Springfield Business Journal Articles


Funding Your Retirement

We all know we need to save for retirement. The life expectancy of a 65 year old today is 18 years. That’s a long time to live off of savings. So, what is the best way to save for retirement? To a large degree, that depends on your employer.

Anyone with earned income can contribute to an individual retirement account, or “IRA,” but with strict limitations. The maximum contribution to an IRA for 2010 is $5,000, or $6,000 if you are over age 50. If you participate in an employer sponsored retirement account, however, your maximum contribution will be limited based on your adjusted gross income for the year of the contribution.

When making an IRA contribution, you must choose between a traditional IRA and a Roth IRA. With a traditional IRA, you will receive a tax deduction for the amount of your contribution for the year of contribution. Because you receive the deduction on traditional IRA contributions, all IRA withdrawals are taxable as ordinary income (meaning they do not qualify for lower capital gains rates). With a Roth IRA, you do not receive a deduction for your contributions to the Roth IRA, however, all of your withdrawals from the Roth IRA are tax free. Therefore, the traditional IRA offers immediate tax benefits, but the Roth IRA can offer much greater long term tax benefits. You will pay penalties on both types of IRAs if you withdraw the money before you reach age 59 ½.

So, IRAs are a great idea, but at $5,000 a year, it will take a long time to build your retirement funds. What are your other options? There are many, but they generally must be provided by an employer. Two of the most common employer provided plans are 401(k) plans and Simple IRA plans.

401(k) plans are similar to IRAs. Contributions to a traditional 401(k) plan are deductible in the year of contribution, and all withdrawals are taxed as ordinary income. The maximum contribution to a 401(k) plan, however, is much higher than an IRA. For 2010, the maximum contribution is $16,500, plus $5,500 for individuals age 50 or older. A 401(k) plan can also be established as a Roth plan. In that case, contributions are not tax-deductible and withdrawals are not taxed as income.

Retirement accounts for different employers are governed by different code sections. If you work for state government, your retirement account is governed by Section 457 of the Internal Revenue Code. If you work for a school of hospital, you may have a 403(b) plan. Both of these plans are similar to 401(k) plans.

Why doesn’t every employer offer a 401(k) plan? First, there are administrative costs, which can be several thousand dollars each year. Second, the plan cannot benefit the highest paid employees to a greater degree than the rest of the employees. Plans which do so are called “top heavy” and do not qualify under the tax code. A plan can be top heavy even if it offers the same benefits to all employees if the highest paid employees are the main participants in a plan. In order to keep a 401(k) plan from being top heavy, the employer may need to provide matching funds for the lower compensated employees, resulting in additional employer cost.

Simple IRA plans are similar to 401(k) plans. They are usually easier and less expensive for an employer to operate, but the maximum contribution to a Simple IRA is lower than a 401(k) – $11,500 for 2010 plus $2,500 if you are 50 or older.

If you are an employer looking to maximize retirement contributions, there are two other options to consider. One is a defined benefit plan, which is similar to a traditional pension. The plan states that it will provide a certain amount of benefits each year upon retirement. The maximum benefit for 2010 is $195,000. The employer must contribute an amount each year to fund the retirement payout. The amount of the contribution will vary based on the age of the employee, but will generally be much higher than the 401(k) limitations. There are also defined contribution plans which have a contribution limit of $49,000 for 2010.

Both of these plans can, obviously, be very expensive for an employer, particularly if the plan would be top heavy.

Bottom line: If you are an employee, you generally should contribute the maximum amount possible to any employer-sponsored retirement plan, particularly if your employer offers matching contributions. If you are an employer and would like to offer greater retirement benefits to your employees, consult with your financial advisor who can weed through all the regulations and suggest the best plan for you. If you hurry, you may still be able to fund a plan for 2010.

by Sarah Delano Pavlik
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