will be tax free. The second account will be the employer’s account where the deposit is made without any tax deduction. The withdrawals from this account are liable for tax deduction. These include the growth of investment over the period of time.

 

The some of the differences between the two plans Roth (k) and traditional 401(k) are: – a) the contributions by the employees to Roth 401(k), are made after deducting the taxes while in the traditional 401(k) plan the contributions are made pre-tax deductions   b) there is no further tax on the investment growth while growth in traditional 401 (k) plan is taxed only after withdrawal   c) the withdrawals of contributions and growth are tax free provided the account is held for at least 5 years and you are 59 1/2 years or older whereas in the traditional 401 (k) plan taxes are deducted by Federal and most State authorities on  withdrawals and investment growth.

 

You can make contributions to both Roth 401 (k) and the traditional pre-tax 401 (k) accounts in the same year but within the prescribed limits stated above. The catch-up contributions permitted in the Roth accounts for 50 years or older persons are also allowed in Roth 401 (k) plan.  

 

In case reporting or record keeping, you are not obliged to either report or keep a record as far as designated Roth contributions are concerned. However, if you are rolling over your account from Roth 401(k) to Roth IRA you are required to keep track of the account as per the instructions on form 8606.

A longer healthier life translates inevitably into additional years in retirement. This is the phase of life for which you have to provide income if you are to relax and enjoy these twilight years of your life.  The Social Security provisions are not enough to live the comfortable life which you were used to during your working years. You need something more and that’s where Plan 401(k) comes in. This is the powerful retirement tool that can provide you with that extra income.

 

The Plan is similar to the IRA account which is also, basically a retirement savings plan. However, Plan 401(k) is employer initiated and usually funded with your pre-tax salary contributions and also at times with equal employer contribution.  All contributions and growth of funds under Plan 401(k) are not taxed but any of the amounts once withdrawn is taxable according to prevalent tax laws.   However, withdrawals cannot be effected before the age of 59 1/2 years unless under special circumstances. The employers have now started to include some special loan provisions for withdrawals in this Plan.

 

Your contribution to this account is limited to some percentage of your pre-tax salary. This year it is $ 15,000 which is the maximum amount allowed legally. This limit may increase or decrease depending on further IRS notifications. However, if you are 50 years or older you are allowed to contribute additional amounts, which will be over and above your regular contribution, to make-up for earlier years. But you need not wait to be 50 years old to be eligible to join the Plan. You are eligible, if you are 21 years of age and an employee of an organisation that offers this Plan to its employees. But at the same time you have to be an employee of the company for a period of time not exceeding one year.

 

As for the employer’s contribution, it varies from employer to employer. There are those who contribute 25 to 50 per cent of your own contribution. That too is limited to some extent. At the same time under Plan 401(k), you will not be able to withdraw the company’s share of the contribution unless you have worked in the organisation for a sufficient or specified number of years.

 

The investments which you make for your funds in Plan 401(k) should be selected carefully. One of he reasons for this is that 401(k) options are not federally insured and any mistake is liable to prove costly. A good and planned investment strategy will definitely help to add growth to your existing investments.  All help, professional or otherwise should be taken and will prove beneficial to you.

 

In case you have the time, about 12 to 15 years, invest in the stock mutual funds. These are generally better performers in the long run. Stock mutual funds many a time give far better results than other options. One of the reasons for selecting this option is that Plan 401(k) does not allow frequent transfer of funds from one option to another. However, in case you leave your present employment, Plan 401(k) allows you to transfer your investment your new employer provided the transfer goes directly from your present employer to your new employer without any withdrawal.

Education IRA is a popular savings plan for all those aspiring to study in future. It provides an appreciable coverage of various education expenses including tuition fees, lodging, supplies cost and any other special costs involved during the course of education.

However, over the last few years many alternative options have developed. One of them is the Education Plan 529 Savings Plan offered by the Education Trust Board of New Mexico. This Plan 529 is available to all US residents. There are some very critical distinguishing features in Plan 529 Savings Account which gives it an edge over the Coverdell Education Savings Plan. Coverdell Education Savings Account (CESA) was formerly known as Education IRA.

The biggest distinguishing point is the limit of contribution. Maximum contributions to an Education IRA plan are $2,000 per year subject to income limits. However, contributions to 529 education plan could be a staggering $300,000 subject to income limits. If you have a plan of doing a post-graduation program at any university, then the expenses, including tuition fees, lodging, supplies, will be a minimum of $50,000. Now compare this to the paltry contribution of $2000 a year allowed in Education IRA. Obvious, you can’t meet all your education expenses with just the Education IRA account.

