The retirement savings account is an arrangement which accumulates money to be used later in life, typically for retirement. These accounts include pension plans, 401k variations, and traditional, ‘simple,’ and Roth IRA’s. Accounts are set up to be tax deferred, either until the money is taken out, or when it is put in.
In the case of employer sponsored 401 (k) plans, money contributed to the account is not counted as taxable income for that year. Pension plans, or defined employee benefit plans, are uncommon today, but were once a common way for American workers to enjoy their retirement. Replacing these plans are the more common options listed below.
401 (k) and Keogh Plans
Funded by employees contributions, the 401k is a savings plan with several benefits. The money contributed is not counted as taxable income for the year it is deposited, employers have the option to make matching contributions, and the money is tax-deferred until it is withdrawn or the person stops working. To continue earning interest on the savings, this type of account can be rolled over to an ira, at which point it is taxed as regular income, but continues to compound over time.
The Keogh plan requires attention to detail and costs more to maintain, but it is ideal for business owners and higher income earners. For one thing, the maximum annual contribution limits are $49,000; this is much higher than the maximum of $16,500 for the 401k. A person can also be contributing to an ira at the same time. The Keogh plan does have limitations, though.
The paperwork and calculations associated with this plan are complex and best left to a professional, and employers with more than 10 employees are not qualified. It is also inaccessible to independent contractors, unless they own a business that is legally incorporated. As with other retirement plans, exceptions aside, the minimum age for withdrawing money penalty-free is 59 ½, and the maximum is 70 ½.
Roth IRA
The Roth, named after senator Roth of Delaware, and included as part of the ‘Taxpayer Relief Act of 1997,’ is another tax-deferred retirement savings account. Traditional IRA’s and 401k plans are frequently rolled over into a Roth account for several reasons. To begin with, a rollover to this arrangement offers a tax break as of 2010, allowing the payments to be separated into two tax years. Distributions from this plan are tax and penalty-free as well, although contributions are not tax-deferred.
Another advantage are the rules for taking money out; after an initial seasoning period of five years, direct contributions and rolled over income may be withdrawn tax free and without a penalty. Earned interest is still subject to a 10% penalty if it is cashed out early, and the owner loses the benefit of years of compounded interest as well. Any funds distributed on or after the age of 59 ½ are also free and clear. Best of all? The Roth has no maximum age for taking distributions.
While each retirement account has unique features, consistent contributing to an account with a moderate growth interest rate will compound exponentially over time. Pick and choose, but start saving as early as possible.
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