Today is the best day to start planning and saving for the rest of your life. The 401(k) is a wonderful savings plan if offered by your employer because the money goes directly into your retirement account. Not only is the money tax deferred when placed direct into your retirement account, but the interest earned in your retirement account is also tax deferred, which means that you do not pay annual taxes on the growing account value. Changes in the tax law have allowed new types of qualified retirement plans with subtle but important differences.
The 401(k) allows you to avoid paying income tax on the amount that you contribute directly to your retirement plan. Once you retire, the amount that you withdraw from the retirement plan in considered taxable income at the time that you withdraw it from your plan. In essence, you avoid paying tax on the deferred income and interest until you take the money out of your retirement savings plan to use it during your retirement. Some retirement plans have provisions that allow the individual to borrow against the savings reserve under certain circumstances, like paying for a college tuition. The provisions that allow for borrowing against the reserve typically also have interest rates and payment plans to return the funds into the retirement plan. If you take the money out of the plan prematurely, then substantial penalties are applied.
The new Roth 403(b), also called the Roth 401(k), does not allow you to avoid paying income tax on the amount that you contribute to your retirement plan. However, once you retire, the amount that you withdraw from the retirement plan is not treated as taxable income. The maximum yearly contribution for a Roth 401(k) is $15,000 for individuals under 50 years of age, and $20,000 for individuals 50 years old and older. There are no limits to participation based on individual Adjusted Growth Income.
The Roth IRA has been around for more than a decade and can be started by any individual. It does not require an employer contribution. However, there are limitations that apply to the Roth IRA. A person may not contribute to a Roth IRA if the personal Adjusted Growth Income (AIG) exceeds $110k per year, or $160k for couples filing jointly. Furthermore, the maximum yearly amount for contribution is $4,000 for individuals under 50 years of age, and $5,000 for individuals 50 years old and older.
In addition to 401(k), Roth 401(k) and Roth IRA, there are many other alternatives for building a nest egg for a comfortable retirement. Many employers offer retirement investment plans and may even provide a matching contribution. If your employer matches your contribution, this is an easy way to earn extra income that goes directly into your retirement savings. If you can afford this deduction from your paycheck, find out the maximum matching contribution from your employer and treat that extra percent in your savings as if it were a deferred bonus.
If your employer does not offer a retirement plan or matching contributions, or if you need to rollover your retirement plan due to a change in jobs, there are also alternatives available from banking institutions and life insurance carriers. For example, some packages offer to match S&P 500 increases on a yearly basis and provide protection in the event that the market declines. With this type of plan, if the stock market increases substantially, so does your retirement, without risk of going down. Typically the plans with the greatest potential reward also have the greatest risk, so review your options with consideration to the amount of time that you have remaining until you will be considering retirement. As you get closer to retirement age you probably want to minimize your risk.
"Income tax returns are the most imaginative fiction being written today." - Herman Wouk
"The income tax has made liars out of more Americans than golf." - Will Rogers
"The government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it." - Ronald Reagan
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The good news about the Internet is the information we can get our cursors on instantly; the bad news is the information we can get our heads around instantly, but without any way of gauging accuracy, relevance, or completeness. This is particularly evident in the financial-investment-retirement world, where thousands of websites tell us how to do things and why, and why things work the way they do and how.
Few gurus explain why and how certain concepts and plans of action just may not work the way they are supposed to. You don't need to read very far before the fingernail-screeching 401(k) chalkboard becomes deafening.
For example, do they provide: 1) free money from employers, 2) lower taxable income, 3) retirement without any worries about money, or are they, 4) one of the most popular retirement plans.
The inadequacies I'm talking about may seem nit-picky at first blush, but the misconceptions and invalid expectations they nurture in inexperienced investors are mind blowing.
Employers are providing a valuable benefit in the form of a defined contribution savings plan, a self-directed investment program that has little in common with defined benefit retirement and pension plans. It's not free money at all. It's a clever, goal-directed, business expense that is both touchy-feely visible to you and far less expensive for your boss. It's a good deal, but not a retirement plan.
Although it is true that you do not pay taxes on your contributions during your earning years, you will undoubtedly pay through both nostrils when you retire. If your karma is off, you may find yourself trying to retire at a time when the stock market is not in a party mood and your shrinking mutual funds just don't seem as secure as you thought they were a few months earlier. Typically, the 65-year-old retiree can expect four or five major mutual fund shrinkages during retirement.
Similarly, more fortunate retirees (those who get the "gelt" during a rally) generally fail to lock in a guaranteed stream of income, and find themselves in the same cyclical conundrum as their less market-timely brethren. The money worries continue well after retirement; the taxes become much larger than anyone ever anticipates; the misconception that the 401(k) is a retirement plan continues. In fact, a recent president once proposed to change the only true retirement program that most of us belong to into a similar non-retirement program.
No, this isn't just semantics. The differences between retirement programs and savings programs are very real, extremely fundamental, and politically incomprehensible to legislators--- so long as it's not their money.
Retirement programs are income machines designed to support people, not to make them feel wealthy, investment savvy, or temporarily tax-free. Pension plans produce fixed amounts of monthly income that don't change appreciably when dot-coms, real estate, CDOs, or index funds (they're next) self-destruct. You just can't buy dinner or medications with currency futures, gold bars, or appreciated acreage.
The investments contained in a pension plan are designed to produce income, and are managed by trustees who are experienced in constructing safe, conservative, diversified programs that are just as boring as they can possibly be. Most pension plan benefits are calculated as a percentage of the amount earned while employed.
The Social Security retirement/welfare plan is a tontinesque Ponzi scheme based on the government's ability to continually abuse taxpayers. There are no investments at all, and no trustees... just IOUs.
Defined benefit pension programs are rapidly becoming extinct--- corporate America can no longer afford them, along with 50% of total Social Security contributions, employee health care, and CEOs who collect $50 million per year from their unwary shareholders. But those that have survived (notably, labor union plans, retirement annuity contracts, and the Congressional Pension System) produce monthly income checks without any problems whatsoever.
And here we thought our congressional leaders were incompetent--- not when it comes to their own benefit package + COLAs.
Still, the 401(k) plan deserves to be every bit as popular as it has become. It, and the vast array of complicated IRAs, could help save Social Security, improve the economy, and create jobs--- all those good things that neither of the presidential candidates have a chance of achieving. Just two simple strokes of an Oval Office ballpoint get it done: 1) Eliminate all taxes of any kind, at any jurisdictional level, on any form of investment and/or retirement income. 2) Replace the failing Social Security system with a private pension system, funded by taxpayers only and managed by the existing insurance industry infrastructure.
How do we make the 401(k) plan provide more retirement security? That's not so difficult either. Simply dictate that all plans require participants to invest at least 60% of their assets in individual (plain vanilla) income securities that can be withdrawn "in kind" at retirement.
Until that happens, we just have to educate people better and make the appropriate distinctions between an as-speculative-as-you-care-to-make-it savings and investment plan and a pretty-much-guaranteed retirement or pension plan. Existing 401(k) participants should contribute enough to get the matching contribution, and start a personal tax-free income account with whatever disposable income is left.
Now about that Congressional Pension Plan--- we've only our apathetic selves to blame.
Both John Mehrmann & Steve Selengut are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
John Mehrmann has sinced written about articles on various topics from Finances, Tax and Software. John Mehrmann is a freelance author, industry expert and President of Executive Blueprints Inc, an organization dedicated to developing human capital and personal growth.. John Mehrmann's top article generates over 49500 views. Bookmark John Mehrmann to your Favourites.