Retirement Plans Establishing or Understanding Different Types of Retirement Plans In this section you will find descriptions of the various retirement plans available today. Some are employer sponsored and others are personal retirement plans where you, alone, are contributing towards your nest egg. We will discuss some of the questions, issues, or concerns related to these retirement plans. 
You may click on the bullet below to go directly to your particular area of interest or read the body of material which follows. What are defined contribution plans? Defined-contribution plans
You may work for a company that provides a traditional pension plan. A traditional pension plan pays retired employees a fixed amount to qualified participants. The amount is determined by the qualified participant's salary history and years of service. A traditional pension may, or may not, include a cost-of-living adjustment, known as a COLA. A pension factoring in a "COLA" , will provide a "pension income" designed to keep pace with inflation, perhaps increasing by 2% to 3% annually. Such a plan is designed to help retired employees keep up with inflation, and thereby maintain their purchasing power. The Pension Benefit Guaranty Corporation (PBGC), a government agency, guarantees traditional pension plans. These traditional pension plans are known as the defined-benefit plans. Unfortunately, this government agency as been called upon to bailout many a bankrupt company, and rescue the retirement dreams of its employees. The PBGC is supported by U.S. taxpayers and businesses.
Today, most employers use a defined-contribution retirement plan, which is truly a sign of the times, indicating greater and greater individual responsibility, when it comes to securing our own retirement. Employer sponsored defined-contribution plans are essential to America's future retirement, providing a fundamental opportunity to set aside pre-tax retirement savings, on a consistent basis. Defined-contribution plans grow in account values based on how much you and/or your employer contribute during your working years to your own retirement account. Most plans invite you to invest your contributions in mutual funds or, in some cases, the stock of your employer. A new trend emerging in retirement plans is the addition of fixed and fixed-indexed annuities being made available as additional investment or savings options. Those who consider themselves to have a more conservative or moderate view towards saving or investing for retirement, may find these new offerings, fixed, and fixed indexed annuities, suit them best. For that portion of your plan allocated to market sensitive investments, (mutual funds, stocks), the size of your retirement account is determined by the investment performance of those mutual funds and the appreciation in the share price of the underlying securities. For those who choose to place retirement savings in fixed or fixed-indexed annuities, your savings will be protected, as your annual interest earnings are locked-in and are not subject to stock market losses. A principal reason for participating in retirement plans sponsored by your employer, (besides the fact that we all need to save for retirement), is the simple ability to receive an employer sponsored matching deposit to our retirement savings. If one thinks about it, and one does not take an employer's matching 401k plan for granted, (as some employers have no retirement plan, and many people are self-employed and have no plan to speak of), that match is free money. Is it not? If your employer contributes a dollar for every dollar of yours, up to the yearly limit, it is making a fully matching contribution. If your employer contributes a percentage of your contribution, perhaps 25 or 50 cents for every dollar you contribute, up to the annual limit, your employer is said to be making partially matching contributions. Either fully matching or partially matching, this automatically increases your savings for retirement!
The most common type of defined-contribution retirement plan is a 401(k) plan.
If you are an employee of a "for profit" corporation, this is probably the type of plan you have. If you are a teacher, or you work for a school system or a university or non-profit organization, you may contribute to what is called a 403(b) plan. If you are a state or local government employee, you likely participate in what is called a 457 plan. All three of these plans are named after the sections of the IRS tax code which govern the plan. Beginning in 2006, there is a new type of plan known as the Roth 401(k).
