Retirement Plans, Demystified
Retirement planning is a challenge at any life stage, whether you’re just starting out in your job or you’re nearing retirement. I’ve met countless individuals throughout my financial writing career who either don’t know where to begin, or are in denial about getting their financial houses in order.
Isabelle is one of them. Now 15 years from retirement, she and her husband both have old retirement plans from former employers. Her husband just returned to the work force after a six-month hiatus resulting from a layoff. Isabelle now runs her own small business, for which she has not established a retirement plan.
As she looks toward the future and caring for her young children, whom she wants to send to college, Isabelle has valid concerns.
She worries about the potential for another layoff in her husband’s career. Isabelle also is the primary caregiver for her father, who has dementia. While she knows that quitting her job to care for her father was the right move emotionally, she worries about her family’s financial security.
Amid their financial concerns, preparing for retirement has been a challenge for Isabelle and her husband. The good news is, there are multiple options for people in Isabelle’s type of situation.
Need help with your own retirement planning? Check out the options below, and consult with a retirement planner for help in identifying the right choice for you.
SEP-IRA (Simplified Employee Pension Individual Retirement Plan)
With high contribution limits and immediate vesting, SEP-IRAs offer the benefit of tax-deductible contributions and reduced income tax liability. They are considered ideal for self-employed individuals or small-business owners because they offer access to tax-deferred benefits for their retirement planning.
For employees of these business owners, however, the benefits are not as obvious or immediate. As an employee, you have no control over the amount contributed, as all money is contributed by the employer.
In addition, you would need to work at least three years for a single employer in a five-year period to become eligible for a SEP-IRA. That’s much longer than you would wait for a typical employer-sponsored 401(k). And although the contributions are tax-deductible, withdrawals/earnings are taxed.
SIMPLE IRA (Savings Investment Match Plan for Employees)
Employers with fewer than 100 employers can choose the SIMPLE IRA. With its simple administrative rules and ability to deduct employer contributions as business expenses, these plans make retirement planning easy for both the employer and the employee. Employers may match up to 3 percent, or a flat 2 percent, and help employees set aside extra money for their financial future.
Contribution limits are lower for SIMPLE IRAs — $11,500 as of 2010. Note that employers cannot maintain any other retirement plans while offering a SIMPLE IRA.
Roth IRA
The Roth IRA allows you to make post-tax contributions and withdraw the money tax-free in retirement. While you do not pay taxes on earnings and withdrawals, you cannot deduct these contributions from your income taxes. Essentially, it comes down to choosing between paying the taxes and giving up the deduction now, or choosing a plan that lets you take the deduction now and pay the taxes later.
Roth IRAs offer a wide range of investment options, and you may withdraw up to $10,000 for the purchase of a home. However, you cannot otherwise withdraw funds before age 59.5 unless you meet certain other requirements first — and you’ll have to pay a 10 percent penalty.
To qualify for a Roth IRA, you must earn less than $107,000 if filing as single/head of household. The threshold is higher, at $169,000 or less, if you are married and filing jointly — or less than $10,000 if married and filing separately.
Single-Person 401(k)
A single-person 401(k) works well for small-business owners with no employees. You gain the benefit of making larger, tax-deferred contributions than those allowed with more traditional profit-sharing plans. The 2010 and 2011 contribution limits are $49,000 per year ($54,500 for ages 50-plus).
These plans also offer the flexibility of borrowing against your plan without taxes or penalties — up to $50,000 and no more than 50 percent of the balance. You also can roll over IRAs, SEP-IRAs, and other retirement and profit-sharing plans.
If you own a business with relatively low amounts of income and are considering taking out a loan to support your business, then you may benefit from an individual 401(k).
Profit-Sharing Plan
This type of plan is based on company profitability. The employer determines the contribution amounts and can opt not to make contributions if the company shows little or no profit in a given year.
Profit sharing offers a type of accountability that isn’t necessarily present in other retirement plans. Employees may feel motivated to perform at their best if they know they are sharing in company profits. Profit sharing also allows you to borrow against your plan in the event you need a loan.
Any size business can create a profit sharing plan. However, these plans work best when company profits are stable. Otherwise, employees may become unmotivated if the company shows consistent losses and is unable to contribute to the plan.
About the Author
Felicia Gopaul writes frequently on retirement planning and other money matters for FeliciaGopaul.com and CollegeFundingResource. She offers money-saving tips, college financing advice, retirement tips and other valuable insight that helps consumers make better, more informed money decisions. When she’s not offering retirement planning advice, Felicia enjoys spending quality time with her husband and two daughters.
