Denver Retirement Account Rules FAQ
What’s the difference between a 401(k), IRA, Roth IRA, 403(b) and other versions of it?
401(k)A tax-deferred retirement plan offered through an employer. Often employers will have matching contributions to encourage employee participation. 401(k) funds can be rolled into “like” accounts (such as an Traditional IRA or a Roth IRA if it is a Roth 401(k)).
403(b)Similar to a 401(k), but specifically offered for public education organizations, some non-profits, hospitals, and clergy.
457(b)Similar to 401(k), but specifically offered for government employees and some non-governmental employees.
Traditional IRAThis is an account set up by individuals (often through a broker) that is given special tax treatment by the IRS. Contributions up to the current year’s contribution limit are tax deductible (tax deductibility may be based on AGI or other factors). Distributions are taxed as ordinary income. If withdrawals are made before 59 ½ there is a 10% penalty (there are some allowances for early distribution). When the participant turn 70 ½ the IRS requires distributions on any Traditional IRA funds. The IRS allows converting from an Traditional IRA to a Roth IRA.
Roth IRAA kind of IRA that is given different tax treatment. Funds added to a Roth IRA or not tax deductible, but distributions are made tax free. Roth IRAs do not have the Required Minimum Distributions (RMD) that Traditional IRAs have; however, early withdrawals (before age 59 ½ or within 5 years of opening the account, whichever is later) have the same 10% penalty.
Other IRAs – SEP, SARSEP, SIMPLEThese IRAs are less common ways for business owners who want to offer retirement benefits to their employees. The most common way that employers offer retirement benefits is through a 401(k).
What are the contribution limits to IRAs?These can change every year. For 2011, here are the contribution limits:
- Traditional or Roth IRA – If under age 50 (at the end of 2011) $5,000 or the amount of your taxable compensation for 2011. The limit can be split between each type of IRA, but the total can’t be more than $5,000. Participants over the age of 50 can contribute $6,000.
- 401(k) - $16,500 for participants under the age of 50, those over 50 can contribute $22,000.
- You can contribute to a traditional IRA even if you participate in an employer-sponsored retirement plan. However, if you or your spouse is covered by an employer retirement plan, this will affect how much, if any, of your contribution is tax-deductible.
How will required minimum distributions (RMD) work when I’m 70 ½?
- An account owner must take the first RMD for the year in which he or she turns 70 ½. However, the first RMD payment can be delayed until April 1st of the year following the year in which he or she turns 70 ½. For all subsequent years, including the year in which the first RMD was paid by April 1st, the account owner must take the RMD by December 31st of the year.
- The calculation of how much needs to be taken changes each year with the participants age and retirement account balances. It’s best to consult an advisor to help you determine the exact amount.
- If you don’t take your withdrawal (or take less than you should have), the IRS penalizes you in the amount of 50% of the amount not distributed as required.
How can I determine how long my money will last me?
- This is a tricky balance of (1) How much you are taking from it (2) What it’s invested in. There are ways of determining where that sweet spot is. Just to highlight how this is done, if someone is $1,000 and is invested in something earning 0%. If they took $1.00 per month from it, it would last 83 years.What if they took $5.00 per month? It would last 16 years. But what it wasn’t earning 0%, but was earning 4%? Then it would add more years to it. However, usually people have their money in something that moves around in value (like the stock market). If the stock market goes down is it still okay for me to give myself my “paycheck” from my savings? It’s not a simple answer, but the point is that there is a way to get a fairly solid projection of how to make your money last you the rest of your life. Making your money last you brings in the third major factor which is inflation; it’s safe to assume that the price of everything will constantly increase the rest of your life.