There are also notable differences when it comes to ownership of the account. The contribution donor has a control of the Education IRA account. However, in case of Plan 529, the account owner has the control on the account. As far as tax on the account earnings is concerned, both the plans have identical treatment. Earnings, for both the account, are tax free. The same applies to the Gift Tax parameter. If you are filing status is Single, then upto $12,000 contribution there is no gift tax. If the filing status is Joint, the limit is $24,000. The above is true for both Education IRA/CESA and Plan 529. However, there is a slight advantage in case of Plan 529. You can make a lump sum contribution of $60,000 (for Single filers) or $120,000 (for Joint filers) which covers five years of contribution. If unfortunately, the account owner dies within the 5 years then the contribution will be apportioned for the remaining term. The same may then be liable to federal and state tax.

 

You can also change beneficiary in both the plans anytime. The tax implications on the new beneficiary are also same for both the plans. One of the biggest drawbacks of Education IRA plan is the age limit for using the funds accumulated in your account. Education IRA funds can be used for education purpose only till the age of 30. The same limitation is not present in Plan 529.

FDIC Insurance is also an important factor to consider. Education IRA is FDIC insured but Plan 529 is not. Also the plan invests money in mutual funds and hence value can depreciate.
Education is critical to one’s success and hence the account for it. A wise selection can not only make you highly educated but also bring a lifetime happiness.

401(K) plan is one of the most critical financial instrument for any individual in US. Hence, its very important to know about the benefits and risks involved in the plan.

This plan was initially meant for the executives but it was the workers who popularised it as they found the yearly contribution limits to be higher than the limits provided to them in the Individual Retirement Account (IRA). Moreover Plan 401(k) also included a matching contribution from the employer. There is more flexibility in this plan than in the Individual Retirement Arrangement (IRA). One can also avail of loans and if required, offer the employer’s stock as an investment alternative.

The 401(k) Plan, unlike other retirement plans, allows the employees to operate their own accounts. It allows them to select the areas of investment and make suitable investments which they feel will provide them with better returns. They have a choice and can seek or reject proposals on their own terms and the investments can be made in professionally managed funds with no minimum requirements however sometimes you find that some of the retail financial service providers do have minimum investment requirements. If you have a Plan 401(k) account you can start by investing small amounts at a time. As your contributions are deducted directly from the salary the loss from the pay packet is hardly missed as you never get to see the money at the time anyway.

The contributions into this account are made from your salary amounts available before tax can be deducted. This means you save on tax until you withdraw money from your account and withdrawals are generally made after retirement. Even here there is a tax saving because the tax bracket after retirement is much lower. Therefore, the amount deducted on your withdrawals will be lesser than it would be during your working period. The result, you have more money working for you under Plan 401(k) and the growth would be that much faster.

The employer’s contribution too helps as you will have a larger fund working for you. To give an example, suppose your employer contributes 50% of your contribution then for every $ 100 that you contribute; your employer will add another $50. You get instant benefit from this facility under this plan.

You might be tempted to use funds from the employer’s contribution under Plan 401(k) to pay the down payment on your dream house. Though sometimes you are allowed to withdraw from the Plan because of hardship, you will have to pay taxes and penalties on the amount withdrawn and that too must be paid in the same year. Even if you borrow the money from the plan account you have to pay the interest which goes back into your account. The risk here is that in case you leave your job or might just lose it then you have to pay the loan in full, that too within a short period of time. In case you do not pay or are not able to in that short period then this loan is considered as withdrawal and you have to pay tax as well as penalties. At the same time you lose compound interest and overall your account becomes much smaller. Hardship withdrawal is always risky and best avoided.

The actual benefits and risk vary from person to person. However, a honest introspection of your financial position, will make the plan most beneficiary to you.

Basics of Roth IRA

The Individual Retirement Arrangement (IRA) or what is generally known as the Individual Retirement Account is the personal retirement savings plan of an individual, with taxable income that includes salaries, wages, tips, fees, bonuses, commissions, taxable alimony and separate maintenance payments. The Roth IRA is also an Individual Retirement Account which provides growth without you, the account holder, having to pay any taxes.

