In 1935, after bank
failures and the stock market crash of 1929 had destroyed the
savings of millions, Americans turned to their government to
guarantee the nation's workers would not face retirement in
poverty. The solution was Social Security.
Today, with the Baby Boom
generation approaching retirement age, Social Security faces a
dilemma. By about 2012, the Social Security system will be
paying out more in retirement benefits than it takes in from
worker's payroll taxes.
Even if the Social
Security system continues to operate at the present level,
benefit payments may provide only about 18% of retirement
income. At the same time, many people believe you will need
between 70% to 80% of your current annual income to maintain
your lifestyle when you retire.
Here are a number of
tax-advantaged ways to improve your retirement situation.
For the Individual
Traditional IRA -
One of the best ways to save for your retirement is with an IRA
(Individual Retirement Account). An IRA offers the ability to
put away up to $2,000 of compensation annually. With a
traditional IRA, your earnings grow tax deferred so your assets
have the potential to grow faster. Full or partial tax
deductions are still available for many people.
Roth IRAs are
funded with after-tax dollars. As with the traditional IRA, you
may contribute up to $2,000 a year. You may contribute $2,000
total to a traditional IRA, Roth IRA or both. To be eligible to
contribute the full $2,000, you must be a single tax filer with
an adjusted gross income below $95,000 or a married couple who
files a joint tax return and has a joint income of less than
$150,000. Earnings are not taxed as they accrue and
distributions are tax-free, as long as you have had the account
for at least five years and meet restrictions governing
Annuities - A
tax-deferred annuity - fixed or variable - is a contractual
agreement between an investor and an insurance company. The
investor makes a deposit of funds and earnings have the
potential to grow within the contract on a tax-deferred basis.
Remember, variable annuities are sold by prospectus which
contain more information about changes and expenses. Be sure you
read the prospectus and soundinvesting.org's
annuity section before you invest.
For the Workplace
401(k)s are a type
of retirement plan named for a section of the tax law that
allows employees to contribute a portion of their pay, in
pre-tax dollars, to a company-sponsored retirement plan. In a
401(k) plan, the participant chooses to contribute to the plan
and the employer may or may not make matching contributions. A
similar type of plan, the 403(b), is available through
Pension or SEP IRAs provide business owners with an easy
flexible alternative to traditional pension plans. Only the
business owner contributes and contributions can be made up to
fifteen percent of the employee's salary or $24,000, whichever
is less. These contributions are tax deductible to the business.
resemble traditional 401(k)s. They are available only to
businesses with fewer than 100 employees. The SIMPLE allows
employees to defer up to $6,000 of their pay pre-tax into a
retirement account. Employers must also contribute but they have
a choice as to how they do so. One way for an employer is to
match the contributions of only those employees who contribute
up to three percent of pay (which may be reduced to 1% in two
out of every five years). There would be no match for
non-contributing employees. The alternative to this is for an
employer to contribute for all employees, whether or not the
employees contribute. Under this alternative, the employer
profit-sharing plans offer business owners more control over
how much they contribute. Business owners make contributions and
can change them annually. The maximum contribution is fifteen
percent of eligible payroll with an individual limit of $24,000
per employee. A variety of contribution formulas are available
to customize qualified profit-sharing plans, as with all plans
seek a tax specialist in determining the best plan for your
Money purchase pension
plans are often paired with profit sharing plans. They are
funded by mandatory employer contributions only, based on a
fixed percentage of the employees' pay (up to 25% annually),
within IRS limits.
pensions are funded by mandatory employer contributions
which are calculated actuarially, based on the desired annual
retirement income. Because contributions can be significantly
higher than limits in other types of plans, these plans are
popular with business owners who are nearing retirement.
How to allocate your
- First, put the
maximum amount allowable into any account in which your
deposits will be matched. If your employer matches your
contribution dollar for dollar, your investment has already
earned a 100% return!
- If eligible, the
next $2,000 should be put into a Roth IRA.
- Next, if you are not
eligible for a Roth IRA, contribute the maximum to your
- Finally, consider
using any additional funds for a tax-deferred annuity.
If there is one hard and
fast rule about saving for a comfortable retirement, it's this:
start early. And if you haven't started early, start now. If you
are an employee, many retirement plans have hidden or internal
charges and it is critical to have an independent analysis of
your total cost before you establish a plan, and even with
IRA's which have been limited to a $2,000 maximum annual
contribution per individual since inception, will now permit
larger contributions incresing from $3,000 in 2002 to $4,000
in 2005 and $5,000 in 2008. Additionally, there is now a
provision to index the contribution limits to the annual
Cost of Living Adjustments allowing for further increases
post-2008 in $500 increments. These changes apply to both
Traditional and Roth IRA's.
The maximum amount that a 401(k), 403(b) or Salary Reduction
SEP plan participant can defer out of salary to the plan
(currently $10,500 for 2001) will also increase in $1,000
increments until 2006 at $15,500, at which point the
increases will be based on Cost of Living Adjustments.
The Education IRA annual contribution limit increases from
$500 to $2,000.
The amount of eligible compensation taken into account for
determining contributions to Tax Qualified Retirment Plans
and SEP IRA's has been increased from $170,000 to $200,000.
This will affect Profit Sharing, 401(k), and Money Purchase
Pension plan participants, among others.
SIMPLE IRA and SIMPLE 401(k) participants will be able to
increase elective deferrals (currently capped at $6,500) in
$500 increments until 2005 at $10,000.
Individuals over the age of 50 will permitted to make
catch-up contributions to IRA's, 401(k), 403(b), 457 and
IRA Contribution Limits
||Current IRA contribution limit is
|2008 and beyond
$5,000, indexed in
IRA Catch Up For Individuals over 50
SIMPLE IRA Contribution Limits
||SIMPLE maximum elective deferral is
$6,500 per year.
||SIMPLE elective deferral increased
|2006 and beyond
$500 increment COLA
Education IRA Modifications
|Current Education IRA
contribution limit is $500.
eligibility range for married taxpayers
filing a joint tax return is $150,000 to
$160,000 of Modified Adjusted Gross Income
(MAGI). Thus, joint filers with over
$160,000 MAGI cannot contribute to an
|Annual contribution limit
increased to $2,000.
range for married taxpayers filing a joint
return has been invcreased to $190,000 to
$220,000 of MAGI.
|Corporations and other
entities are permitted to make contributions
to Education IRA's.
The foregoing information is for informational purposes only. It
was prepared from sources believed to be reliable but is not
guaranteed as to accuracy and is not a complete summary or
statement of all available data. Please consult a professional
advisor before implementing any of the strategies discussed