Individual Retirement Accounts (IRAs)
The problems that exist today which threaten the financial security of retired Americans face the self-employed as much as they do those who work in a company. However, 401k plans are available only to those who work in a company that actually participates in the 401k program. The only real alternative is an Individual Retirement Account (IRA). Sponsored by the U.S. government, it functions in a very similar manner to a 401k Retirement Plan. However, it is available to any American with enough money to contribute, as well as being subject to a few other eligibility rules.
You can set up an IRA if you have any income at all or money that is reported on your W-2 statement. Essentially, if you worked and were paid for it you can have an IRA, and it does not matter if you were paid $100 dollars or $100 million last year. The Internal Revenue Service (IRS) allows you to contribute up to $2,000 of your earned income (or the amount you earned if it is less than $2,000) into an IRA, as long as you are under age 70s.
Types of IRAs
Keough Pension Plans
Keough Pension Plans are similar to traditional IRA’s. However, the difference between them is that Keough Plans are divided into two groups: Defined Contribution Plans and Defined Benefit Plans. These two plans allow a much greater contribution on the part of the employee.
Defined Contribution Plan:
Defined Contribution Plans allow an employee to add up to $30,000 a year, or 20% of their income into an IRA fund. However, the level of contribution cannot be changed or altered and remains constant throughout its entire duration.
Defined Benefit Plan:
Defined Benefit Plans allow a large annual contribution, but differently than Defined Contribution Plans their funds are calculated differently. Rather than setting a contribution and making it regular and constant throughout the life of the plan, a benefit goal is chosen. Contributions are then assessed, with the help of an accountant or financial professional, on a regular basis to determine what is necessary to achieve the goal and what is available to contribute.
Roth IRA’s are very similar to traditional IRA’s in that they allow for contributions from the income of an employee to fund a retirement investment. However, rather than being tax-deferred, contributions are made after taxes have been paid. This precludes pre-tax growth with more interest growing from more money, but once benefits are paid out upon retirement, no income is due on them.
Savings Incentive Match Plans for Employees (Simple) IRA’s are a way for smaller businesses to offer retirement plans to their employees in a way that they might not be able to. Very similar to 401k Retirement Plans but applying to businesses that have 100 employees or less, it allows workers to contribute tax-deferred income into a fund to be invested and developed for retirement.
If you or your spouse does not work or has an income less than $2,000, it might be difficult to provide for retirement. Spousal IRA’s allow for a retirement fund that can be paid for by an individual’s spouse should an individual not be able to afford contributions.
412i plans operate similarly to 401k plans. However, they are ideal for small businesses that seek to provide retirement funds to their employees when numbered six or fewer. Contributions are tax-deferred funds from income, and unlike 401k plans or other retirement funds, benefits can be cashed out upon retirement in a lump sum rather than being spread out in many payments.
Traditional IRAs vs. Roth IRAs
Traditional IRA’s require only that you have an income and that you are under the age of 70 and one half. Roth IRA’s demand an income of under $110,000 if you are single, and under $160,000 combined for a married couple.
The maximum contribution for both Roth and Traditional IRA’s is $2,000. If your entire income is less than $2,000, you may invest it all.
While Roth IRA’s are not tax-deductible at all, if your employer does not offer any retirement plan at all, including a 401k Retirement Plan, you may write off your Traditional IRA contributions as tax-deductible.
Tax Advantages of Contributions
The advantages of Traditional IRA’s in terms of tax benefits is that you can usually write off your payments. Also, by contributing tax-deferred money, you will have more money in your fund earlier that will grow greater interest. Roth IRA’s, while you can only contribute income that has already been taxed, will not require additional taxes when you actually withdraw your money.
While there are certain exceptions, there will be a 10% excise tax penalty against you if you remove money from your IRA of any type before age 59 and one half. If you hold your money from a Roth IRA and do not use it in any way for five years, you will not be penalized.
Traditional IRA’s require that distribution begins no later than the point a which you turn 70 and one half years old. Roth IRA’s can begin distribution any time after age 59 and one half.
By Michael Brown
Retirement planning expert and rollover IRA to gold adviser.