The Roth IRA account provides you with better tax facilities which are simple and effective. This is because all your contributions into this account have already been taxed. It also means that you have to pay all your taxes before making any contribution to Roth IRA. Once this is done and the money is invested in your Roth IRA account you have not to pay any taxes on any withdrawals and there is no need for these withdrawals to be reported at any time. Your gross adjusted income (AGI) during retirement thus remains unaffected. However, the only drawback of this account is that you might have to pay a higher tax, as it is paid during your working period rather than after your retirement.

This account can be opened through any provider who provides normal investment accounts including stockbrokers and mutual funds. In case you meet the criteria in a given year for opening a Roth IRA account, you will have to do so by the following April 15. The eligibility criteria are of course based on your age but your income level and filing status. There is no compulsory requirement for distribution.

It is an account created basically for working people so that they can save for their retirement. Here, the contributions have to be made from salary and not from any other source of income. Therefore lazy kids and wealthy people generally do not make the grade. However, the limits and rules change every year.

There are some withdrawals in Roth IRA such as:

a) The withdrawals made to your beneficiary or to your estate agent after your death

b) The one made on or after you become 59 1/2 years old

c) When according to the IRS code, you become disabled

d) if used to pay qualified first time home buyer expense.

If the withdrawals are made for any one of the above mentioned purposed and within the five year tax period the distribution (that is the withdrawals made from additional contributions, earnings or conversions) will not be qualified for tax exemption. The qualified withdrawals are those which are previously taxed before the contribution stage and are made after the five year tax period. The tax year will begin on the day when the tax payer first contributed to the Roth IRA.

The tax breaks in Roth IRA is different in as much as in Roth IRA the savings are tax exempt while in others the tax is deferred and has to be paid at a later date. The difference is that while the traditional IRA allows you to increase your wealth like Roth IRA, it also makes you pay for the profits at a later date which is what the Roth IRA does not do. It is better to pay the government while working than after your retirement.

As the name suggests, Traditional IRA is one of the oldest Individual Retirement Account in United States. IRA accounts are primarily savings account; the benefits of which are reaped in one’s old age. IRA accounts are used to accumulate money with a government sponsored agency or some other reliable private agency. For example you can open a Traditional IRA account with a bank. The bank may allow you to invest your IRA account contributions in instruments like bonds and CDs (Certificate of Deposit). Thus your contribution will start earning interest thereby adding a sizeable amount to your savings. Similarly, if you open a Traditional IRA account with a brokerage firm, then you can invest into securities, equity funds, debt funds, etc.

One of the main advantages of a Traditional IRA is its tax free contributions. This means that as far as the money lies in your Traditional IRA account, it will not attract tax. This includes your contributions to the account. Since you can invest your contributions into fixed and variable return instruments, you are bound to mostly make some income on your investment. Even these additions to the account are not taxable.

However, the catch lies in withdrawal. All withdrawals from a Traditional IRA account are tax liable. Applicable federal tax rates apply when you withdraw money. This is exact opposite to a Roth IRA where contributions are tax liable but not any withdrawals.

Contributions to a Traditional IRA account are limited. For example, if you are 50 or above the age of 50, then for the year 2006 you can maximum add $5,000 to a Traditional IRA account. So say, if the federal tax rate applicable to you is @15% then you will save a tax of $750. However, if you are below the age of 49, then maximum contribution for 2006 is $4,000. At rate of 15%, you will then save only $600.

Another major rider to Traditional type of IRA account is the income limits. On an approximate scale, if your gross income exceeds $80,000, then all your contributions are taxable. That means you loose the biggest advantage of Traditional IRA account. On the other hand, if your gross income is approximately below $40,000, then your entire contributions for the year (provided they are below the maximum contribution allowed) are tax free. The exact gross income threshold limits depends upon how you file your income tax return. Singles have least income threshold and if you file “Married filing jointly” or similar, then income thresholds are higher.

So which IRA account is best for you? The answer lies in your foresight. If you think, that you will retire from professional life and your income will be very less in your old days, then Traditional IRA can be a good pick. But remember that, after age of 70 and a half, you cannot take or continue a Traditional IRA. A thoughtful selection can prove to be a big help at the time when you need it most.

No wonder how healthy we might be but we all realize that one day we will grow old. Hence, we all know that we should plan our retirement such that we have sufficient money to support ourselves and our family in those last 2-3 decades of life. Most of us invest money in retirement plans like IRA. However, though there could be many common things among us there are also major differences in our income and lifestyle. Hence, an IRA which might be good for someone may not be the best fit for you. This article compares two of the most popular IRA plans; Traditional IRA and Roth IRA.

