Once upon a time, retirement planning was relatively simple in the United States. The reason for this was that employers routinely provided workers with generous pension plans that rewarded lifelong employment and loyalty to the company. In addition, several decades ago a worker could actually expect to be able to survive off of the Social Security benefits he/she would receive after reaching retirement age. Those days are gone though. Today, retirement planning is more complicated and should be started early on to ensure that a retiree has sufficient assets and income to live comfortably during his/her “Golden Years.” As a result of the declining number of employers that offer pension plans or other types of employer sponsored retirement plans, a new type of retirement planning tool has become increasingly popular – the “Individual Retirement Account,” commonly known as an “IRA.” Should your retirement plan include an IRA? To answer that question you need to first gain a better understanding of what an IRA is and how one works and then decide whether an IRA is a good fit within your retirement plan.
What Is an IRA?
An IRA is a retirement tool that provides you with the advantage of both compound interest and tax savings. Think of an IRA as a pension plan that you create for yourself and fund by yourself or with the help of an employer. The earnings generated from your IRA can compound on a tax–deferred basis until withdrawal, a huge benefit from any retirement planning tool.
Which IRA Is Right for Your Retirement Plan?
As IRAs have become increasingly popular, new types of IRAs have evolved to meet the diverse needs of investors and retirement planners. For many people the question is not whether they want to include an IRA in their retirement plan, but rather which type of IRA should they include in their retirement plan. Given the complex nature of IRAs and the importance of your retirement plan in general, it is always best to consult with both your estate planning attorney and your financial advisor before deciding which type of IRA is best for you. It does help, however, to familiarize yourself with the different types of IRAs so that you can contribute more to the discussion regarding which one is right for your plan. With that in mind, brief explanations regarding the four common types of IRAs will follow.
- Annual tax deductible contributions are based on income level.
- Withdrawals can begin at age 59½ and are mandatory by age 70½.
- Taxes are paid on earnings when withdrawn from the IRA.
- Anyone with earned income under age 70½ can contribute up to the annual maximum limit.
- Funds withdrawn before age 59½ are subject to a 10 percent penalty unless an exception applies.
- Traditional IRAs may be converted to Roth IRAs by paying income taxes (but no tax penalties) on the IRA distribution before rolling over to a Roth IRA, regardless of income limits.
- Annual contributions are not tax deductible, but eligibility depends on income level.
- Mandatory distributions at age 70½ are not required.
- All earnings and principal are 100% tax free as long as you follow the IRS rules.
- Traditional, SIMPLE and SEP IRAs may all be converted to Roth IRAs by paying income taxes (but no tax penalties) on the IRA distribution before rolling over to a Roth IRA, regardless of income limits.
- Eligibility is determined based on income
- Principal contributions can be withdrawn any time without penalty as long as the required 5-year holding period is met.
SEP IRA – Simplified Employee Plan
- Established by an employer
- Allows the employer to make deductible contributions to a Traditional IRA for participating employees
- Employer decides how much to contribute, up to 25 percent of income (dollar limits also apply)
- Contribution percentages must be the same for all employees
- Employer decides whether to contribute each year; however, if the employer makes a contribution, even to his/her own account, contributions must be made to all accounts.
- Good for small family businesses
SIMPLE IRA – (Savings Incentive Match Plan for Employees)
- Designed for small businesses with 100 employees or less
- Allows employees to make salary-reduced contributions and receive matching contributions from their employer.
- Similar to a SEEP IRA; however, contributions may be made by both the employer and the employee.
- Employer is required to match the employee’s contribution up to three percent.
For additional information, please download our FREE estate planning worksheet. If you have additional questions or concerns regarding how an IRA will fit into your retirement plan, contact the experienced New Hampshire estate planning attorneys at DeBruyckere Law Offices by calling (603) 894-4141 or (978) 969-0331 to schedule an appointment.