Types of
Retirement Accounts
Summarized
below are the main types of retirement accounts:
IRAs
are tax-deductible personal retirement
savings accounts available for anyone not covered by another retirement
plan. Contributions are tax-deductible, but are subject to adjusted gross
income earnings limits. 2006 contributions are limited to $4,000.
Individuals age 50 and over are capped at $5,000. The assets and earnings in
the account grow tax-free until withdrawals are made. Distributions at
retirement are taxed as ordinary income. Normal distributions can begin at
59 ½ and are mandatory at 70 ½. Early withdrawals made before 59 ½, allowing
for certain exceptions, are subject to a 10% penalty, plus inclusion as
ordinary income. The rules require that in the year when you reaches age 70
½, you must take a Minimum Required Distribution (MRD). This applies to all
tax-deferred accounts, except for Roth accounts. The IRS has life expectancy
factors, which need to be applied against the balances, to calculate the MRD.
Shortfalls on MRD are subject to a 50% penalty.
Roth IRAs
are retirement accounts where contributions are non-deductible and are made
with after-tax dollars. The earnings / profits on the assets, however, are
allowed to grow tax-free. Contribution limits are the same as traditional
IRAs; they are also subject to adjusted gross income limits. The big benefit
is that normal distributions made after age 59 ½ are tax-free! To qualify,
however, there is a five year holding period. As with traditional IRAs,
there are early withdrawal penalties on distributions made prior to 59½.
Contributions, however, can be made past age 70½ and there is no mandatory
distribution age.
401(k) and 403(b)
Plans are pretax employer
sponsored savings programs. 401(k)s are for-profit, business sponsored
plans, while 403(b)s are for tax-exempt not-for-profit organizations,
typically schools and hospitals. 401(k) plans often match a portion of the
employees’ contributions, while 403(b) plans do not offer a matching
contribution. There are no limits on earnings. Contributions on both plans,
for 2006, are capped at $15,000; and $20,000 for participants age 50 and
over. Remember, if you worked for and left a small company, always
immediately take your 401k funds with you by rolling them over into an IRA.
Never leave your 401k plan savings at small companies.
457 Plans
are pretax deferred compensation plans for
state and local government employees. Contributions are pretax, and
withdrawals are treated as ordinary income. The nice part of these plans is
that there is no 10% penalty for early withdrawals. Contribution limits are
the same as 401(k) and 403(b) plans. The negative is that there is no
employer matching. If you are within 3 years of retirement, you may be able
to contribute up to twice the contribution limit. You need to contact your
HR department for exact figures.
Roth 401(k) or Roth
403(b) Plans are after-tax company
sponsored savings programs. There are no income limits on Roth accounts.
Contributions, however, are capped at $15,000 in 2006 plus an additional
$5,000 for catch-up contributions for participants age 50 and over. The
accounts grow tax-free. Qualified distributions are subject to a 5 year
waiting period, made on or after the employee attains age 59 ½.
Non-qualifying distributions are taxed on the earnings (profit) portion of
the distribution.
The employer’s matching
contributions are still made with pretax dollars, and will accumulate in a
separate account that will be taxed as ordinary income when the funds are
disbursed.
