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Tax-Smart Retirement Planning

Company-sponsored 401(k) plans offer tax advantages, possible matching by the employer and an easy way to automatically accumulate retirement money, so they’re well worth investigating. 

In a 401(k), you choose a percentage of your salary, up to an annual limit, that is set aside in an investment retirement account. Matching by an employer can mean “free money.” 

Generally, employers match 3%, or even more! Although it makes a difference if the employer matches each paycheck or does it once per year. 

You save money on the contribution because it is deducted from your taxable wages in the year you contribute it. Employees over age 49 can make additional catch-up contributions. 

In addition, you don’t have to pay taxes on the earnings on your money in your 401(k) until distributions are made--a time when you’ll likely be in a lower income tax bracket.

Some employers offer Roth 401(k) plans. The contribution is not deductible, but the future distributions from the account will be tax-free. Your CPA can help you determine which plan is right for you.

Distributions made before age 59½ are subject to income tax and are generally also subject to a 10% penalty for premature withdrawals. 

Many employers will deposit a certain amount to your retirement plan based on your own contributions. For example, a company might match 50% of your contribution up to 6% of your salary deferral. 

The company match essentially amounts to a tax-free bonus, so it’s well worth contributing enough to your account to qualify for the maximum match. 

Not all 401(k) plans are alike, however, so you should examine your investment options under the plan. Look for a reputable investment manager and fund choices that enable you to pick an investment that meets your risk tolerance and investment goals.

And monitor the plan’s performance to see if it’s time to move into a different investment.

401(k) accounts are great investments because of the employer match and because the maximum contributions are typically higher than those of IRAs.

However, if your employer does not provide for a 401(k), you should consider opening an individual retirement account. There are some basic choices:

  • With a traditional IRA if you receive compensation that is includable in income and are under age 70½ during the tax year, your IRA contributions may be tax deductible. Your spouse may also qualify for a contribution, even if your spouse does not have any compensation. Earnings on the IRA investments are not taxed in the year received. However, IRA distributions are taxable in the year they are made. In a Roth IRA, the contribution itself is never deductible. However, the earnings and appreciation on the investments are free from income tax when money is withdrawn from the account, if you meet the age and holding period requirements.
  • Consider converting traditional IRA funds to Roth IRA accounts. In a lower income year or when the market has a decline, you might benefit in the long-term by converting. There is no early withdrawal penalty for the conversion, but the amount converted will be subject to regular income tax in the year converted. Your CPA can help you determine if and when this is a good idea..
  • Self-employed taxpayers can set up SEP-IRAs. The contribution limits are higher than for other IRAs and you can make a tax deductible contribution after April 15 if you have a valid extension. Other rules apply to these accounts. Therefore, planning with your CPA is crucial before opening a SEP-IRA..
  • Your choice of an IRA will depend on your financial situation and what you expect your tax burden to be when you retire. No matter which you select, consider a spousal IRA if you are married and filing a joint return. Even if only one spouse is employed, the other spouse may be allowed to make an IRA contribution as well, which is a great opportunity to expand your family’s tax-deferred retirement savings. Your CPA can answer any questions about retirement plans and any other important financial issues facing your family.