Age Eligibility

Traditional IRA can be taken by people only below the age of 70 and half years. So if you have already crossed this age threshold, then you should stop thinking of taking a Traditional IRA plan. Roth IRA however has no age limits.

Compensation criteria

In both Traditional and Roth IRA, to apply for one, you should be getting compensation. While calculating compensation, you can also include compensation received by your non-working spouse.

Contribution rule

Both the plans have similar rules pertaining to Contributions. In both your contributions, including that of your non-working spouse cannot exceed your combined compensation.

Income limits

Traditional IRA has no income limits. However, in Roth IRA for individual filers, income limit is set to $95,000. If you are filing jointly, then the combined income limit is $150,000.

Contribution limits

$4,000 or 100% of compensation (whichever is less) per person per year is the contribution limit in both the plans. If you are above the age of 50, then there is a provision of “catch – up’ that you can use to increase your contributions. Under this provision, you can make limited additional contribution. This “catch up” contribution is set as $1000 for 2006.

Tax Advantage & Disadvantage

In traditional IRA, you Contributions can be tax deductible. That means you can deduct the contribution from your taxable income and hence save tax. However, in case of Roth IRA, contribution is not tax deductible. But the growth of the corpus is not tax free in Traditional IRA. And it is tax free growth in Roth IRA.

Withdrawals

In Roth IRA, you can withdraw money anytime during the plan tenure. This is a great advantage as you get great assurance against future financial uncertainties. You can also withdraw anytime from a Traditional IRA. However, if the withdrawal is made before the age of 59 and half, you have to pay penalty. Penalty can be avoided only under circumstances. For example, if you are buying a house for the first time and if you satisfy certain other conditions, then you can escape getting penalized. Similarly, if you have to spend high on medical services or educational services, then you can do a penalty free withdrawal from your Traditional IRA. However, in this case your medical expense should be more then 7.5% of your annual income. There are a few more such clauses.

Both the IRA plans has their unique pros and cons. You would need to do an honest introspection and decide which plan to opt for. A wise choice can prove to be your backbone for the future.

IRA or the Individual Retirement Account provides double benefits to the customer. In the first instance it provides Compound Interest and the additional benefit is that there is no tax on this income. This mode of saving is really good if you have the money and can afford to keep it in the account for a longer period. The benefit of compound interest, without the additional burden of tax on this amount, is a powerful incentive to contribute in the Individual Retirement Account or IRA as it is commonly known.

It is better to know some of the terms and what they mean to you as an Individual Retirement Account holder.

1. Annual Contribution Limits.

There are limits to the amount of money that you can contribute annually in any type of IRA. Roth IRA limits the contributions to a maximum yearly amount which excludes the traditional IRA contributions of the taxpayer. However contributions in education IRA can be made in addition to the annual limits that are imposed on the traditional as well as Roth IRA contributors.

2. Adjusted Gross Income or AGI.

It relates to the entire amount you collected or your total income minus the adjustments made towards moving expenses, deductible retirement plan contributions and any other expense which has been paid through this account.

3. Contributions.

The term does not refer to your original contribution to the IRA account. This is also not a reference to the money, usually called the principal amount that you deposit into your account. It is the ‘conversions’ to the Roth IRA that are termed by the IRS as ‘qualified rollover contributions’. These amounts are treated as additional contributions when IRS regulations are applied. The distribution rules for ‘qualified rollover contributions’ however differ from those of regular contributions.

4. Distributions or Withdrawals.

The term refers to the amount taken from your IRA account. Distributions usually consist of additional contributions, earnings or conversions.

5. Education IRA (EIRA) refers to the account created to help fund education. It has since been renamed as Coverdell Education Savings Account.

6. Group IRA or Employer and Employee Association Trust Account. This refers to the IRA account set up by employers, employee associations for members and unions.

7. Individual Retirement Annuity.

This refers to the IRA account set up with the participation of a life insurance company by having a special annuity contract.

8. Inherited IRA

Inherited IRA refers to the deceased IRA holder’s account which in the absence of a spouse, benefits some other individual. Here the contributors are not allowed a tax deduction according to the Internal Revenue Code.

9. Rollover (Conduit) IRA

This refers to the account operated to get distribution from a defined contribution, benefit or retirement plan. These distributions are not bound by any contribution limits.

10. Individual Retirement Account

This refers to an account with a broker, mutual fund or bank where the contributions can be invested in various types of securities such as bonds, stocks and the money market.