The Roth 401-(k) has the same contribution limits as a regular 401(k) plan, but employee contributions are made with after-tax dollars, and future distributions on the employee's portion (the Roth 401 (k) portion), are tax-free. This tax free growth alone is very advantageous, but a Roth account is even more appealing when you consider the normal restrictions associated with required minimum distributions (RMDs),which are required of qualified (pre-tax) contribution plans. A Roth 401-k account will allow you to keep a portion of your savings growing tax free, and if you roll to a Roth IRA, you will not be forced to take any withdrawals until you decide the time is right. With a Roth 401-k, your contributions are "after tax", but after that, you earn interest on your after-tax contribution, interest on your interest, and interest on the money you would have eventually paid on the taxation of your interest inside a regular 401-k. You will not ever be responsible for paying tax on the Roth portion of your 401(k), but keep in mind that only the elective deferral of the employee's current $15,500/year is eligible for Roth treatment, not the employer's matching contributions. In regard to paying tax on the growth of this Roth 401-k portion, it really grows tax free! Even more impressive, if you think about it, is the fact that this money can continue to grow tax free, benefiting the next generations as well. If you roll to a Roth IRA , there are no RMDs during the owners life. After the death of the owner/spouse, the beneficiaries will have to take minimum distributions, based on their life expectancies, based on the single life expectancy table. It should be noted that provided the Roth account has existed for five years, the stream of income received as RMDs are not taxable to the beneficiaries. If the Roth has been open for less than 5 years, and the beneficiaries take all of the death benefit/account value in one lump sum, than they may be responsible for income tax on the earnings beyond the cost basis. As a special note regarding qualification of Roth status, distributions are tax free, only if you take qualified distributions. Distributions are considered "qualified" if you: wait 5 yrs, if distributions occur after your death, after a disability, and/or after age 59 1/2. Again, only the elective deferral of the employee ($15,500/year currently), is eligible for Roth treatment, not the employer's matching contributions. With defined-contribution plans, your employer deducts a portion of your income, before taxes, or in the case of Roth 410(k)s, after taxes, and makes deposits in your account. Because these are tax-deferred in the case of regular 401(k)s, and a portion is tax-free in the case of Roth 401(k)s, your contributions grow to a larger amount than if you were to pay income taxes.
As a result of the Economic Growth and Tax Relief and Reconciliation Act of 2001, you can make larger contributions to your 401(k) or other retirement plans than in the past. In addition to increased contribution limits, there is a catch-up provision allowing workers who turn age 50 to make even larger contributions. The individual contribution limits for 401(k), 403(b), and 457 plans for 2008 is $15,500. For those who will be 50 years of age or older during 2008, the contribution limit is increased to $20,500. Beginning in 2007, limits are indexed to inflation in increments of $500.
Yearly individual contribution limits (2004-2010): | Year | Yearly limit | Additional contributions (age 50 or older) | Catch-up limit | | 2004 | $13,000 | $3,000 | $16,000 | | 2005 | $14,000 | $4,000 | $18,000 | | 2006 | $15,000 | $5,000 | $20,000 | | 2007 | $15,500 | $5,000 | $20,500 | | 2008 | $15,500 | $5,000 | $20,500 | | 2009 | $16,000 | $5,000 | $21,000 | | 2010 | $16,500 | $5,500 | $22,000 | | Your contributions to a 401(k) or other defined-contribution plan are made to a tax-deferred account. Tax-deferred investments receive triple compounding; you earn interest on your principal, interest on your interest, and interest on the money you would have paid on taxation of your interest. Your money is allowed to compound until you begin to take out money from that account. As a result, they grow to a much larger sum than if you had to pay taxes each year along the way. Keep in mind, again, that with Roth 401(k)s, you receive all of the triple compounding discussed above, but because you make your contributions with after-tax money, you will not pay taxes when you make withdrawals.
Employer sponsored plans are essential to America's retirement. These plans provide an excellent opportunity, to save for retirement on a consistent basis. The tax advantages of tax-deferred accounts make them a great way to save for your retirement. If your employer has a 401(k) plan or other tax-advantaged retirement plan, it clearly pays to contribute as much as you can afford to each and every year, and to start as soon as possible. If matching contributions are available -- whether partial or fully matching -- a defined-contribution plan makes even more sense.
The following issues point to the importance of handling employer sponsored retirement plan savings, properly: - Early withdrawals. If you take out money from your 401(k) plan before you turn age 59-1/2, you will owe income taxes on the amount of the withdrawal, and, under most circumstances you will also have to pay an early-withdrawal penalty of 10% on that amount to the IRS.
- Required minimum distributions. The IRS requires you to begin taking distributions every year after you turn 70-1/2. You will finally be required to pay income tax on these required minimum distributions, and the government will finally begin to receive tax revenues on your qualified (pre-tax) savings. These are called required minimum distributions (RMDs). RMDs are sometimes referred to as MRDs. You should note that RMDs do not apply to the after-tax portion of your contributions of a Roth IRA. The Roth IRA permits you to grow and grow your savings tax free. You're never required to withdrawal any of your Roth IRA.
- Rollovers. If you leave your employer or retire, you can move your 401(k) plan assets to an IRA or retirement plan of another employer. This process of moving your retirement plan is called a rollover. Be sure to handle a rollover carefully so that you avoid any early-withdrawal penalties or income taxes. If the funds are sent directly to you specifically, the employer is obligated (by the IRS) to withhold 20% for taxes.
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser. You may be able to move your 401-k while still employed. 
Many retirement plans today offer employees "in service non-hardship withdrawals/rollovers". Enron set the stage by which many employers now permit in-service rollovers. Enron would not permit employees to move their retirement savings or sell their Enron stock until the employee reached age 50. At the time of Enron's demise in 2001, per a June 5th 2006, Newsweek magazine article, 19% of 401-k plans in the U.S. had similar clauses in the plan documents that govern "the plans". After Enron went under, plans started to make changes to their documents, to avoid potential problems, and in 2006, the number of employer sponsored plans with such a restrictive clause was down to 8%. If your plan allows "in-service non-hardship rollovers", per the plan documents found with your human resource manager/ office, you are able to exercise a rollover of your retirement savings into a new retirement savings plan of your choice. Why would you want to consider rolling money out of your employer sponsored retirement plan? Perhaps you want more choices. Perhaps you want to diversify beyond the mutual fund options made available by the plan. Perhaps you simply want more control of your own money. Perhaps your financial perspective has changed and you have become more moderate, and you want more savings options, such as fixed annuities, or fixed-indexed annuities, where your principal and interest are guaranteed and locked-in annually. IF you work for a small business that offers a retirement plan, you may have a SEP or SIMPLE retirement plan. SEP plans and SIMPLE plans
If you work for a small business that offers a retirement plan, your employer may offer a SEP, SIMPLE or other qualified retirement plan. Small businesses are those, generally considered to have less than 100 employees. Business owners can also participate in these plans to provide for personal retirement benefits.
These small-business retirement plans offer the same advantages of tax-deferred growth as 401(k) and other defined-contribution plans. Your contributions, or elective deferrals, are tax-deductible. Here are the basic features of each plan: - SEP plans. Employers with any number of employees can use a Simplified Employee Pension (SEP) plan. The employer opens a SEP-IRA for each eligible employee and makes contributions to the account.
For 2008, your employer can contribute up to the lesser amount of $46,000 or 25% of your compensation. If you participate in another defined-contribution plan, the overall limit increases to the lesser of 100% of compensation from all employers or $46,000, but the employer making the SEP contribution is still limited to a contribution of 25% of the compensation from that employer.
Your employer may be using a SARSEP. A SARSEP is a SEP plan set up before 1997 that includes elective contributions. SARSEPs allow you to make tax-deductible contributions to your SEP-IRA. For 2008, the most an employee can contribute in elective deferrals is the lesser amount of $15,500 or 25% of their compensation ($20,500 if age 50 or older). The employer can make matching contributions up to the lesser amount of $46,000 or 100% of the employee's compensation. How much can I contribute to my SIMPLE retirement plan each year? - SIMPLE plans. Employers with 100 or fewer employees can use a SIMPLE plan. SIMPLE plans are set up as either a SIMPLE-IRA or a SIMPLE 401(k) plan. If you have a SIMPLE-IRA, your employer will open an account for each eligible employee. In 2008, you can make up to $10,500 in elective deferrals, or $13,000 if you are age 50 or older.
With a SIMPLE plan your employer may match your contributions up to 3% of your compensation. You may however, make additional contributions up to the allowable maximum. In addition, your employer has the option to make non-elective contributions equal to 2% of your compensation. If your employer chooses to make such contributions, these contributions are made regardless of whether or not you contribute to a SIMPLE-IRA.
Employers may offer qualified retirement plans that are known as either a defined-benefit plan or a defined-contribution plan. A defined-benefit plan pays a fixed benefit that is based on your years of service and salary history. The value of a defined-contribution plan is dependent on your contributions and can be either a profit-sharing or money-purchase pension plan.
In regards to defined-contribution plans, a profit-sharing plan is a deferred compensation plan that an employer may offer its employees, based on its profits. A money-purchase pension plan is a defined-contribution plan in which contributions from the employer are determined by a specific formula, usually expressed as a percentage of pay, and contributions are not dependent on company profits.
In 2008, the most an employee may receive in annual benefits with a defined-benefit plan is the lesser of $185,000 or 100% of the largest average salary that they earned over a consecutive three-year period.
In 2008, with a defined-contribution plan, the maximum allowable contribution is the lesser of $46,000 or 25% of compensation.
The much-higher limit for defined-benefit plans allows employers to fund a pension that may pay benefits for the remainder of the retired employee's life.
These are some of the basic features of the main types of small-business retirement plans. For more information, see IRS Pub. 560.
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser. What is involved in moving your retirement plan? Moving your retirement plan
When you change jobs and leave an employer that has a 401(k) or other defined-contribution retirement plan, you usually arrange to transfer your retirement account. You will do this by way of direct transfer paperwork. With a defined-contribution plan, you are asking your ex-employer, by way of the direct transfer paperwork, to transfer your plan assets to a new retirement plan or IRA using either a trustee-to-trustee transfer or lump-sum distribution.
By filling out this paperwork, you directly transfer your accounts or their values to a new institution of your choice. This institution may be an insurance company, a bank, a brokerage account, or the new retirement plan with your new employer.
By way of this direct transfer, or trustee to trustee transfer paperwork which you will fill out, you do not take constructive receipt of your savings, and therefore, you pay no income taxes and avoid any early-withdrawal penalty that may apply. This direct transfer will not cause a taxable event. You will not be taxed until you withdrawal this money at a later date. (You will not receive a 1099, which would signal a taxable distribution.)
This is not the case with a defined-benefit plan, which pays you a fixed benefit monthly, based on the portion of your account that you have vested. Vesting is a process by which an employee earns a legal right of ownership to benefits, stock options or stock ownership plan.
Should you elect a lump-sum distribution, you are telling your employer that you will handle the money on your own. Be careful because you only have 60 days to complete a rollover, which involves moving the plan assets to your new employer's plan, or to an IRA. If you pass the 60-day deadline, you will owe income taxes and face an early-withdrawal penalty. (If you're 59 1/2 or older, the penalty won't apply.) If the funds go directly to you, request that the check be made payable to the new trustee FBO (for the benefit of). If this is not done, the employer must withhold 20% for taxes.
You are only allowed one rollover in a year with a lump-sum distribution.
Be aware that the clock starts ticking on the date you take your distribution. You should also know that your ex-employer is required to withhold 20% of the lump sum for income taxes, and this could be a problem. In order to recover this 20%, you must scrape together the amount of the withholding from another source. Additionally, the 20% would be taxed as ordinary income, and may be subject to penalty.
For example, say you are age 52, have $250,000 in your retirement plan, and accept a lump-sum distribution. Your employer withholds 20%, or $50,000, and distributes $200,000 to you. In order to recover the $50,000 that is withheld and avoid the 10% penalty, you have 60 days to roll over the full $250,000.
If you were born before 1936, you may be able to stretch out your tax bill over 10 years. For more on this rule, see "Lump-Sum Distributions" in IRS Pub. 575: "Pension and Annuity Income."
Most people will move their retirement plan when they leave their employer for another career opportunity. However, instead of moving your retirement plan, you may be able to leave your plan with your ex-employer if the plan has more than $5,000 in assets. Most likely, your decision to leave your assets with your ex-employer's plan will be influenced by the past performance of your retirement plan. If the performance of your retirement plan at your ex-employer was stellar, you may decide you will earn a higher investment return by simply leaving your plan assets where they are. The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser. How are shares of company stock contributed by your employer to your retirement plan, handled when it comes to taxation? Taxation of company stock
Your employer may have contributed shares of its stock to your retirement account over the years, by way of an investment election by you, in the form of compensation bonus. If contributions were made years ago, it is possible the value of those shares may be much higher today.
If you were to take a lump-sum distribution when you retire, you may be concerned with a potentially large tax bill. The value of the potential gain in these shares in your account is called the net unrealized appreciation. The amount of unrealized appreciation is simply the gain in the value of shares while in your retirement account. The gain is said to be unrealized because you have not yet sold the shares for a profit.
If a lump-sum distribution consists of company stock, you may qualify for a tax deferral on the amount of net unrealized appreciation.
Assume that your employer contributed 1,000 shares to your retirement account 30 years ago. Assume the total value of the stock at that time was $20,000. At retirement, assume the total value of the stock has appreciated, and at today's stock price, is valued at $300,000.
In this example you would only owe income taxes on the original cost basis of $20,000. Taxes on the $280,000 in appreciated value would be deferred until you decide to sell the stock. When you do sell the stock, you will then be taxed at the long-term capital gains rate of only 15%, per current tax laws. If you were born before 1936, you may elect to pay these taxes over a 10-year period. For more information, see IRS Form 4972: "Tax on Lump-Sum Distributions."
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser. |
